Mediating the Insurance Coverage Dispute

By Richard C. Mason

1. Introduction

Proficiency in insurance coverage law and practice is as important to a mediator of coverage disputes as fluency in mathematics is to an economist. Examples of insurance coverage concepts that are important for the mediator to understand are: (i) impact of an underlying dispute upon settlement of a claim under a liability insurance policy; (ii) the potential impact of per-occurrence (or per-claim) limits and aggregate limits (iii) complexities arising from multiple insureds, and (iv) allocation of long-tail claims among insurers. A mediator needs to recognize how such issues intersect with the differing motivations and perspectives of each party to best facilitate compromise between insureds and insurers. This article will highlight issues that frequently bear upon settlement of the insurance coverage dispute, before turning to how a mediator’s knowledge of these issues adds value and facilitates resolution.

2. Roadblocks to resolution in coverage mediations

a. Impact of underlying action

Courts frequently press insureds and insurers to mediate the coverage dispute notwithstanding that the underlying action is pending and thus the insured’s liability and the actual amount at stake (if anything) is unknown. I have more than once seen demands made whereby an insurer, should it agree, would commit millions to the insured to settle underlying litigation without knowing whether the basis of the insured's liability, if any, would trigger a duty to indemnify under the policy. (Often, such demands emanate, directly or indirectly, from the underlying plaintiff).

There are constructive approaches, however, that can prove useful. An insurer may, without making an actual payment, conditionally agree to make a certain sum (a dollar cap) available as a contribution to a settlement subject to express conditions. For example, an insurer might agree to contribute a fifty percent share of a settlement offer of up to $2 million. Alternatively, insurers may agree to an “Interim Funding and Non-Waiver Agreement.” Under such agreements, the insurer may agree to make a sum or sums available for settlement, with insurer and insured reserving all rights as to their coverage positions, and in exchange the insured agrees that if the insurer ultimately prevails on the coverage question then the insured must reimburse the insurer. The parties also may agree to a “Coverage-in-place Agreement,” pursuant to which the insurer acknowledges the claim is covered under the policy, though the insured may be asked to compromise on or stipulate as to certain contested issues, such as policy limits, allocation, or non-covered elements of the underlying claim.

b. Reinsurers

Reinsurers often have the right to approve settlements, at least above a certain dollar threshold. However, a reinsurer may have an incomplete understanding of the dynamic of the coverage dispute. Moreover, it may object not merely to the amount of any prospective offer, but also to the structure of a particular settlement. For example, some settlements have been structured so that an insurer pays on the basis of a single “occurrence,” which, if the reinsurance contract is subject to separate retentions that would have applied in the case of multiple “occurrences,” may mean that an excess-of-loss reinsurer’s liability will attach more quickly and will be higher than had the underlying liability been characterized as arising from multiple “occurrences.” An excess-of-loss reinsurer may object to that aspect of the underlying settlement, placing it in conflict with the Insurer. Conflicts between reinsurers and insurers thus may introduce a competing and complicating “behind the scenes” element to the coverage mediation if the reinsurer's position is not accounted for in connection with the mediation.

c. Bad faith claims

Insurers often complain that bad faith claims can be challenging to precisely measure. In some cases insurers may perceive there is little in the way of consequential damages to quantify, though if the bad faith damages consist of fees incurred in the coverage action, that is easier to measure. Punitive damages are often regarded as difficult to quantify and for that reason may not be accurately assessed as a liability that can move the needle during mediation, even though in certain cases an argument can be made that it should.

Another challenge is that bad faith claims may not fall within an insurer’s reinsurance protection. Thus, an insurer faces a battle with its reinsurer if the reinsurance contract does not indemnify for punitive damages, but the insurer has settled on a basis from which, notwithstanding recitals to the contrary in the settlement agreement, one may infer from the claim handling history that bad faith exposure drove a significant portion of the ultimate settlement amount.

Bad faith claims often stir emotions as well. The claims may declare that the insurer is not only wrong in its coverage position, but has acted maliciously or incompetently. The mediator’s challenge is to reduce the friction in such cases via the lubricating effect that a focus on economics rather than accusations can achieve.

3. Noteworthy Settlement Terms and Conditions

a. Parties to settlement agreement

i. Officers and employees

Under Directors and Officers Liability Insurance policies, directors and officers typically qualify as “insureds” for specified purposes and may directly claim insurance under the policy. As there may be numerous past and present directors and officers, not all of whom can be “brought to the table” to acknowledge a release of the insurer, the insurer will typically request a hold harmless and indemnity from the insured for any claims by former or current directors or officers. Similarly, under general liability policies, officers, employees, or both, may qualify as “insureds.” If such individuals have been or might be joined as defendants in underlying litigation then they may need to be signatories to the settlement agreement, unless the corporate policyholder has the authority (as is sometimes reflected in the policy terms) to settle on their behalf.

ii. Additional Insureds

Similarly, “Additional Insureds,” such as subcontractors, may need to be parties to a settlement agreement. They also can have an interest in being parties to the mediation. Consider a mediation resulting in payment of the entire policy limit to one Insured, leaving an Additional Insured with no coverage. In such instances, some Additional Insureds have sued insurers to recover amounts in excess of the policy limits, where they could show they weren't given notice of the settlement and were treated unfairly. One solution to this problem is for the insurer to interplead the settlement amount into a court having jurisdiction so that each of the “Insureds” thereafter can litigate apportionment of the insurer’s payment.

iii. Underlying claimant

Insurers may request that the underlying claimant be a signatory to the insurance agreement, to ensure finality. A number of states, such as Georgia and Louisiana, statutorily permit “direct actions” whereby an underlying claimant can sue an insurer directly to recover any covered portion of damages the insured owes to the claimant. A similar risk can arise when the insured becomes insolvent and creditors pursue the insurer, contending that the policy is an asset of the bankruptcy estate. Thus, following an insured’s bankruptcy filing, the insurer may need certain underlying claimants to be participants in the mediation if needed to ensure those parties also are bound by any settlement agreement that is reached.

b. Policy release vs. claim release

There are a number of issues in settling coverage disputes that rarely or never arise in other commercial disputes. For example, will the insurer insist upon a “policy release” or, rather, accept a “claim release?” A “policy release” is a settlement component whereby the policy is acknowledged to be void, such that no further claim, even if unrelated to the claim currently in dispute, can be asserted under that policy.

The narrower “claim release” merely releases the claim against the Insured that is currently at issue. The policy remains in force to respond to other and further claims. However, the parties may broaden the “claim release” such that it applies to any “related claims.” An insurer often will request a release of “related claims” if it fears that similar claims based upon the same conduct that yielded the settled claim may lurk on the horizon.

c. Allocation of long-tail claims

Various formulae govern allocation among policies and insurers of “long-tail claims;” i.e., claims deemed to involve continual, latent, and progressive harm extending over multiple policy periods. In certain states, loss is allocated among triggered policies based upon the “time on the risk.” In other jurisdictions, the Insured is authorized to select a policy year to access coverage and then, should all primary and excess coverage in that year become exhausted, select another year to access coverage, and so on until the entire claim or set of claims has been paid. New Jersey has adopted a notably complex regime, under which the total amount of coverage applicable during a policy year can increase or decrease the relative sums allocable to each layer of insurance for that policy year.

Indeed, long-tail claim allocation is considered so complex that many astute judges candidly admit they lack proficiency. Instead, they urge parties to accept the use of “allocation masters,” who are mathematically adept and have experience applying allocation formulae to complex claims. Like some judges, a non-specialist mediator may struggle to adequately grasp the issues in a mediation if complex allocation is the subject of, or impacts upon, the settlement amount or structure.

d. Policy limit exhaustion or depletion

An insurer often will request a provision confirming that a settlement payment on the insured’s behalf exhausts the policy limit or “erodes” the limit by a certain dollar amount. The insured may push back, arguing that such a provision is superfluous – if the settlement indeed exhausts the policy, can’t the insurer introduce evidence of the settlement payment in the event the insured seeks to make another claim under the policy? Yet, if certainty has value for the insurer, it may be in the insured’s interest to agree in exchange for other consideration or for the sake of resolution.

e. Confidentiality, non-admission, and “use” provisions

Both insureds and insurers frequently insist that settlement terms reflect that by entering into the agreement the insured does not disclaim and the insurer does not admit to coverage. This may be important given the likelihood that similar coverage disputes may be ongoing or arise in the foreseeable future.

Broad prohibitions on future reference to the agreement may be objected to by the insurer. As noted above, the insurer may in the future need to prove the fact of payment under the policy, and a concurrent reduction or exhaustion of the limits, should future claims arise. Thus, it should be unsurprising to see an insurer seek to include a carveout in the confidentiality provisions to allow latitude to introduce the fact of payment should the need arise.

4. Addressing expectations in coverage cases

While remaining impartial, the mediator of a coverage dispute can encourage parties to re-examine their methodologies for calculating the likelihood of success. Sometimes parties, while having a sold grasp on the general strength of their substantive claims or defenses, nevertheless are not applying the most reliable calculus to predict the extent to which their legal and factual points are likely to lead to a judgment or jury award in their favor, as discussed below.

a. Are multiple coverage defenses each independent variables?

Clients frequently ask attorneys the probability of prevailing in an action in which the defendant has interposed multiple defenses. Some calculate the likelihood of an ultimate defense win by assigning percentages to each defense and then multiplying the percentages together. Notably, this methodology treats each defense as an “independent variable;” i.e., a rejection of one defense is deemed uncorrelated to the odds another defense will be rejected. So, for example, the lawyer might assign a 40% chance of rejection to the strongest defense and a 60% chance of rejection to two weaker defenses. A lawyer employing the “independent variable” approach would yield a prediction of a nearly 86% chance of success (i.e., 40% x 60% x 60% = only a 14.4% chance all three defenses fail).

However, experience in insurance coverage disputes teaches that with regard to certain sets of defenses (particularly when linked by common themes), a court or jury that is inclined to dislike the strongest defense may be equally disposed to dislike all the defenses. For example, if a judge were to find the clearest exclusion to be “ambiguous,” the chances that same judge will find a weaker exclusion to apply may be vanishingly small. Thus, in many cases, calculating the ultimate chance of success based upon three defenses that are at least somewhat “dependent” would warrant merely adding a small premium to the percentage chance of success on the strongest defense. So in the above example, we might assign a 66.7% chance of over-all success rather than the perhaps over-optimistic 86% estimate that had assumed independent variables.

b. There is no certain coverage outcome, because courts make mistakes

Both insurer clients and insured clients are sometimes justifiably sure that their position is correct and that the other side is wholly unreasonable. These are contract disputes, so sometimes one side really is entirely right, and the other utterly wrong. In such an instance, it's understandable that a party may be inclined “as a matter of principle” (if not as a matter of economics) in refusing to discount or, as the case may be, in offering little more than “nuisance” (litigation expenses) costs.

But often it’s best to keep economic considerations at the fore. Parties should come to appreciate that, even in contract disputes, being 100% right based upon a contract provision does not (absent a ruling directly on point by the State’s highest court) bring any guarantee of victory. Judges are fallible and are capable of making surprising decisions, some of which are “rubber-stamped” on appeal. Thus, we see one state’s highest court applying a pollution exclusion to bar a claim by a worker whose injury ensued after falling into a ditch when overcome by chemical fumes,[i] while another state’s high court declined to apply the same kind of exclusion where a waterway was polluted by oil that leaked from a refinery.[ii]

An assumption that being right on the law and facts warrants an unyielding settlement position is analogous to the mistake made by the apocryphal vacuum salesperson. Selling door-to-door the salesperson promised a homeowner to eat with a spoon any household dirt that the sample vacuum failed to pick up. The homeowner reached into a drawer and said, “Here’s a spoon.” “But first give me a chance to vacuum the rug,” said the salesperson. “Well, you can try your vacuum,” said the homeowner, “but we don’t have electricity.”

Likewise, before some courts even the perfect case no more guarantees a clean success than having a powerful electric vacuum in a home without a power source.

4. The value of the insurance coverage mediator specialist

While it is not the role of the mediator to advise or argue with a party in mediation, the mediator needs to be fluent in the operative “language” to be fully effective. Mediators are sometimes “facilitative” (i.e., offering no evaluation, but rather focusing purely upon process), and are sometimes “evaluative” (i.e., offering an objective evaluation concerning the merits of a parties’ claim or their prospects for success). In either role, fluency in insurance coverage law and practice increases the mediator’s value and thus the likelihood of settlement on acceptable terms. For example, where a sticking point in an insurance coverage mediation is an insurer’s insistence upon a “policy release,” the roadblock might be obviated by exploring whether the dollar amount of the remaining available aggregate limit is economically worth making this “a hill to die upon.”

Without proficiency in insurance coverage law and practice, even a mediator operating purely as a “facilitator” who is asked to convey to a party the positions (or “ammunition”) furnished by the other party is as likely to botch that communication as a messenger untrained in higher math seeking to convey an algebraic message conveyed by a mathematician. Thus, understanding the insurance concepts need not always be in service of acting “evaluatively,” yet can facilitate accurate and effective communication, via the mediator, between the parties. And certainly the worth of an evaluation requested of a mediator is only as valuable as the mediator’s grasp of the coverage issues and the applicable law.

[i] Madison Constr. Co. v. Harleysville Mut. Ins. Co., 735 A.2d 100, 107 (Pa. 1999).

[ii] Doerr v. Mobil Oil Corp., 774 So. 2d 119, 127 (La. 2000). I am not opining that these cases were wrongly decided; merely that the outcomes may have surprised both the winning and losing parties to the cases.