A recent Minnesota coverage decision provides guideposts for a commercial policyholder’s proper handling of an insurance claim as well as a cautionary tale regarding an excess insurer’s attempt to readjudicate liability in a subsequent coverage action.
In RSUI Indemnity Company v. New Horizon Kids Quest, Inc., the commercial policyholder (1) promptly and properly notified its primary insurer and its excess insurer (RSUI) of a potentially covered claim; (2) involved those insurers in the underlying defense strategy; and (3) stipulated to liability in a manner that avoided a potentially applicable exclusion (and with the insurers’ consent). Nevertheless, after the verdict, the excess insurer attempted to readjudicate liability in a coverage action by arguing that an exclusion applied. The court, in a thoughtful decision, rejected the excess insurer’s arguments and granted summary judgment to the policyholder.
The Underlying Case
In the underlying case, a child’s parents sued the policyholder alleging that their 3-year-old son was physically and sexually assaulted by a 9-year-old child while both were under the policyholder’s care, custody, and control. In consultation with both the primary insurance insurer and the excess insurer, the policyholder did not contest liability, conceded that an “assault” occurred, but disputed the “nature, type, and extent of” the injuries sustained by the minor child. The jury awarded $13 million in damages against the policyholder (later reduced to $6 million after a second trial), but did not determine whether a “sexual assault” occurred because it was not asked to do so. After the jury award in the underlying case, the excess insurer filed a coverage action seeking to avoid paying the excess verdict by invoking a sexual abuse exclusion.
The Coverage Litigation
In the coverage litigation, the court determined that although the jury was presented with evidence of sexual assault in the underlying case, the presentation of evidence alone was insufficient to support the excess insurer’s exclusion defense because the jury was not asked to determine whether a sexual assault occurred. The court explained, “With no insights into the jury’s method of awarding damages, and no effort by anyone—including RSUI—to ask the jury to parcel out its award, any conclusion at this stage that same or all of the damages arose from sexual abuse—whether by the undersigned or a new jury—would constitute pure and unfettered speculation.” Additionally, the court noted that the excess insurer participated in both trials in the underlying litigation (more substantially in the second trial) and consented to the policyholder’s admission of liability.
Guideposts and Warnings for Commercial Policyholders
Promptly and Properly Notify All Insurers Potentially on the Risk
Providing prompt notice to all insurers on the risk, including excess insurers that may be impacted by a judgment or settlement, can avert unnecessary coverage litigation or at least place the policyholder in a better position if coverage litigation later ensues. In this case, the policyholder promptly and properly notified both its primary insurer and its excess insurer, thus avoiding a preemptive challenge to coverage based on late notice or failure to comply with applicable notice provisions. Although not apparent from the court’s decision, providing prompt notice better positioned the policyholder in the later coverage litigation as well by focusing the insured on its insurance coverage as it formulated its defense to the lawsuit. In addition, an insurer’s failure to assert certain defenses or, conversely, its participation and endorsement of particular defense strategies, may estop the insurer from raising particular defenses in a subsequent coverage litigation, as occurred in this case.
Mitigate Risks Arising from Different Defenses Asserted by Excess Insurers
As this case demonstrates, primary and excess insurers may take different coverage positions, even when the excess policy follows form or incorporates language similar to the primary policy. This decision does not reveal whether the excess policy followed form or included a different exclusion. If the former, the excess insurer adopted a coverage position different than the primary insurer based on similar policy language. A primary insurer with the duty to defend must support defense strategies that are in the policyholder’s best interest even if those defenses are detrimental to the insurer’s potential coverage defenses. This conflict – which must be resolved in favor of the policyholder where the duty to defend is concerned – may preclude the primary insurer from asserting certain exclusions that require a liability determination. In contrast, an excess insurer with no defense obligation may not face the same conflict of interest and therefore may be better positioned to assert certain coverage defenses not available to the primary insurer bearing the defense obligation.
A savvy policyholder can mitigate certain excess insurer coverage defenses by involving the excess carrier in the defense of the underlying claim (or providing an opportunity for the excess carrier to decline to be involved). In this case, the policyholder promptly notified the excess insurer, consulted the excess insurer during the underlying litigation, and obtained the excess insurer’s approval of the admission of liability – critical facts that the court relied on when ruling in favor of coverage. By involving the excess insurer, the policyholder preserved coverage under both policies. Policyholders should be aware that different insurers may take different coverage positions – even on the same policy language – and take steps to mitigate that risk, as did the policyholder in this case.
Coordinate Defense and Insurance Recovery Strategies
Commercial policyholders can minimize uninsured losses by coordinating defense and insurance recovery strategies. While an insurance recovery strategy should not drive the defense of an underlying claim, coordination of the best available defenses to the underlying case with available insurance recovery strategies can minimize a commercial policyholder’s ultimate exposure. In this case, the policyholder coordinated its defense and insurance recovery strategies by admitting liability but disputing damages. This approach is an important strategic option available for policyholders seeking to maximize insurance recovery in litigation that involves both covered and uncovered claims. Admitting liability to avoid an unfavorable jury finding on an uncovered claim can help preserve insurance coverage for the entire liability. While asserting a strong liability defense for the uncovered claim or settling the entire matter may be a preferable option when available, an admission of liability can be an effective risk mitigation strategy. In a minority of cases, policyholders may adopt defense strategies that maximize insurance recovery at the expense of the underlying defense. To minimize liability and maximize insurance recovery, policyholders should carefully consider the risks and rewards of available insurance recovery strategies early in the defense of the underlying litigation (if not before).
Follow Form Coverage Does Not Always Follow Form
This case also highlights the discrepancies that can sometimes arise between different layers of insurance. Although the primary insurer defended under a reservation of rights and subsequently paid its share of the judgment, the excess insurer disputed coverage based on the sexual assault exclusion. The court’s decision does not specify whether the primary insurance policy included a sexual assault exclusion, but does note that the primary insurer defended under a reservation of rights. Assuming that the primary policy did not incorporate a sexual assault exclusion, the policyholder could have avoided the coverage with its excess insurer by ensuring that its excess policy followed the primary policy form without any additional exclusions. Although there are exceptions to every rule, policyholders rarely benefit from excess coverage that is more restrictive than their primary coverage. Commercial policyholders should carefully review their coverage towers to ensure that their insurance protection is coordinated across the primary and excess layers.
Past Insurer Cooperation Does Not Guarantee an Insurance Recovery
Finally, an insurer’s cooperation in the defense of an underlying claim does not preclude that insurer from later disputing coverage, especially when the insurer issues a reservation of rights letter. Disputes can arise despite an ongoing business relationship between the policyholder and the insurer. In this case, the excess insurer received prompt and proper notice of the claim, monitored the litigation through the first trial, consented to a defense strategy, actively participated in the defense of the second trial, and then denied coverage only after the second trial. These events underscore the need to proceed carefully when seeking insurance coverage. The outcome in this case may not have been the same if the policyholder had not complied with its notice obligations and involved the excess insurer in the underlying case.