5-35 DEFENSE & SETTLEMENT OF CLAIMS 5.05[1]

5-35 DEFENSE & SETTLEMENT OF CLAIMS 5.05[1] 5.05 The Professional Liability Insurer s Settlement-Related Duties Most liability insurance policies grant the insurer not only the right to control the insured s defense, but also the right to control settlement of claims against the insured. For example, a typical policy provision permits the insurer to enter into any settlement of claims against the insured that the insurer deems expedient. An insurer may not, however, completely disregard its insured s interests in considering whether to settle a claim against the insured. The case law regarding an insurer s duties with respect to settlement have developed along two lines: (1) cases examining an insurer s settlement duties with respect to those claims that the insured wishes to settle over the insurer s objections; and (2) cases examining an insurer s settlement duties with respect to those claims that the insurer wishes to settle over the insured s objections. [1] When Insurer Resists Settlement Sought by Insured There are a variety of reasons why an insured may seek to settle a claim over an insurer s objections. Most commonly, the insured is facing a potential verdict in excess of the policy limits and seeks to have the insurer accept a settlement demand within limits, even though the insurer believes that the settlement demand is excessive. Under such circumstances, an insurer s duties with respect to settlement may be said to arise on a number of bases. Some courts have held that the insurer s duty to consider settlement arises on the basis of its fiduciary obligations to the insured. 1 In some jurisdictions, the duty to consider settlement also may arise under claims handling statutes. 2 More generally, however, courts have recognized that where 1 Smith v. Blackwell, 791 P.2d 1343, 1346 (Kan. App. 1989) (duty to consider settlement results from [t]he fiduciary relationship of the insurer and the insured [which] imposes a duty upon the insurer to make reasonable efforts to negotiate a settlement of a claim against the insured. ). 2 Illinois: Van Vleck v. Ohio Casualty Insurance Co., 471 N.E.2d 925, 927 (Ill. App. 1984) (section 154.6(d) of the Illinois Insurance Code makes it an unfair claim practice for an insurer to not attempt[] in good faith to effectuate prompt, fair and equitable settlement of claims submitted in which liability has become reasonably clear ). Massachusetts: Hartford Casualty Insurance Co. v. New Hampshire Insurance Co., 628 N.E.2d 14, 17 (Mass. 1994) (insurer commits statutory unfair practice in failing to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear ).

5.05[1] PROFESSIONAL LIABILITY INSURANCE 5-36 the insured has ceded control of settlement to the insurer, the carrier bears a duty of good faith toward the insured with respect to considering settlement. 3 In connection with this duty, the insurer must exercise reasonable care and diligence in determining whether to settle. 4 In this regard, the insurer has a duty to exercise the same degree of care and diligence as a person of ordinary care and prudence should exercise in the management of his own business. 5 For a decision against settlement to have been made in good faith, the insurer must have thoroughly evaluated all of the circumstances surrounding the claim and have consulted its insured. 6 Among the factors that courts have identified in reviewing the reasonableness of an insurer s decision whether to settle a claim against its insured are the following: (1) the strength of the claimant s case against the insured on liability and damages; (2) the defense lawyer s evaluation of the insured s defenses and potential liability; and (3) the amount of financial risk to the insurer and the insured in the event that a settlement is not reached. 7 Courts differ as to whether consideration Montana: Mont. Code Ann. 33-18-201(6) (insurers cannot neglect to attempt in good faith to effectuate... settlements of claims in which liability has become reasonably clear ). New York: State of New York v. Merchants Insurance Co. of New Hampshire, 486 N.Y.S.2d 412, 413 (N.Y. App. Div. 1985) ( Insurance Law 2601(a)(4) notes, enter alia, that it is an unfair trade practice for insurers not [to attempt] in good faith to effectuate prompt, fair and equitable settlements of claims submitted in which liability has become reasonable clear ). 3 Florida: Boston Old Colony Insurance Co. v. Gutierrez, 386 So.2d 783, 785 (Fla. 1980) (when an insured has surrendered control to the carrier, the insurer had a duty to make decisions in good faith and with due regard for the interests of the insured). Wisconsin: Baker v. Northwestern National Casualty Co., 132 N.W.2d 493, 496 (Wis. 1965), overruled on other grounds by DeChant v. Monarch Life Insurance Co., 547 N.W.2d 592, 598 (Wis. 1996) (an insurer has the duty to investigate and evaluate the claim against its insured, and to inform its insured of all settlement offers and negotiations). 4 Perry v. U.S. Fidelity & Guaranty Co., 359 S.W.2d 1, 6-7 (Tenn. App. 1962) (insurer must exercise such ordinary care and diligence as will allow it to exercise an honest judgment regarding whether the claim should be settled). 5 Florida: Boston Old Colony Insurance Co. v. Gutierrez, 386 So.2d 783, 785 (Fla. 1980). Texas: Stowers Furniture Co. v. American Indemnity Co., 15 S.W.2d 544 (Tex. App. 1929) (insurer must exercise same degree of prudence that ordinarily prudent person would exercise in management of own business). 6 Mowry v. Badger State Mutual Casualty Co., 385 N.W.2d 171, 178 (Wis. 1986) ( a decision not to settle a claim must be based on a thorough evaluation of the underlying circumstances of the claim and on informed interaction with the insured. ). 7 Bollinger v. Nuss, 449 P.2d 502, 512 (Kan. 1969).

5-37 DEFENSE & SETTLEMENT OF CLAIMS 5.05[2] of these factors will require an insurer to take into account the potential of a punitive damages award against the insured. 8 The factors are examined on the basis of the information available to the insurer at the time it was considering settlement. 9 Courts are divided regarding the extent to which it is appropriate for an insurer to consider its potential coverage defenses in determining whether and at what amount to settle a claim against an insured. A number of states have held that a carrier is entitled to consider its coverage defenses in connection with settlement evaluation. 10 Other courts, however, have held that an insurer may not include consideration of its coverage defenses in determining whether to settle. 11 [2] When Insured Resists Settlement Sought by Insurer At times, the insured may object to and seek to block a settlement that the insurer proposes to accept. Such objections are particularly frequent in the area of professional liability insurance, where settlement of claims against the professional may be seen as undesirable by the insured because of their real or perceived effect on the insured s professional reputation or on the insured s future ability to 8 Some courts have required insurers to give consideration to the insured s exposure to punitive damages in determining whether or not to accept a settlement offer. See, e.g.: Fifth Circuit: Ging v. American Liberty Insurance Co., 423 F.2d 115, 116 (5th Cir. 1970). Tenth Circuit: Magnum Foods, Inc. v. Continental Casualty Co., 36 F.3d 1491, 1505-1506 (10th Cir. 1994). 9 Glenn v. Fleming, 799 P.2d 79, 85 (Kan. 1990). 10 Florida: Robinson v. State Farm Fire & Casualty Co., 583 So.2d 1063, 1068 (Fla. App. 1991). Illinois: Stephenson v. State Farm Fire & Casualty Co., 628 N.E.2d 810, 813 (Ill. App. 1993). Kansas: Snodgrass v. State Farm Mutual Automobile Insurance Co., 804 P.2d 1012, 1022 (Kan. App. 1991). New York: Dawn Frosted Meats, Inc. v. Insurance Co. of North America, 470 N.Y.S.2d 624 (N.Y. App. Div. 1984). Tennessee: National Service Fire Insurance Co. v. Williams, 454 S.W.2d 362, 365 (Tenn. App. 1969). Wisconsin: Mowry v. Badger State Mutual Casualty Co., 385 N.W.2d 171, 178 (Wis. 1986). 11 Arizona: State Farm Auto Insurance Co. v. Civil Service Employees Insurance Co., 509 P.2d 725, 733 (Ariz. App. 1973). California: Johansen v. California State Auto Ass n Inter-Insurance Bureau, 538 P.2d 744 (Cal. 1975). Louisiana: Trahan v. Central Mutual Insurance Co., 219 So.2d 187, 194 (La. App. 1969).

5.05[2] PROFESSIONAL LIABILITY INSURANCE 5-38 obtain malpractice insurance at reasonable rates. In addition, the insured may object to a settlement if the majority of the payment to the claimant will be funded by the insured pursuant to a deductible or selfinsured retention provision in the policy. Where the insurer is granted the right to control settlement of claims against the insured and settles a claim within its policy limits, courts have not been particularly receptive to claims against the insurer for wrongful settlement. In Shuster v. South Broward Hospital District Physicians Professional Liability Insurance Trust, for example, the insurer settled a claim against an insured doctor over the doctor s objections. 12 The policy at issue provided that the insurer would have the right to settle any claims against the insured as it deems expedient. The insured, however, objected to the proposed settlement on the basis that it exceeded the reasonable value of the claims against him and would render future malpractice insurance unobtainable for certain procedures, thus subjecting him to diminished income as a result of no longer being able to perform those procedures. Noting that the policy language granted the insurer broad discretion in determining whether to settle claims, the court rejected the insured s claims: [The policy]... expressly provides that the insurer can settle as it deems expedient. As the district court pointed out, expedient is defined in Webster s New World Dictionary, College Edition as useful for effecting a desired result, and based on or offering what is of use or advantage rather than what is right or just; guided by self interest. The language of the provision is clear and the insured was put on notice that the agreement granted the insurer the exclusive authority to control settlement and to be guided by its own self-interest when settling the claim for amounts within the policy limits. The obvious intent behind placing the provision in the agreement was to grant the insurer the authority to decide whether to settle or defend the claim based on its own self-interest.... 13 Other courts similarly have held that an insurer has broad discretion in settling claims against its insured within policy limits, and that a cause of action normally will not lie for the insurer s doing so over 12 Shuster v. South Broward Hospital District Physicians Professional Liability Insurance Trust, 591 So.2d 174 (Fla. 1992). 13 Id., 591 So.2d at 176-177.

5-39 DEFENSE & SETTLEMENT OF CLAIMS 5.05[2] the objection of its insured. 14 Some courts, however, have allowed the insured to pursue claims for wrongful settlement on the basis that the insurer s decision to settle imposed liability on the insured. 15 Some insurers now include a so-called hammer clause in their professional liability policies that is intended to explicitly deal with the situation in which an insurer recommends a settlement to which the insured objects. Under such a provision, if the insured declines to participate in a settlement recommended by the insurer, the insurer s further liability for defense costs may be cut off and the insured may become liable for any later settlement or judgment to the extent it exceeds the amount at which the insurer recommended settlement. One such clause provides: If, however, the named insured shall refuse to consent to any settlement recommended by the Company, and shall continue litigation at the trial level or at the appellate level in connection with such claim, then the company s liability for that claim shall not exceed the amount for which the claim would have been settled plus the cost and expenses incurred with the Company s consent up to the date of such refusal to settle. 14 Alabama: Mitchum v. Hudgens, 533 So.2d 194 (Ala. 1988) (insurer not compelled to seek the insured s permission before settling a claim). California: Western Polymer Technology, Inc. v. Reliance Insurance Co., 38 Cal. Rptr.2d 78, 85 (Cal. App. 1995), review denied (Cal. April 13, 1995) ( No reasonable reading of [the deems expedient language] would create an expectation that the insurer has to forgo settlement in favor of vindicating the insured s reputation. ). Idaho: Selkirk Seed Co. v. State Insurance Fund, 22 P.3d 1028 (Idaho 2000). New Jersey: Frankel v. St. Paul Fire & Marine Insurance Co., 759 A.2d 869 (N.J. App. 2000) (bad judgment on the part of the insurer does not constitute bad faith given the insurer s broad discretion in disposing of third party claims) North Carolina: Cash v. State Farm Mutual Automobile Insurance Co., 528 S.E.2d 372 (N.C. App. 2000) (recognizing that an insurer, when settling claims with a third party, acts in its own self-interest). Ohio: Marginian v. Allstate Insurance Co., 481 N.E.2d 600 (Ohio 1985) (where a contract of insurance provides that the insurer may, as it deems appropriate, settle any claim or action brought against its insured, a cause of action alleging a breach of the insurer s duty of good faith will not lie where the insurer has settled such claim within the monetary limits of the policy). 15 Fifth Circuit: National Service Indus., Inc. v. Hartford Accident & Indemnity Co., 661 F.2d 458 (5th Cir. 1981) (where insurer proposed to settle claim in a manner that would require policyholder to pay deductible under two policies instead of one, insurer was required to obtain policyholder s consent). State Courts: Louisiana: Employers Surplus Line Insurance Co. v. City of Baton Rouge, 362 So.2d 561 (La. 1978) (where insurer settled claim for $75,000 and policy had a $10,000 deductible, insurer could not recover $10,000 deductible from policyholder unless policyholder consented to the settlement).

5.05[3] PROFESSIONAL LIABILITY INSURANCE 5-40 Less extreme versions of the hammer clause may provide that in the event the insured declines a settlement proposed by the insurer, the insurer will pay only a set percentage of future defense costs or of the amount by which any future settlement or judgment exceeds the recommended settlement. Although there is a relative paucity of case law interpreting and applying these clauses, at least one court has indicated that such clauses may be applied only if the insured unreasonably withholds consent to the settlement recommended by the insurer. 16 Another court has held that an insurer may rely on a hammer clause only if the settlement recommended by the insurer was one that would have extinguished the insured s liability to the claimant. 17 Regardless of whether a settlement over the insured s objections is deemed to be a breach of duty by the insurer, insurer-retained defense counsel should be sensitive to the potential conflict of interest that can develop around such a disagreement. In Rogers v. Robson, Masters, Ryan, Brumund & Belom, for example, a physician sued his insurer-retained attorneys for settling a malpractice claim without his consent, even though the doctor s insurance policy gave the insurer the right to settle. The court held that the attorneys had breached their duties to the insured in settling over his objection: Apart from any considerations arising from the insurance policy, we believe that when defendant became aware that a settlement was imminent because of the preferences of the insurance company, and that their other client, the plaintiff, did not want the case settled, a conflict arose and defendant could not continue to represent both without a full and frank disclosure of the circumstances to its clients. Furthermore, the general duties of the defendant in representing plaintiff were strengthened by the defendant agreeing, if it did, to defend the case rather than settle. Having continued representing both the insurer and insured without the requisite disclosure, defendant breached its duty to plaintiff. 18 [3] When an Insurer s Settlement Duties Ripen Another issue that frequently has arisen with respect to an insurer s duties regarding settlement is the point at which those duties ripen. Although it is clear that once a settlement demand within policy limits is received by the insurer, the insurer s duties to evaluate 16 Clauson v. New England Insurance Co., 254 F.3d 331 (1st Cir. 2001). 17 Security Insurance Co. v. Schipporeit, Inc., 69 F. 3d 1377 (7th Cir. 1995). 18 Rogers v. Robson, Masters, Ryan, Brumund & Belom, 392 N.E.2d 1365, 1371-1372 (Ill. App. 1979), aff d 407 N.E.2d 47 (Ill. 1980).

5-41 DEFENSE & SETTLEMENT OF CLAIMS 5.05[3] settlement possibilities ripen, courts have reached differing conclusions with respect to whether an insurer owes a duty to its insured to initiate settlement discussions with a claimant. Some courts have held that an insurer does not have such a duty. 19 The modern trend, however, appears to support the notion that, in appropriate circumstances, an insurer has a duty to initiate settlement discussions on behalf of its insured. 20 In this regard, insurers must be especially cognizant of the potential applicability of claims-handling statutes and regulations that may be interpreted as imposing on the insurer a duty to consider settlement even before a settlement demand is received from the underlying claimant. 21 Oregon s Insurance Code, for example, can be read to impose on the insurer a duty to seek settlement once liability becomes reasonably clear. Under that code, an insurer has engaged in an unfair claim settlement practice by [n]ot attempting, in good faith, to promptly and equitably settle claims in which liability has become reasonably clear. 22 19 Fifth Circuit: Commercial Union Insurance Co. v. Mission Insurance Co., 835 F.2d 587, 588 (5th Cir. 1988). State Courts: Minnesota: Short v. Dairyland Insurance Co., 334 N.W.2d 384, 387 (Minn. 1983). Texas: Birmingham Fire Insurance Co. v. American National Fire Insurance Co., 947 S.W.2d 592 (Tex. App. 1997). 20 Second Circuit: Hartford Insurance Co. v. Methodist Hospital, 785 F. Supp. 38, 40 (E.D.N.Y. 1992) (applying New York law). Tenth Circuit: City of Hobbs v. Hartford Fire Insurance Co., 162 F. 3d 576 (10th Cir. 1998). State Courts: Arizona: Fulton v. Woodford, 545 P.2d 979, 984 (Ariz. 1976). New Jersey: Rova Farms Resort, Inc. v. Investors Insurance Co., 323 A.2d 495 (N.J. 1974) (insurer, having restricted negotiating power of insured, has positive fiduciary duty to take the initiative and attempt to negotiate a settlement within the policy coverage). Oregon: Maine Bonding & Casualty Co. v. Centennial Insurance Co., 693 P.2d 1296, 1299 (Ore. 1985) (under Oregon law, insurer s duty may require that an insurer make inquiries to determine if settlement is possible within the policy limitations. ). Tennessee: State Auto Insurance Co. v. Rowland, 427 S.W.2d 30, 32-34 (Tenn. 1968) ( to hold as a matter of law that an [insurer] cannot be guilty of bad faith unless it received an offer... within the policy limits could most certainly lead to inequitable results. ). Wisconsin: Alt v. American Family Mutual Insurance Co., 237 N.W.2d 706, 710-711 (Wis. 1976). 21 Oregon: Goddard v. Farmers Insurance Co., 22 P.3d 1224 (Ore. App. 2001). Texas: ROCOR International, Inc. v. National Union Fire Insurance Co, 77 S.W.3d 253 (Tex. 2002). 22 Ore. Rev. Stat. 746.230(1)(f).

5.05[3] PROFESSIONAL LIABILITY INSURANCE 5-42 To the extent that an insurer directing the defense of a claim against its insured is charged with exercising the same degree of diligence that a party would exercise in the conduct of its own affairs, it is not surprising that courts would impose a duty on the insurer to pursue settlement discussions under circumstances in which an insured would do so on his or her own behalf. 23 Moreover, the imposition of such a duty on the insurer takes proper account of the insured s lack of control over the litigation process despite potential liability for an adverse verdict: The assured is not in a position to exercise effective control over the lawsuit or further his own interests by independent action, even when those interests appear in serious jeopardy. The assured may face the possibility of substantial loss which can be forestalled only by action of the carrier. Thus the assured may find himself and his goods in the position of a passenger on a voyage to an unknown destination on a vessel under the exclusive management of the crew. 24 Indeed, even those courts that have been hesitant to recognize a general duty on the part of insurers to initiate settlement discussions have held that such a duty may be imposed where circumstances, such as the high probability of an excess verdict against the insured, are present. 25 Moreover, some courts have even held that the duty to initiate settlement discussions need not await initiation of a lawsuit by the claimant, and that the insurer may have a duty to initiate settlement 23 See Coleman v. Holecek, 542 F.2d 532, 537 (10th Cir. 1976) (insurer s duty to settle arises if the carrier would initiate settlement negotiations on its own behalf were its potential liability equal to that of its insured. ). 24 Rova Farms Resort, Inc. v. Investors Insurance Co., 323 A.2d 495, 509 n.7 (N.J. 1974). 25 Fifth Circuit: Texoma Ag-Products v. Hartford Accident & Indemnity Co., 755 F.2d 445 (5th Cir. 1985) (insurer had duty to initiate settlement negotiations in case involving serious injuries and high likelihood of liability). State Courts: Florida: Powell v. Prudential Property & Casualty Insurance Co., 584 So.2d 12, 14 (Fla. App. 1991), review denied 598 So.2d 77 (Fla. 1992) (if an insured s liability is clear and the injuries of a claimant are so severe that a judgment in excess of policy limits is likely, the insurer has an affirmative duty to initiate settlement negotiations). Illinois: Kavanaugh v. Interstate Fire & Casualty Co., 342 N.E.2d 116 (Ill. App. 1975) (duty to initiate settlement negotiations where damages are likely to exceed limits and liability is likely).

5-43 DEFENSE & SETTLEMENT OF CLAIMS 5.05[3] discussions once it becomes aware of the existence of a claim or potential claim against its insured. 26 26 Fifth Circuit: Texoma Ag-Products, Inc. v. Hartford Accident & Indemnity Co., 755 F.2d 445 (5th Cir. 1985). Tenth Circuit: Roberts v. Printup, 422 F.3d 1011 (10th Cir. 2005). State Courts: Illinois: Haddick v. Valor Insurance, 763 N.E.2d 299 (Ill. 2001). Kansas: Smith v. Blackwell, 791 P.2d 1343 (Kan. App. 1989).