In its simplest form, insurance is protection for you in case something goes wrong. For example, you have insurance for your house in case it burns down. If that happens, you get money from the insurance company to house your family and rebuild (or replace) your home. You can purchase insurance for a wide variety of perils – fire, theft, natural disasters (floods, earthquakes, etc.), property damage, personal injury claims, and so forth.
What are the different types of coverage?
Again in a simplified format, consider two basic types of coverage: first party coverage, and third party coverage.
What is “first party” coverage?
A “first party” policy is one that protects you in case you suffer damage or loss. Thus, a home insurance policy is usually a “first party” policy ¡V you, as the homeowner, are the first party (you own the home), and you are the person who can receive benefits under the policy. Most often first party policies provide property damage coverage and medical coverage to you, the policyholder.
What is “third party” coverage?
Contrast “first party” coverage with “third party” coverage, which usually protects you against claims brought by others. The person making the claim sometimes is referred to as a “third party claimant.” Typical examples of third party coverage are automobile liability policies that offer protection when you are in an auto accident. Not only do they provide medical coverage for you (first party coverage), but they also “cover you” if an inured party brings a claim against you for careless driving. Another example of “third party” coverage is the liability coverage in your homeowner’s policy – coverage that protects you if somebody is injured while on your property.
What is the insurance company’s obligation if I have a claim?
If you have a claim, whether a first party claim for yourself or a third party claim when you are requesting the company to protect you from a claim brought by another person, your insurance company has two basic duties. These are (1) the duty to fairly and promptly investigate the claim; and (2) the duty to pay the claim if it is valid. Both of these obligations must be carried out with reasonable speed, and they are governed by the insurance company’s duty of “good faith and fair dealing.” Sometimes, this duty is referred to by lawyers and courts as the covenant of good faith and fair dealing. It is called a covenant because insurance policies are basically contracts which contain a series of promises (covenants) that the parties rely on. The most important of those covenants, from the policyholder’s point of view, is that the carrier will step up to bat when necessary to protect the policyholder. The courts have noted over the years that what a person really is purchasing when he/she buys insurance is peace of mind ¡V the security that a just claim will be taken care of properly.
What is the “duty to defend”?
Part of the duties discussed above is the insurance company’s “duty to defend.” This means the duty to defend you, the policyholder, in the event a third party brings a claim. Pursuant to this duty the insurance company, at its expense, must hire a lawyer to represent you, and must pay the costs of defending the litigation. Those costs can be substantial, and this is an important part of the carrier’s duty.
What is the duty to indemnify?
Indemnity is a big word that really means “pay money.” In short, the duty to indemnify is the duty to pay money to a third party if there is liability. Stated another way, if it is established that you, the policyholder, are liable to a third party for damages, the insurance company must pay the amount of damages assessed by the court, arbitrator, etc. This payment is called indemnity in the world of insurance.
What if liability is unclear?
In many cases, the issue of liability is disputed. This is to be expected, because often witnesses’ accounts of an incident (say, an auto accident) conflict, and it is hard to determine just who was at fault. Because of this uncertainty, and to reduce the risk of an adverse judgment, many cases are settled. People decided to “buy their peace,” rather than continue to dispute liability and risk a high judgment against themselves. In most policies, the insurance company has the right to investigate and settle claims in its discretion, as long as the settlement is within the limits of the policy coverage and is paid entirely by the carrier. (In some types of policies, the insured has the right to approve all settlements. This is sometimes a term in a policy that covers a professional for malpractice.)
What if the case cannot be settled?
The simple answer is that cases that cannot be settled go to trial, either before a judge or a jury. After trial, the judge or jury issues its decision, either fixing or denying liability and setting the amount of damages.
What if a case is tried and the amount of the judgment is more than my insurance policy?
This is a key question, and it has resulted in a number of key court decisions. The most important principle to remember in this area is that the insurance company has a duty to defend you, which includes a duty to reasonably settle claims so that you are protected from third parties coming after your assets.
If you are involved in a case, and the third party (the person suing you) makes a demand that the case be settled within the limits of your policy, your insurance company must either honor that demand (pay it) or else bear the risk that the judgment will exceed the policy limits. If the settlement offer is turned down by the insurance carrier and a higher judgment results, the insurance company has to pay the entire judgment, even if the amount is more than your insurance policy.
A simple example illustrates the point. Say you are in an auto accident. There is a big dispute as to whether you were careless and the cause of the accident. A third party (say, the person whose car you hit) suffers serious injuries. Let’s further assume you have an insurance policy that provides $100,000 of coverage for third party liability claims. We will also assume that in our example, the injured person’s claim amounts to $500,000.
This presents an obvious problem for you, the policyholder. If the case cannot be settled within your insurance policy, your assets could be exposed to the third party’s claim. (You probably will receive a letter from the carrier explaining this in detail.) However, let’s assume the lawyer for the injured party learns of your insurance limits and knows you may not have sufficient assets to cover a judgment in excess of those limits. That lawyer will probably then make what is commonly referred to as a “policy limits” demand. He/she will ask the carrier to pay out the limits of the coverage in settlement of the claim. This is a common tactic because it sets up the insurance carrier for a “bad faith” claim. That is, if the carrier turns down the policy limits offer, and a higher judgment results, the carrier has breached its duty of good faith and fair dealing toward the policyholder. By exposing the policyholder to “excess” liability when the case could have been settled within policy limits, the carrier has breached the covenant of good faith and fair dealing and is liable for the excess. This rule is very protective of the policyholder.
What if there is no coverage? Will the insurance company still defend me? Will it still pay the claim?
Again, this is a key question. Insurance coverage is controlled by the language of the insurance policy. Every policy has limitations, and all contain outright exclusions that eliminate coverage in a variety of circumstances. For example, most policies include an exclusion for “intentional acts” of the insured. If you, the policyholder, hit someone over the head with a baseball bat and are sued for assault and battery, there may not be coverage because your act was intentional.
Note: To avoid this issue and “trigger” coverage, many attorneys who represent injured parties bring cases based on a variety of legal theories. In the baseball bat example above, the injured party’s lawyer may claim that there was an intentional injury (and ask for punitive damages), while at the same time also pleading that the injury resulted from your negligence, thus triggering insurance coverage.
Often, if there is a dispute over coverage, the insurance company may file a separate lawsuit to determine if coverage applies. These cases are called “declaratory relief” actions (the common shorthand among attorneys is “dec. relief.”). In a declaratory relief case, the parties seek a declaration from the court about the nature and extent of coverage.
Sometimes, despite the uncertainty, the carrier will pay the claim anyway, thus avoiding an adverse ruling on the coverage issue. There are few hard and fast rules here. Each case, however, must be carefully evaluated on its individual merits to determine the likely course of action. The point to remember is that the terms of insurance coverage are sometimes vague and require interpretation by the courts. Just because you have a policy, that does not automatically mean you are covered. What you need to do is square up the type of claim and the facts of the claim with the terms of your liability coverage.
Does the insurance company always have to defend me?
No. If it is clear that there is no possibility of coverage, the insurance company does not have to defend you. The duty to defend only arises if there is a possibility that the claim will be covered. Take the baseball bat example cited above. If it is clear that the incident was an intentional assault, there might not be any possibility of coverage, and thus no duty to defend. However, suppose the witnesses were in conflict ¡V one saying you just hauled off and hit the person, another who says you were warming up for a softball game, turned around and bumped into the plaintiff? In that case, it would be unclear, and because the injury might have resulted from your failure to carefully wield the bat on your shoulder, there would be a duty to defend and, if it were determined that it was your negligence that caused the injury, there would be a duty to indemnify you (i.e., a duty to pay the claim).
Do the attorney’s fees and other costs of litigation come out of my liability coverage, or are they paid in addition to it?
It depends. The key factor is the language of the policy. For example, in most auto policies, the defense costs are in addition to the amount of liability coverage. Thus, if you have $100,000 in liability coverage, and if the legal costs of a case are $75,000. This does not reduce your liability coverage to $25,000. The company must pay all the legal costs, and there is still $100,000 to cover the third party’s claim.
A policy in which defense costs come out of the liability limit is called a “declining limits” policy. The term is pretty self-explanatory – the amount of liability coverage declines, dollar for dollar, with each expenditure of legal costs. In the example above, the $75,000 in legal fees would be subtracted from the liability limit of $100,000 and would, in fact, reduce the coverage to $25,000.
What are “occurrence” and “claims made” policies?
These are important terms, and they govern virtually every insurance policy. Every policy has an effective time limit. For example, a policy may provide coverage between January 1st and December 31st of a given year. Where the terms “occurrence” and “claims made” come into play is when we consider what is covered during that policy year.
If you have an “occurrence” policy, it covers occurrences that take place during the policy year regardless of when the claim is brought against you.
If you have a “claims made” policy, the date of the occurrence does not matter at all, because the policy covers you for claims that are first made against you during the policy year, regardless of when the claim actually occurred.
Once again, simple examples help make the point. Say you have an occurrence policy in force between January 1st and December 31st and the incident in question occurs on October 30th. A lawsuit is brought two and a half years later. The policy in force during the year of occurrence is the one that will offer coverage.
Assume the same facts, except that the policy is a “claims made” policy. In that case, the policy that was in force when the incident occurred will not provide coverage. The pertinent policy (if it exists) is the one in force when the claim is made two and a half years later. The coverages exist for different reasons. Often, in the business world, things happen, but claims are not brought until several years later. Thus, a doctor or lawyer might have a malpractice policy that is a claims made policy rather than an occurrence policy. Most personal coverages, however, are occurrence policies.
This all sounds complicated. What do I do?
Two things. First, rely on an experienced insurance broker or salesperson to provide the proper insurance coverages for your individual situation. Second, if something happens and you have questions, consult with a knowledgeable insurance person or a lawyer well versed in insurance issues.
If I am sued, should I tell my lawyer about my insurance situation?
Yes. In fact, often it is one of the first questions your lawyer will ask you. It is very helpful if you bring a copy of the policy to the first meeting so your lawyer can review it and, if appropriate, invoke coverage on your behalf.
How does my lawyer invoke coverage on my behalf?
It is a simple procedure, and it does not have to be done by a lawyer, although it often is done that way. Someone needs to put the insurance company on notice that a claim has been made and that you need their help. This is done by way of a letter tendering the claim to the carrier. The “tender letter” usually requests both a defense and indemnity, thus triggering the carrier’s duties outlined above. While it may be a good idea to make a phone call to alert the carrier, never stop there. A letter must be written, both to provide documentation that the insurance company has been put on notice and, often, to comply with express terms of the policy which may require some form of written notice. Send tender letters by some form of mail that provides a receipt or other tracking information so you can verify that delivery has been made (i.e., use certified mail or Overnight Express Mail, Federal Express, DHL, etc.).
Can the other side discover my insurance information?
Yes. In fact, many states expressly state that a party’s insurance information is discoverable because it helps people to evaluate a claim and a party’s ability to respond should there be an adverse judgment. Bear in mind that discovering insurance information is totally distinct from discovering a party’s wealth. Discovery of assets generally is not allowed. Insurance is different because is it a contract specifically set up to administer and deal with litigated claims, and the legislatures and courts in most states have determined that open communication about insurance relationships is in the public’s best interest because it leads to fair settlements of disputed claims.