Articles WHEN PREJUDGMENT INTEREST STATUTES AND INSURANCE POLICY LANGUAGE COLLIDE: SHOULD FREEDOM OF CONTRACT TRUMP LEGISLATIVE INTENT?

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1 Volume 20 Number 3 Winter 2001 QJR Articles WHEN PREJUDGMENT INTEREST STATUTES AND INSURANCE POLICY LANGUAGE COLLIDE: SHOULD FREEDOM OF CONTRACT TRUMP LEGISLATIVE INTENT? Erich H. Gaston* The assessment of prejudgment interest in actions for personal injuries or wrongful death has been the subject of scholarly debate.' Despite the existence of arguments against the award of prejudgment interest in actions for personal injuries or wrongful death, the award of such interest is permissible in a significant and growing majority of the states. 2 * Juris Doctor, 1998, Quinnipiac College School of Law. L.L.M. Candidate, Insurance Law, University of Connecticut School of Law. Member, bars of Arkansas and Connecticut. Associate, Morrison, Mahoney & Miller, LLP, Hartford, Connecticut, a law firm specializing in defense work on behalf of insurance companies and corporations. 1. See Michael K. Brown, Comment, The Availability of Prejudgment Interest in Personal Injury and Wrongful Death Cases, 16 U.S.F. L. REv. 325, (1982) (discussing pecuniary loss, fair and unjust compensation, and policy considerations); Anthony E. Rothschild, Comment, Prejudgment Interest: Survey and Suggestion, 77 Nw. U. L. REv. 192, (1982) (setting forth the typical arguments favoring the award of prejudgment interest). See generally James D. Wilson et al., Prejudgment Interest in Personal Injury, Wrongful Death and Other Actions, 30 TRIAL LAW. GUIDE 105, (1986) (discussing arguments for and against the award of prejudgment interest in actions for personal injuries and wrongful death). 2. The fact that the majority is growing is apparent by a comparison of the states' prejudgment interest laws in 1986, as set forth in Wilson, supra note 1, at , with 359

2 QLR [Vol. 20:359 Prejudgment interest provisions vary somewhat from state to state but can be grouped into general categories. "Mandatory" prejudgment interest statutes provide for prejudgment interest from the time the claimant gives notice-of his or her injury to the tortfeasor, or from the time that the claimant files a complaint against the tortfeasor, to the entry of judgment. A variation of these mandatory prejudgment interest provisions is the "escape hatch" variety, which may allow a defendant to stop the accumulation of prejudgment interest by making a settlement offer. 3 Another group of states have passed statutes or rules of court of the current state of the law. See infra notes 3-6. Since 1986, additional states (Arizona, Idaho, Indiana, and Nebraska) now permit the imposition of prejudgment interest in tort cases based on the acceptance or on the rejection of an offer to settle. See infra note 4. South Dakota now permits the imposition of such interest as a matter of right in tort cases for economic damages such as medical bills and lost wages. See infra note See ALASKA STAT (b) (Michie 2000) ("[P]rejudgment interest accrues from the day that process is served on the defendant or on the day that the defendant receives written notification that an injury occurred and that a claim may be brought."); COLO. REV. STAT. ANN (1997) (authorizing interest from the time the suit, if filed, or of the appeal, when the cause of action accrues); LA. REV. STAT. ANN. 13:4203 (West 1991) (applying as a matter of right in tort cases); ME. REV. STAT. ANN. tit. 14, 1602 (West Supp. 2000) (authorizing prejudgment interest to accrue from time of notice or filing of claim); MASS. GEN. LAWS ANN. ch. 231, 6B (West 2000) (authorizing prejudgment interest as a matter of right in tort cases); MASS. GEN. LAWS ANN. ch. 229, 11 (West 2000) (requiring prejudgment interest as a matter of right in wrongful death cases); MICH. STAT. ANN. 27A.6013 (Michie 2000) (allowing interest on judgment calculated from date of filing complaint); NEV. REV. STAT (2000) (requiring interest to run from time of service until entry of judgment unless defendant makes an offer to settle, the plaintiff rejects it, and then does not recover an amount as favorable as the defendant's offer); N.H. REV. STAT. ANN. 524:1-b (Michie 1997) (mandating interest on damages from date of writ or filing of petition); N.J. Civ. PRAC. R. 4:42-11 (1999) (authorizing interest on judgment awards, taxed costs and counsel fees); N.Y. EST. POWERS & TRUSTS LAW (McKinney 1999) (authorizing prejudgment interest as a matter of right in wrongful death cases); N.C. GEN. STAT (1999) (authorizing a legal interest of eight percent per annum as interest accrues); OHIO REV. CODE ANN (Anderson Supp. 1999) (authorizing interest in tort actions to be computed from date of judgment, decree or order); OKLA. STAT. ANN. tit. 12, 727 (West 2000) (authorizing prejudgment interest from the date of filing to the date verdict accepted or judgment filed with the clerk); R.I GEN. LAWS (1998) (insurer obligated to pay prejudgment interest authorized by R.I. GEN. LAWS (1997) in excess of policy limits); S.D. CODIFIED LAWS (Michie Supp. 2000) (prejudgment interest in tort cases a matter of right as to economic damages); TEX. REV. Civ. STAT. ANN. art , 6 (Vernon 2001) (codifying and amending the court-made prejudgment interest rules of Cavnar v. Quality Parking Control, Inc., 696 S.W.2d 549, (Tex. App. 1985) to make prejudgment interest run from time of filing of the complaint and to make prejudgment interest recoverable as to future damages); UTAH CODE ANN (Michie 1999) (stating legal rate of interest for loan or forbearance of any money, goods, or chose in action);

3 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 361 the "trigger" variety. These measures allow for prejudgment interest when the plaintiff makes a formal settlement offer-typically called an "offer of judgment"-the defendant rejects the offer, and the plaintiff recovers an amount at trial that equals or exceeds the offer of judgment.! There is also a group of states permitting the assessment of prejudgment interest in tort cases on a discretionary basis, either by statute or by judicial decision. Finally, a minority of the states follow the traditional W. VA. CODE (Michie 1997) (authorizing prejudgment interest as a matter of right for economic damages). 4. See ARIZ. R. Civ. P. 68 (West 2000) (providing for prejudgment interest from the date of the offer if the offeree fails to accept and the judgment is equal to or greater than the offer to settle); CAL. CiV. CODE 3291 (Deering 1999) (providing for the award of prejudgment interest in tort actions if the defendant fails to accept an offer to settle by plaintiff and plaintiff then obtains a more favorable judgment at trial); CONN. GEN. STAT (a) (2001) (authorizing interest if the defendant fails to accept offer of judgment and the plaintiff recovers an amount greater or equal to the offer of judgment); GA. CODE ANN (Supp. 1999) (authorizing recovery of interest from thirtieth day following mailing of settlement notice, or in trial judgment is an amount less than sum not less than the sum claimed in settlement notice); IDAHO CODE (Michie 1999) (authorizing prejudgment interest awarded if claimant makes an offer to settle, the defendant rejects the offer, and the claimant recovers an amount equal to, or greater than his or her offer to settle); IND. CODE ANN to (Michie 1999) (setting forth applicability of prejudgment interest); IOWA CODE ANN , (West Supp. 2000) (allowing interest on judgments and decrees to accrue from date action commenced); MINN. STAT. ANN (West 2000) (authorizing interest to be accrued from time of verdict to the time of the award or judgment); MONT. CODE ANN (1999) (authorizing prejudgment interest on economic ascertainable damages from date of demand and fulfillment of other conditions set forth in statute); PA. R. CIV. P. 238 (2000) (discussing damages for delay in action for bodily injury, death or property loss); Wis. STAT. ANN (West 1999) (allowing defendant to recover costs on demand of complaint where plaintiff does not accept offer of judgment and plaintiff fails to recover more favorable judgment at trial). 5. See HAW. REV. STAT (1993) (permitting award of prejudgment interest in the discretion of trial court); see also Page v. Domino's Pizza, Inc., 908 P.2d 552, (Haw. Ct. App. 1995) (discussing standards under Hawaii law for the imposition of prejudgment interest); Nucor Corp. v. Gen. Elec. Co., 812 S.W.2d 136, (Ky. 1991) (discussing the imposition of prejudgment interest under Kentucky law in cases involving unliquidated damages). Maryland has a statute that permits courts to impose prejudgment interest in automobile accident cases when a defendant (or his or her insurer) causes unnecessary delay in having the case ready for trial. MD. CODE ANN., CTS. & JUD. PROC (Michie 1995). With the exception of auto cases involving unreasonable delay, Maryland follows the traditional rule that prejudgment interest is not available in tort claims involving unliquidated damages. See Lawhorne v. Employers Ins. Co. of Wausau, 680 A.2d 518, (Md. 1996). In New Mexico, prejudgment interest in tort actions is likewise discretionary. N.M. STAT. ANN (Michie 1996); see also N.D. CENT. CODE (1991); TENN. CODE ANN (1995); VA. CODE ANN (Michie 2000); O'Meara v. Commercial Ins. Co., 376 P.2d 486, 490 (N.M. 1962) (stating award of prejudgment interest is not a matter of statutory right).

4 QLR [Vol. 20:359 rule that prejudgment interest is not permissible in actions for personal injury and wrongful death, which by their very nature involve unliquidated damages until such time as the finder of fact renders a decision. 6 There is no question that defendants found liable to tort claimants can be obligated to pay prejudgment interest as authorized by state statutes, rules of court, or judicial decisions. There is also no question that insurers are obligated to pay prejudgment interest when the amount of a judgment, including prejudgment interest, falls within a defendant/insured's policy limit. But what if a defendant has liability 6. See, e.g., LeFevre v. Westberry, 590 So. 2d 154, 163 (Ala. 1991) (prejudgment interest not available under Alabama law in underinsured motorist action involving personal injuries); Woodline Motor Freight, Inc. v. Troutman Oil Co., 938 S.W.2d 565, (Ark. 1997) (following a long line of Arkansas decisions holding that the award of prejudgment interest is not permissible in cases involving unliquidated damages); Nutt v. GAF Corp., No. 80C-FE-8, 1987 Del. Super LEXIS 1192, at *3 (May 21, 1987) (finding prejudgment interest in unliquidated damages cases impermissible under Delaware law); George Hyman Constr. Co. v. DiNicola, 514 A.2d 1180, (D.C. App. 1986) (declining to disturb trial court's finding that prejudgment interest was not permissible in a tort case but not reaching the issue on appeal); Lumbermens Mut. Cas. Co. v. Percefull, 653 So. 2d 389, 390 (Fla. 1995) (explaining Florida law on prejudgment interest); Wilson v. Cherry, 612 N.E.2d 953, (I1. App. 1993) (discussing Illinois case law denying prejudgment interest); Warwick v. Matheney, 603 S.2d 330, 342 (Miss. 1992) (recognizing Mississippi judicial authority to award prejudgment interest to a prevailing party in a breach of contract suit); Catron v. Columbia Mut. Ins. Co., 723 S.W.2d 5, 6 (Mo. 1987) (indicating Missouri follows the general rule disallowing prejudgment interest for unliquidated claims but indicating that exceptions to the rule exist under Missouri law); Love v. New York, 583 N.E.2d 1296, (N.Y. 1991) (stating that under New York Civil Practice Law and Rules, prejudgment interest is not recoverable in personal injury actions in contrast to the rule in wrongful death actions); Tifft v. Stevens, 987 P.2d 1, 12 (Ore. App. 1999) (prejudgment interest not awarded under Oregon law unless damages are ascertainable); Babb v. Rothcock, 426 S.E.2d 789, 791 (S.C. 1993) (holding that damages must be certain for prejudgment interest to be available under South Carolina law); Bull v. Pinkham Eng'g Assoc., Inc. 752 A.2d 26, 36 (Vt. 2000) (prejudgment interest recoverable in cases where damages are ascertainable, which may include tort claims); Langston v. Huffacker, 678 P.2d 1265, 1272 (Wash. App. 1984) (allowing prejudgment interest on liquidated claims and unliquidated claims when specified calculation contained in contract); World Mart, Inc. v. Ditsch, 855 P.2d 1228, 1236 (Wyo. 1993) (stating that an award of prejudgment interest cannot be recovered on an unliquidated claim). While Florida follows the traditional rule that prejudgment interest is not available in cases involving unliquidated damages, it does have a "fee shifting" statute that permits the award of attorneys' fees predicated upon the acceptance or rejection of a settlement offer. FLA. STAT. ANN (West Supp. 2000). A discussion of fee shifting statutes is outside the scope of this article.

5 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE insurance, she is found liable for injuring a plaintiff, and the amount of the award with prejudgment interest exceeds her liability insurance policy limits-should the defendant's liability insurer be obligated to pay prejudgment interest in excess of its policy limits? And, if so, under what circumstances? Does the answer change if the insurance policy specifically defines prejudgment interest as "damages" subject to a policy limitation? Like the debate over prejudgment interest in general, the foregoing questions involving insurers' liability for prejudgment interest in excess of policy limits have received some analysis by legal commentators. 8 A number of courts have addressed these questions as well. 9 David Pierce's 1983 article correctly points out that the issue of whether liability insurers should be liable for prejudgment interest in excess of policy limits implicates the tensions between the public policies of prejudgment interest statutes and the competing public policies favoring the enforcement of insurance policy language.' 0 After analyzing the 7. Liability insurance protects an insured by paying for damages to third parties that the insured becomes legally obligated to pay. In addition to providing financial protection to insureds, liability insurance can also serve an important function of providing a "pool" of money with which to compensate injured persons. See ROBERT E. KEETON & ALAN I. WIDISS, INSURANCE LAW 4.8(a) (1988). Claims made under a liability insurance policy in which an injured party seeks compensation from a tortfeasor are third-party claims. The tortfeasor's liability insurance company typically defends and indemnifies the tortfeasor/insured up to the limit of the applicable policy. This is in contrast to first-party claims in which a claimant seeks payment from his or her own insurer. 8. See generally David J. Pierce, Insurer's Liability for Prejudgment Interest: A Modern Approach, 17 U. RICH. L. REv. 617 (1983); Brown, supra note 1, at See generally Alexander C. Black, Annotation, Liability of Insurer for Prejudgment Interest in Excess of Policy Limits for Covered Loss, 23 A.L.R.5th 75 (2000) (discussing cases addressing liability of insurance companies for prejudgment interest in excess of their policy limits). 10. See Pierce, supra note 8, at ; see also Brown, supra note 1, at More recent commentary has argued that there are three schools of thought regarding insurer obligations for prejudgment interest in excess of policy limits: the "total compensation" school, the "voluntary contract" school, and the "limited liability school." See Sherri Snelson Haring, Note, Baxley v. Nationwide Mutual Insurance Company: A Key Loophole in the Financial Responsibility Act of 1953 Comes to Light, 72 N.C. L. REv. 1809, (1994). In reality, however, there are only two ways to view insurer liability for prejudgment interest in excess of policy limits. Such an obligation is either governed by the language of the policy, or the law imposes such an obligation upon insurers irrespective of policy language. The difference between Haring's "limited liability" school and her "voluntary contract" school is not significant. Both schools view insurer obligations for prejudgment interest as a matter of contract law. The only difference between the two is arguments over the meaning of policy language.

6 QLR [Vol. 20:359 arguments on both sides of the issue, Pierce concluded that courts should hold insurers liable for prejudgment interest in excess of policy limits. In fact, he went so far as to argue that an insurer's obligation to pay prejudgment interest should not only extend to that part of a judgment falling within a liability insurer's policy limits, but perhaps even to prejudgment interest on the entire amount of the judgment, regardless of policy limits. Pierce also described decisions holding insurers liable for such prejudgment interest as "a modem trend."" But, rather than advocating holding insurers liable for prejudgment interest in excess of policy limits as a matter of public policy, Pierce advocated a contract-language approach, the judicial expansion of existing policy language.2 This article will revisit the issue of liability insurers' obligations to pay prejudgment interest in excess of their policy limits under representative "mandatory," "escape hatch," and "trigger" prejudgment interest statutes. Since the time of the Pierce article, a number of courts have declined to hold that insurers are obligated to pay prejudgment interest in excess of policy limits. 3 This article argues that the emerging majority rule holding that liability insurers are not obligated to pay prejudgment interest in excess of policy limits-while not a perfect solution-is a sound rule of law, given the operation of typical prejudgment interest statutes." Despite contrary arguments, courts should allow insurers to avoid the payment of prejudgment interest in excess of their policy limits through policy language. Alternatively, policy makers should enact reforms addressing insurer responsibility for prejudgment interest in excess of policy limits. 11. Pierce, supra note 8, at Id. at See, e.g., Farm Bureau Mut. Ins. Co. v. Milne, 424 N.W.2d 422, 425 (Iowa 1988) (discussing this emerging majority rule and citing numerous authorities applying the rule); see also Black, supra note 9, This article does not address insurers' obligations to pay prejudgment interest in first-party cases involving homeowner's insurance, property insurance, or life insurance. Nor does it address uninsured or underinsured motorist coverage, although similar issues involving insurer responsibility for prejudgment interest have arisen in the uninsured/underinsured motorist context. See Baxley v. Nationwide Mut. Ins. Co., 430 S.E.2d 895, (N.C. 1993) (stating that in underinsured motorist case, insurer's obligation to pay prejudgment interest was governed by the terms of the policy, which contained no provision authorizing the payment of such interest in excess of the policy limit). See generally Black, supra note 9, at 75.

7 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 365 Part I sets forth recent changes to Insurance Services Offices, Inc. ("I.S.O.") standard-form policies. 5 Predictably, it will show that insurers have responded to the expansion of policy language to provide coverage for prejudgment interest by changing policy language. This Part will show how I.S.O. policies have been in a state of transition, with more recent editions of I.S.O. policies specifically defining prejudgment interest as "damages" subject to a policy limit defense. This change is significant because it would seem to foreclose the further judicial expansion of policy language to provide coverage for prejudgment interest in excess of policy limits. When faced with the new language, courts will either have to enforce it, meaning that insurers can cap their obligation to pay prejudgment interest at their policy limits, or void it. In light of the new policy language, Part II describes the public policy arguments in favor of holding insurers liable for prejudgment interest in excess of their policy limits. All of these arguments are closely related and, in fact, blend together. One of the arguments discussed in Part II is that there is a need to compensate plaintiffs for the loss of use of money between the time of injury and the time of judgment. According to the argument, the loss of use of money is typically caused by insurer delay. Unless insurers are liable for prejudgment interest, or so the argument goes, plaintiffs will not receive full compensation for their injuries. Another argument is that insurers should be liable for prejudgment interest in excess of their policy limits based upon their control of their insureds' defenses. A further argument is that allowing insurers to cap their exposure for prejudgment interest encourages insurers to act contrary to the best interests of their insureds. A final argument is that existing prejudgment interest statutes are really "back door" attempts to encourage insurers to settle cases by holding insureds liable for prejudgment interest. Allowing insurers to "contract around" the payment of prejudgment interest negates the incentives to settle that are created by prejudgment interest statutes. 15. I.S.O. is the leading supplier of statistical, actuarial, and underwriting information for and about the property/casualty insurance industry. I.S.O. provides advisory services to more than 1500 insurers and their agents. See Insurance Serv. Office, About ISO, at (on file with the Quinnipiac Law Review). I.S.O. also "develop[s] standardized policy language for most lines of property/casualty insurance. I.S.O.'s policy forms contain simplified language-letting consumers know what they're buying and agents know what they're selling. Standardized forms simplify claim settlement and reduce costly litigation, because the meaning of coverage technology becomes established and known." Id.

8 QLR [Vol. 20:359 At first glance, these arguments are somewhat compelling. Thus, it is not entirely surprising that several states hold insurers liable for prejudgment interest in excess of their policy limits. Part II also discusses and analyzes this minority rule in detail, using case law and statutes from two jurisdictions, Michigan and Rhode Island, that have adopted it, the former by judicial decision and the latter by statute. Despite the foregoing arguments, Part III argues that insurers should not be obligated to pay prejudgment interest in excess of their policy limits as a matter of public policy. Instead, courts should enforce policy language that defines prejudgment interest as damages. There are a number of reasons for this. One reason is that conceptually, there is no reason to treat an insurer's obligation to pay prejudgment interest on behalf of an insured any differently than its obligation to pay any other damages on behalf of an insured. If it is permissible for insurers to sell liability insurance policies that limit coverage to fixed amounts, then there is no compelling reason why insurers cannot also limit their obligation to pay prejudgment interest to whatever the applicable policy limit happens to be. Such a rule allows insurers to quantify exposure in any given case while insureds always have the option to protect themselves against exposure for prejudgment interest in excess of policy limits by purchasing higher amounts of liability coverage. Another argument against holding insurers liable for prejudgment interest in excess of their policy limits involves the relationship between prejudgment interest statutes and the duty-to-settle doctrine. 16 part 11, 16. In the context of a third-party case, see supra note 7, under the law of most states, an insurer does not have a duty to settle with an injured third-party claimant. See generally Kent D. Syverud, The Duty to Settle, 76 VA. L. REv. 1113, (1990). But, the insurer does owe a duty to its own insured to settle on behalf of the insured and thereby protect the insured from personal liability. To illustrate, assume that an insured tortfeasor negligently injures a claimant in an auto accident. The claimant sues the tortfeasor. There are some questions as to liability but a jury would most likely find that the tortfeasor/insured is liable. Further assume that there is a dispute over the extent of the claimant's damages. The tortfeasor's liability insurance policy limit is $50,000. The insurer-in accordance with the terms of most liability insurance policies-has the exclusive right to defend the claim or to settle with the claimant. Taking into account the disputed liability and damages issues, the insurer believes that the case is worth $20,000. The claimant's attorney believes that her client has no comparative fault for the accident. She further believes that the full value of her client's case is $85,000. Notwithstanding this assessment of value, the claimant wants to settle early. The claimant is willing to accept the tortfeasor's $50,000 policy limit to settle. The insurer refuses. Given this very typical fact pattern, under the law of most states, the claimant cannot add a count to the complaint and sue the tortfeasor's insurer for failing to settle with the claimant prior to trial. Further, assume that the case is tried and the jury returns a verdict of $125,000. In such a situation, the tortfeasor will typically settle with the

9 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 367 discusses this inter-relationship, again using the law of Michigan and Rhode Island, as well as using the law of Colorado and Connecticut. These states' prejudgment interest statutes and judicial decisions are representative of recent trends on the issue of insurers' liability for prejudgment interest in excess of policy limits. The fact of the matter is that the typical prejudgment interest statute has inherent flaws. This is true regardless of whether it is the "mandatory" variety, the "escape hatch" variety, or the "trigger" variety. The flaw of prejudgment interest statutes is that such statutes are subject to manipulation by plaintiffs. In certain cases, typically where the plaintiff has extensive injuries and the defendant/insured's policy limit is low, the statutes create powerful incentives for plaintiffs not to settle and to prolong litigation for the purpose of attempting to recover prejudgment interest. Thus, even if an insurer offers to settle and to secure a release for its insured, the plaintiff may decline to do so in the hope of making the tortfeasor's insurance company pay prejudgment interest in excess of its policy limit. In such cases, plaintiffs have little to lose by attempting to "take a shot" at the insurer to recover prejudgment interest. In other words, prejudgment interest statutes merely serve to increase the demand in some cases." The point is that a defacto rule obligating insurers to pay statutory prejudgment interest in excess of their policy limits does not take into account whether an individual insurer defending its insured has made reasonable efforts to settle on behalf of its insured. On the other hand, the emerging majority rule does take into account an insurer's conduct. While not a perfect rule of law, the emerging majority rule is the better alternative. Part IV suggests alternatives to the present state of the law. Such alternatives include the creation of bench-made or statutory measures absolving liability insurers of the obligation to pay prejudgment interest in excess of their policy limits if they make efforts to settle cases. Part IV includes an example of how such a measure could be drafted. Finally, Part V summarizes and concludes this article. claimant and assign his or her rights against her insurer to the claimant. The claimant then pursues an action against the insurer for acting in bad faith/violating the duty to settle. Or, if the tortfeasor has assets, he or she may pay that part of the judgment not covered by insurance and sue the insurer. Id. 17. See Lucian Arye Bebchuk & Howard F. Chang, The Effect of Offer-Of- Settlement Rules on the Terms of Settlement, 28 J. LEGAL STUD. 489, (1999).

10 QLR [Vol. 20:359 I. THE TRANSITION IN I.S.O. STANDARD-FORM POLICIES Older liability insurance policies were silent on the issue of prejudgment interest. A Chubb & Sons, Inc. liability insurance policy from 1977 is typical. It states: The company will pay on behalf of the insured all sums which the insured shall become obligated to pay as damages by reason of liability to which this insurance applies, imposed by law or assumed by the insured under any written contract for bodily injury, property damage, or personal injury caused by an occurrence and the company shall have right and duty to defend any suit against the insured seeking damages on account of such bodily injury, property damage, or personal injury, even if any of the allegations of the suit are groundless, false, or fraudulent, and may make such investigation and settlement of any claim or suit it deems expedient. The company shall not be obligated to pay any claim or judgment or to defend any suit after the applicable limit of the company's liability has been exhausted by payment of judgments or settlements. 18 In addition to the foregoing terms, the policy also obligates the insurer to pay [a]ll expenses incurred by the company, all costs taxed against the insured in any suit defended by the company and all interest on the entire amount of any judgment therein which accrues after the entry of judgment and before the company has paid or tendered or deposited in court that part of the 1 udgment that does not exceed the limit of the company's liability thereon... Courts construing this type of standard-policy language routinely concluded that it did not require insurers to pay prejudgment interest in excess of policy limits. 0 This supplementary payments provision, however, has been viewed as a vehicle to hold insurers liable for prejudgment interest in excess of policy limits. The Pierce article 18. Chubb & Sons Comprehensive Liability Insurance Policy 1 (1977)' (on file with the Quinnipiac Law Review). Automobile, homeowner, and commercial general liability policies typically allow the insurer to have exclusive control over an insured's defense. As in the Chubb policy, insurers are typically allowed to settle or to defend claims as they deem fit. 19. Id. (emphasis added). This clause is typically part of a policy provision referred to as "extended, additional, or supplemental coverages." THE CPCU HANDBOOK OF INSURANCE POLICtEs (1st ed. 1994). 20. See, e.g., Guin v. Ha, 591 P.2d 1281 (Alaska 1979); Laplant v. Aetna Cas. & Sur. Co., 219 A.2d 283 (N.H. 1966); Factory Mut. Liab. Ins. Co. v. Cooper, 262 A.2d 370 (R.I. 1970).

11 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 36S advocated such an approach. 2 ' Additionally, at least two reported judicial decisions have applied similar rationales. One decision is Cox v. Peerless Insurance Co. 22 The Cox case arose from a car accident in The injured plaintiff filed a diversity action against the tortfeasors in the United States District Court for the District of Connecticut. In this underlying action, the jury found liability and the tortfeasors became obligated to the plaintiff for $150,000 plus prejudgment interest. The policy limit was $50,000. After the entry of judgment, the injured plaintiff brought a direct action 23 against the tortfeasors' insurer, Peerless, to recover the prejudgment interest. The parties stipulated to the facts and requested that Judge Eginton render a decision based upon the trial memoranda. 4 Peerless's policy language was the focal point of the decision. The policy in issue contained language very similar to the Chubb policy referred to above. It stated, We will pay damages for bodily injury or property damage for which any covered person becomes legally responsible because of an auto accident. We will settle or defend, as we consider appropriate, any claim or suit asking for these damages. In addition to our limit of liability, we will pay all defense costs we incur. Our duty to settle or defend ends when our limit of liability for this coverage has been exhausted. 25 Additionally, as in the Chubb policy above, the Peerless policy at 26 issue in Cox contained a supplemental payments provision. Judge Eginton's opinion focused on changes to I.S.O. policies after 1984, which specifically defined prejudgment interest as damages subject to policy limits. 27 He also quoted an I.S.O. bulletin that explained revised I.S.O. standard-form policies that defined prejudgment interest as damages. 21. Pierce, supra note 8, at F. Supp. 83 (D. Conn. 1991). No state appellate court in Connecticut has addressed the question of whether an insurer is obligated to pay prejudgment interest in excess of a policy limit. See infra Part III. 23. See CONN. GEN. STAT. 38a-321 (1999) (stating that by operation of law, a plaintiff can become subrogated to the rights of an insured and can sue the insured's insurance company). 24. Cox, 774 F. Supp. at Id. (emphasis added). 26. Id. 27. Id. at 85.

12 QLR [Vol. 20:359 [The new policy language], which parallels similar changes in commercial liability policies, has resulted from the enactment in several states of laws that allow claimants to collect interest on judgments between the time the suit was entered and judgment was rendered. Because the policy language states that such amounts are included as damages, they are subject to [policy] limits that apply to all damages. 28 The court then used the policy-language distinction to manipulate the language of the Peerless policy in a manner similar to that suggested by the Pierce article. "Although the 1984 insurance policy is silent as to prejudgment interest, it is properly included within the definition of 'defense costs."' 29 In Connecticut, "[a]n award of prejudgment interest arises from a defense attorney's strategic decision to reject an offer of settlement, and proceed to trial. Therefore, an award of prejudgment interest does not arise out of the action's underlying controversy, and is not taxed to the defendant's policy[]... as 'damages."' 3 Even though the policy was silent on the issue of prejudgment interest, the court reached its conclusion on the basis that "the language of the insurance policy [was] clear and unambiguous.' Another decision applying similar reasoning is State Farm Mutual Automobile Insurance Co. v. Crane. Crane was a declaratory judgment action arising from a serious car accident. 3 3 The accident left Crane a paraplegic. The tortfeasor carried a liability policy with a policy limit of $25, Prior to the time that Crane filed suit in the underlying tort case, State Farm, the torfeasor's insurer, offered its policy limit to settle. 5 Crane refused this offer. He filed suit, and then filed an offer to settle for $499, pursuant to California Code of Civil Procedure 998 and California Civil Code Cox, 774 F. Supp. at Id. at Id. 31. Id. (emphasis added) Cal. Rptr. 422 (Cal. App. 1990). 33. Id. at 423. A declaratory judgment action is typically filed by an insurer that believes that it has no obligation to provide coverage to an insured. Such actions seek a judicial determination of whether an insurer has an obligation to defend and to indemnify its insured. See KEETON, supra note 7, 7.6(d)(4). 34. Crane, 266 Cal. Rptr. at Id. at Id. at The Crane case demonstrates how typical prejudgment interest statutes can actually encourage litigation in cases involving low policy limits and large damages. The claimant has nothing to lose by engaging in further litigation. Section 998 is a form of "trigger" statute that can shift the burden of paying a party's litigation costs to the opposing party based on the rejection of an offer to settle and the failure to

13 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 371 In the declaratory judgment action, State Farm sought adjudication of its obligation to pay prejudgment interest under its policy. 37 Like the policy in Cox, the State Farm policy at issue in Crane was silent on prejudgment interest, but did include a supplementary payments provision providing coverage for postjudgment interest. 8 Construing this provision in dicta, the court stated that under California law, a layperson would expect that the provision would provide coverage for prejudgment interest as well as for postjudgment interest. 9 In other words, the court interpreted the policy based upon the "reasonable expectations" of the insured. Although the court ultimately affirmed the trial court's decision holding that State Farm had no obligation to pay prejudgment interest after tendering an offer at the policy limits, the court's reasoning demonstrates an "activist" approach toward expanding a supplementary payments provision to include an obligation to pay prejudgment interest.4 Given decisions like Cox and Crane and commentary like that expressed in the Pierce article, it is not surprising that insurers have reacted by attempting to limit their obligations to pay prejudgment interest by policy language. Prejudgment interest on unliquidated damages poses problems in predicting the value of any given case. After all, if the value of a case is not actually determined until a jury renders its verdict, the amount of prejudgment interest, if any, is also not known, and may depend upon a number of factors such as the amount of obtain a result at trial more favorable than the opposing party's offer to settle. See CAL. CIv. PROC. CODE 998 (Deering 2000). Section 998 can also trigger prejudgment interest under Civil Code In any action brought to recover damages for personal injury... [i]f the plaintiff makes an offer pursuant to Section 998 of the Code of Civil Procedure which the defendant does not accept.., and the plaintiff obtains a more favorable judgment, the judgment shall bear interest at the legal rate of 10 percent per annum calculated from the date of the plaintiff's first offer pursuant to Section which is exceeded by the judgment, and interest shall accrue until the satisfaction of the judgment. CAL. CIV. CODE 3291 (Deering 2000). 37. Crane, 266 Cal. Rptr. at Id. at Id. at Id. at The judicial expansion of existing policy language to provide coverage for prejudgment interest has not received universal acceptance. See, e.g., Allstate Ins. Co. v. Allen, 797 P.2d 46 (Colo. 1990) (reversing a Colorado Court of Appeals decision holding that insurer was obligated to pay prejudgment interest in excess of its $25,000 policy limit based upon language of the "additional payments" section of the applicable policy).

14 QLR [Vol. 20:359 settlement offers under "escape hatch" and "trigger" prejudgment interest statutes. Even if it is possible for adjusters to estimate the verdict value of a case and hence have a rough idea of total exposure with prejudgment interest, limiting exposure to a fixed policy limit is obviously more appealing and predictable to insurers. One such attempt at limiting exposure to a fixed amount is set forth in the 1984 edition of I.S.O. homeowner's policies. 41 The "supplemental coverages" section of the policy states that the insurer will pay "prejudgment interest awarded against the 'insured' on that part of the judgment we pay. If we make an offer to pay the applicable limit of liability, we will not pay any prejudgment interest based on that period of time after the offer., 42 The terms of this provision attempt to limit insurers' obligations to pay prejudgment interest to the liability limit of policies. The terms of the provision also allow insurers to avoid the payment of prejudgment interest by offering to pay their policy limits. Subsequently, I.S.O. forms imposed further restrictions upon the payment of prejudgment interest. For example, endorsement HO deleted the language referring to prejudgment interest. Furthermore, the endorsement specifically defines prejudgment interest as damages subject to the limits of liability of the policy." Later I.S.O. policies include language defining prejudgment interest as damages within the policy itself. I.S.O. form HO is an example of such a policy. It states: If a claim is made or a suit is brought against an "insured" for damages because of "bodily injury" or "property damage" caused by an "occurrence" to which this coverage applies, we will: [play up to our limit of liability for the damages for which the "insured" is legally liable. Damages include prejudgment interest awarded against the "insured"...45 This new language seems clear and precise. It would also seem to set the stage for a direct confrontation between the public policies of 41. Insurance Services Office, HO-3 (Ed. 4-84) 11 (1984) (on file with the Quinnipiac Law Review). 42. Id. 43. Insurance Services Office, HO-350 (Ed. 9-87) 3 (1987) (on file with the Quinnipiac Law Review). 44. Id. 45. ALLIANCE OF AMERICAN INSURERS, THE INSURANCE PROFESSIONALS' POLICY KTr 38 (2000) (containing examples of I.S.O. forms including homeowner's special form HO ).

15 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 37 prejudgment interest statutes and the competing public policies favoring the enforcement of insurance contracts whose language is not ambiguous. After all, it is difficult for a litigant to argue that an ambiguity exists, or for a judge to find that such an ambiguity exists, in an insurance policy provision that specifically defines prejudgment interest as damages subject to a policy limit. Unless courts are willing to apply truly tortured reasoning, courts construing this new policy language will have to either void it or enforce it. In sum, the new policy language is best seen as an attempt by insurers to avoid further decisions like Cox or Crane. II. CLOSE BUT No CIGAR: THE ARGUMENTS IN FAVOR OF HOLDING LIABILITY INSURERS RESPONSIBLE FOR PREJUDGMENT INTEREST IN EXCESS OF THEIR POLICY LIMITS As discussed in Part I, given the recent changes in I.S.O. policies, it appears that courts addressing the issue of liability insurers' obligations to pay prejudgment interest will no longer be able to "take the easy way out" and manipulate policy language to hold insurers liable for prejudgment interest in excess of their policy limits. Nonetheless, there are longstanding public policy arguments for voiding the new policy language, some of which are more compelling than others. With respect to these public policy arguments, changes to the language of newer I.S.O. policies are irrelevant. Although there are a number of variations, the arguments for holding insurers liable for prejudgment interest in excess of their policy limits fall into two basic themes or arguments: the compensation of plaintiffs for the loss of use of money and the encouragement of settlement. A. The Compensation Argument for Holding Insurers Liable for Prejudgment Interest in Excess of Their Policy Limits One common public policy argument for holding liability insurers responsible for prejudgment interest is that "[i]t is often necessary to award prejudgment interest to achieve full and just compensation for an injured plaintiff due to the delay in payment of funds owed him as a result of injuries inflicted by the defendant., 46 In the words of another commentator, 46. Pierce, supra note 8, at 631. While Pierce argued that plaintiffs should receive prejudgment interest to compensate them for the loss of use of money, he advocated the

16 QLR [Vol. 20:359 If the insurer is not liable for prejudgment interest in excess of the policy limits, this burden will fall on the insured... A loophole enabling insurers to delay litigation, knowing their liability is fixed at the policy limits circumvents the entire purpose for awarding prejudgment interest. Equity requires that insurers be liable for all prejudiment interest, including a sum which exceeds the policy limits of the insured. This compensation argument rests on several assumptions. The argument assumes that the purpose of prejudgment interest statutes is to provide compensation to plaintiffs for the loss of use of money and that insurers should pay prejudgment interest in excess of policy limits since they typically control insureds' defenses under most liability insurance policies. 8 Another assumption of this argument is that insurers controlling insureds' defenses routinely delay settlement for as long as possible. It also may, rather naively, assume that plaintiffs' attorneys are entirely reasonable in their demands. According to the argument, because the insurer controls the defense and ultimately makes the decision as to whether or not to try a case, the insurer should have to pay prejudgment interest imposed on the defendant/insured by statute. This argument is similar to the reasoning employed by the court in Cox, 4 9 in which the court concluded that prejudgment interest was a "defense cost" under the terms of the applicable policy. 50 The public policy argument forwarded by Brown reaches the same result as Cox, except that it takes the more intellectually honest approach of advocating the voiding of policy language. While the Pierce/Brown compensation argument seems attractive, it becomes less compelling under closer scrutiny. The argument that prejudgment interest statutes are about compensating plaintiffs for the loss of use of money is hard to justify when a prejudgment interest statute awards prejudgment interest on future damages." Some prejudgment interest statutes, such as Texas, Colorado, Iowa, and Rhode expansion of policy language to provide coverage for such interest rather than arguing in favor of voiding policy language and holding insurers liable for prejudgment interest as a matter of public policy. See id. at Brown, supra note 1, at See text accompanying supra notes F. Supp. 83 (D. Conn. 1991). 50. Id. at 86; see also text accompanying supra notes See Dean Richard, An Award Fit for Alice in Wonderland, 25 TEX. TECH. L. REv. 955, (1994). The amount of future damages is the monetary value of the harm or injuries that a plaintiff has not yet sustained as of the date of judgment. See id. at , n.10.

17 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 37, Island, allow prejudgment interest for future damages. It becomes much more difficult to argue for holding insurers liable for prejudgment interest on the ground that their delay has deprived the plaintiff of the use of money for damages not yet incurred and for money not yet expended. Likewise, with "escape hatch" and "trigger" prejudgment interest statutes, the Brown argument falls flat on its face. With a typical "trigger" statute, no prejudgment interest accumulates until the making of a formalized offer to settle as required by the statute. 3 With an "escape hatch" statute, the making of a settlement offer of a sufficient amount when compared to the final judgment means that the defendant does not have to pay prejudgment interest. 4 If the real goal of such statutes was compensation, it is doubtful that they would have a settlement component. Even with some "mandatory" prejudgment interest statutes, compensation of plaintiffs is not the purpose of the statute. Instead the stated purpose is encouraging settlement. 55 The compensation argument is also less tenable in the context of non-economic damages such as those for pain and suffering. In any 52. See also Scholz v. Metro. Pathologists, P.C., 851 P.2d 901, 908 (Colo. 1993) (discussing COLO REv. STAT (1987)). See generally Richard, supra note 51, at 963 (discussing TEx. REV. CIv. STAT. art (Vernon 1994), making prejudgment interest recoverable as to future damages). In Iowa, in the context of an underinsured motorist claim, the Iowa Supreme Court held that prejudgment interest under IOWA CODE was permissible and that the insurer was obligated to pay prejudgment interest in excess of its policy limit. See Vasquez v. Lemars Mut. Ins. Co., 477 N.W.2d 404, 410 (Iowa 1991) (distinguishing Farm Bureau Mutual Ins. Co. v. Milne, 424 N.W.2d 422 (Iowa 1988), on the ground that it involved a third-party claim rather than a first-party underinsured motorist action governed by contract law). See also KEETON, supra note 7, at For a discussion of Rhode Island law, see Pray v. Narragansett Improvement Co., 434 A.2d 923, (R.I. 1981), which holds that in wrongful death action, no error when trial court awarded prejudgment interest on jury's award, which had been reduced to its present value pursuant to statute. See also LaPlante v. Am. Honda Motor Co., Inc., 27 F.3d 731, (1st Cir. 1994) (applying Rhode Island law, court affirmed award of prejudgment interest for future damages). In reaching its conclusion, the First Circuit rejected the defendant's argument that it would defy common sense to award prejudgment interest to compensate the plaintiff for money not yet expended. The court noted that the compensation of plaintiffs for the loss of use of money was not the primary purpose of section Instead the legislature intended the statute to serve as an encouragement to the settlement of claims. LaPlante, 27 F.3d at 744 (citing DiMeo v. Philbin, 502 A.2d 825, 826 (R.I. 1986)). 53. See, e.g., CONN. GEN. STAT a (1999) (trigger statute). 54. See, e.g., MICH. STAT. ANN. 27A.6013 (West 2000) (escape hatch statute). 55. See Skaling v. Aetna Ins. Co., 742 A.2d 282, 292 (R.I. 1999) (stating that purpose of Rhode Island's "mandatory" prejudgment interest statute "is the encouragement of early settlement of claims").

18 QLR [Vol. 20:359 given case the value of such damages is hard to predict and is not known until the jury or court renders its decision. In such a situation, to argue that an insurer has "deprived" the plaintiff of the loss of use of this money seems to be a legal fiction. On the other hand, the compensation model for holding insurers liable for prejudgment interest in excess of their policy limits works better with actual, out-of-pocket expenses such as lost wages and medical bills not paid by health insurance. Such damages are tangible, quantifiable, and the date upon which the plaintiff incurs the damages is ascertainable. In a case where liability is clear and an insurer withholds payment of such expenses, there is a more colorable argument for awarding prejudgment interest to compensate the plaintiff for the loss of use of this money. Thus, there is a much better argument that an insurer should have to pay prejudgment interest for such damages in excess of the applicable policy limit. Finally, the argument in favor of holding insurers liable for all amounts of prejudgment interest on a judgment as a means of compensation seems a stretch given that it is permissible for insurers to sell liability insurance policies of fixed limits. If an insurer's maximum payment to an injured plaintiff on behalf of its insured is the policy limit, the most money that the insurer can deprive a plaintiff of by delaying settlement is the amount of the policy. It would seem that if an insurer has to pay prejudgment interest in excess of its policy limit at all, the payment of prejudgment interest should be based on the policy limit. The Pierce/Brown compensation argument ignores this and would hold insurers liable on the entire amount of a judgment. For all of these reasons, the Pierce/Brown argument has significant flaws. B. The Settlement Arguments for Holding Insurers Liable for Prejudgment Interest in Excess of Their Policy Limits The flaws in the Pierce/Brown compensation argument do not necessarily apply with as much force to other public policy arguments based on the settlement theme. One of these arguments is that liability insurers should be responsible for the payment of prejudgment interest in excess of their insureds' policy limits because prejudgment interest statutes are really measures meant to govern insurer settlement behavior. In other words, the typical prejudgment interest statute is not meant to provide compensation to plaintiffs for the loss of use of money. Instead, such statutes take into account the fact that "the vast

19 2001] WHEN STATUTES AND POLICY LANGUAGE COLLIDE 371 majority of tort judgments are paid by insurance companies" 6 and that insurance companies control the defense of such cases. 57 Thus, the potential exposure for prejudgment interest creates an economic incentive to settle on the part of the insurer. Trial becomes economically less attractive to the insurer controlling an insured's defense if there is the potential for substantial sums of prejudgment interest being "tacked on" to the expected verdict. Under this theory, allowing insurers to avoid liability for prejudgment interest in excess of their policy limits may blunt some of the economic incentives for settlement that are created by prejudgment interest statutes. This theory assumes that in a close case where the judgment expectation might or might not exceed the policy limit, taking into account exposure for prejudgment interest, an insurer may prefer to "roll the dice" and try a case if its exposure is capped at the policy limit. On the other hand, there is less incentive to "gamble" with a trial if the insurer is liable for prejudgment interest in excess of its policy limit. Instead, the insurer may increase its settlement efforts. On a related note, allowing insurers to avoid liability for prejudgment interest in excess of their policy limits may encourage insurers to act in a manner that is contrary to the interests of insureds. The insured bears the risk of exposure to prejudgment interest in excess of the policy limit at trial while the insurer controls the decision to try the case and stands to reap the result of the "gamble" if the trial result is favorable. The argument is that because the insurer stands to reap the "fruit" of a successful trial, as a matter of public policy, it should also have to bear the risk for exposure to prejudgment interest. With this argument, awarding prejudgment interest on future damages is justifiable. If prejudgment interest statutes are about encouraging insurers to settle, the potential for prejudgment interest on future damages creates additional economic encouragement to settle and creates additional risks in trying a case. 56. Denham v. Bedford, 287 N.W.2d 168, 171 (Mich. 1980). 57. A prior version of North Carolina's "mandatory" type prejudgment interest statute imposed prejudgment interest upon only those defendants covered by liability insurance. N.C. GEN. STAT (1981). This supports the view that prejudgment interest statutes are really about governing insurer settlement behavior and not about compensation to plaintiffs for the loss of use of money. See id. Unsurprisingly, the measure drew constitutional challenge on equal protection grounds. See Lowe v. Tarble, 323 S.E.2d 19, (N.C. 1984), affid on rehearing, 329 S.E.2d 648 (N.C. 1985). Since the time of the Lowe case, North Carolina has amended its prejudgment interest statute so that insured and uninsured defendants are treated the same. See N.C. GEN. STAT (2000).

20 QLR [Vol. 20:359 C. Michigan's Bench-Made Rule Obligating Insurers to Pay Prejudgment Interest in Excess of Their Policy Limits The foregoing public policy arguments in favor of holding insurers liable for prejudgment interest in excess of their policy limits have been adopted by the State of Michigan. The Michigan prejudgment interest statute 58 is an "escape hatch" provision that does not allow for prejudgment interest on future damages. "Interest shall be allowed on a money judgment recovered in a civil action, as provided in this section. However, for complaints filed on or after October 1, 1986, interest shall not be allowed on future damages from the date of filing the complaint to the date of entry of the judgment." 5 9 The "escape hatch" provision of the statute is that it provides a mechanism to stop the accumulation of interest through offers of settlement. If a bona fide, reasonable written offer of settlement in a civil action based on tort is made by the party against whom the judgment is subsequently rendered and is rejected by the plaintiff, the court shall order that interest not be allowed beyond the date the bona fide, reasonable offer of settlement is filed with the court.60 The offer-of-settlement provisions of the Michigan statute also apply to plaintiffs. It states, [I]f a bona fide, reasonable written offer of settlement in a civil action based on tort is made by a plaintiff for whom judgment is subsequently rendered and that offer is rejected and the offer is filed with the court, the court shall order that interest be calculated from the date of the rejection of the offer to the date of satisfaction of the judgment at a rate of interest equal to 2% plus the rate of interest computed under subsection (6).61 These components of the statute encourage litigants to make bona fide, reasonable settlement offers, as that term is defined in the statute. 62 Through the making of settlement offers, litigants have some control over the accumulation of prejudgment interest. 58. MICH. STAT. ANN. 27A.6013 (Michie 2000). 59. Id. 27A.6013(1). 60. Id. 27A.6013(7). 61. Id. 27A.6013(l 1) (providing for a flexible interest calculation based on the average interest rate for five-year treasury bills, plus one percent). 62. MICH. STAT. ANN. 27A.6013(13).