How should you react to a Reservation of Rights Letter?
Reservation-of-rights letters often leave our insureds scratching their heads in shock and anger. What does the insurer mean? How should we react to the letter?
A reservation-of-rights letter does not mean the claim isn’t covered. It does suggest that a cloud hovers over your coverage. It signals that the insurer thinks there might be grounds to deny coverage for at least part of the claim. A claim can allege some counts that the policy may or may not cover, such as intentional torts, financial loss with no property damage or bodily injury, or a matter clearly outside the policy scope. A claim may include both covered and excluded matters.
Months may pass before an insurer knows enough to tell whether coverage exists. In the meantime, the clock ticks. Insurers must enter an appearance, hire a defense lawyer, and file an answer to the lawsuit.
If an insurer does not reserve rights and defends a claim, but later discovers that "questionable" allegations raise coverage issues, the insurer may be estopped from raising a coverage defense. Courts could say that by its acts, an insurer waived its right to deny coverage. Rather than deny coverage outright or proceed as though nothing was wrong, the insurer seeks middle ground by sending a reservation-of-rights letter. The letter says in effect, "We are investigating this claim but preserve our right to later deny coverage if investigation shows that it is not a covered loss." Insureds cannot claim that the insurer, by its actions, led the policyholder to believe that coverage existed.
As confrontational as reservation-of-rights letters tend to be, they steer insurers between the twin perils of total acceptance or total denial of coverage. Reservation-of-rights letters allow the insurer to keep its options open. If no strong coverage defenses emerge, it has not lost face. Reservation-of-rights letters give insurers more time to investigate a claim or unearth facts through the discovery process. Erring on the side of caution, an insurer can disclaim coverage if investigation reveals that the facts do not support coverage.
You have several options when you receive a reservation-of-rights letter.
Maybe the insurer is correct in reserving its coverage rights. For example, maybe a suit seeks punitive damages and your policy clearly excludes them. Or perhaps your policy does not exclude them but your state law forbids coverage on public-policy grounds.
Dispute the reservation.
If you disagree with the reservation of rights, promptly go "on record," advising the insurer of your reason(s). This paper trail will be helpful if the case ends up in court. Maybe the insurer has misinterpreted a state law regarding insurance coverage for punitive damages. Or perhaps its interpretation of "occurrence" is unduly narrow in light of policy language. Spell out your rationale, send it to the claims rep via certified mail return receipt requested, and set a deadline for a response. This turns up the heat on an insurer to reassess its position, or provide further insight as to whether you are on solid footing.
Press for specifics.
Some insurers believe that reservation-of-rights letters should be vague. The rationale is that this leaves the insurer with more options. Policyholders and risk managers should counterattack vaguely worded reservation-of-rights letters. Do not tolerate fuzzy letters that do not specifically refer to policy language and policy provisions, chapter and verse. Press for particulars.
Start your stopwatch.
Once an insurer has reserved its rights, it must eventually declare whether or not it is covering the claim. In other words, reservation-of-rights letters have limited shelf lives. An insurer must eventually get off the fence. If not, a court may decide the issue or an insurer may be estopped (through inaction) from using its coverage defenses, notwithstanding its reservation. Moral to risk managers: after receiving a reservation of rights, keep after the insurer periodically to either disclaim or accept coverage. Seize the initiative. Advise the insurer that after a reasonable amount of time you are entitled to a definitive stance as to coverage, or else the carrier is estopped. Be a nag!
Recognize what new doors and options this opens.
If the insurer reserves its rights, you may be entitled to hire a lawyer of your choice —not the insurer's -- at the insurer's expense. When an insurer hires the lawyer and reserves rights, it creates a potential conflict of interest. Many courts allow insureds to retain their own counsel when an insurer reserves its rights. In California, for example, this has created a whole cottage industry of Cumis counsel, taken from the name of the court case. A reservation of rights might be a blessing in disguise.
Seek a declaratory judgment action.
This will get the coverage issue settled before proceeding on with the merits of the underlying claim. If you and your lawyer feel strongly that coverage exists, you may want to seek a declaratory judgment. A preemptive strike via a declaratory judgment action may make sense to force an insurer's hand. The prospect of spending more legal fees to handle a declaratory judgment action may also inspire an insurer to reconsider its coverage position, and it may even relent, seeing things your way.
Sue the insurer for coverage and for additional damages.
Consider this the "nuclear warhead response." First, though, make sure that you're actually in a war. If you feel an insurer's position is groundless, capricious, or done simply to harass, then you can sue your insurer for bad faith, punitive damages, and breach of contract. Seek legal advice to determine whether you have a strong case.
Simply threatening to play this card may make the insurer sweat. Insurers do not make sympathetic defendants in courtrooms. They know this, and will often avoid the specter of a whopping jury hit and publicity black eye. If the reservation of rights is genuinely premised on a "gray area" in insurance policy interpretation, then a suit against the insurer for money damages may not be viable. Still, recall that insurance policies are adhesion contracts, and courts usually interpret reasonable ambiguities in the policyholder's favor.
If you and your attorney feel the issue is black-and-white and that the insurer is reserving rights on false grounds, consider filing a suit for breach of contract and/or bad faith claims handling. This may get your claim file off the desk of that adjuster trainee and into the domain of the Vice President of Claims, where cooler and more seasoned heads might prevail -- in your favor.
Reservation-of-rights letters are a symptom of a possible coverage gap. To that end, wise insureds treat them as "red flags" and opportunities to diagnose the health of their own insurance and risk management programs.In the Chinese language, the character for the word "danger" connotes a double meaning of opportunity" as well. In a similar vein, reservation-of-rights letters carry overtones of danger, the danger of an uncovered loss.
# # #
SOLUTIONS is a service of The McLaughlin Company and Creative Risk Management, Inc.—offering you timely and creative solutions to all your INSURANCE and RISK MANAGEMENT needs.
THE McLAUGHLIN COMPANY
CREATIVE RISK MANAGEMENT, INC.
1725 DeSales Street, NW
Washington DC 20036
Fax 202-857-8355 - 800-233-2258 - 202-293-5566