Equitable Subrogation: A Useful Tool for Your Excess Insurer When Your Primary Insurer Refuses to Settle Within its LimitsEvery policyholder will likely face a scenario where its primary insurer refuses a settlement offer within limits. The primary insurer is potentially liable for that excess verdict if it acted in bad faith by refusing to settle within limits. Sometimes, a primary insurer will roll the dice because the policyholder procured excess liability coverage that should pay any verdict above the primary limits.

But the primary insurer cannot gamble with the settlement simply because the policyholder was conscientious enough to purchase excess insurance and cannot use the policyholder’s excess coverage as a shield against a claim for bad faith refusal to settle within limits.

Allowing the primary insurer to gamble with the excess coverage impairs both the policyholder and the excess insurer. The failure to settle within limits could impact the policyholder’s future premium and availability of coverage if the excess insurer pays and could immediately impact the policyholder if the excess insurer balks, forcing the policyholder itself to pay the verdict while pursuing a claim against the excess insurer.  And, of course, the excess verdict directly hits the excess insurer’s bottom line.

Assuming that the excess insurer steps up, the legal principle of equitable subrogation allows it to recoup its payments from the primary insurer if the primary insurer acted in bad faith by refusing to settle within the primary limits.  The excess insurer stands in the shoes of its insured to seek indemnification against the third parties legally responsible for the loss  (see, e.g.,  Allstate Ins. Co. v. Mazzola, 175 F.3d 255, 258 (2d Cir. 1999); ACE Am. Ins. Co. v. Fireman’s Fund Ins. Co., 2 Cal.App.5th 159, 167 (2016) (citation omitted)). The excess insurer must demonstrate that the primary insurer refused to settle within the policy limits when it could have done so, and instead gambled with the excess insurer’s limits.

Several courts have considered an excess insurer’s ability to seek equitable subrogation against a primary insurer, but have reached different conclusions.

A Nevada district court, for example, required a primary insurer that acted in bad faith to reimburse the excess insurer in the amount above the primary limit, even though the amount was reached by settlement rather than an excess judgment (see Colony Ins. Co. v. Colo. Cas. Ins. Co., 2018 WL 3312965 (D. Nev. July 5, 2018)). The primary insurer refused a policy-limits demand,  did not provide a counter-offer, did not properly and diligently investigate, and rejected the excess insurer’s demand that it settle within the primary $1 million limit. Only after new counsel evaluated the case did the primary insurer settle with the claimant for $1.95 million – placing the excess insurer on the hook for $950,000. The excess insurer demanded that the primary insurer pay the full settlement amount in light of its alleged bad-faith conduct. When the primary insurer refused, the excess insurer paid the remaining $950,000. Noting that the excess insurer did not voluntarily pay the excess amount and that the primary insurer had acted in bad faith by unreasonably refusing to settle the case within policy limits, the court held that the primary insurer was required to reimburse the excess insurer for the $950,000.

In contrast, a Florida district court rejected an excess insurer’s equitable subrogation claim because the excess insurer “voluntarily” paid the excess amount and never reserved its rights on priority of coverage (see Privilege Underwriters Reciprocal Exch. (“PURE”) v. Hanover Ins. Group, 304 F. Supp. 3d 1300 (S.D. Fla. 2018)). In this case involving defamation claims against attorney Alan Dershowitz, three policies – a homeowners’ policy, a business owners’ policy issued by PURE, and a professional liability policy — jointly provided a defense. Ultimately, the insurers each contributed to a settlement. At no time did the insurers enter into a subrogation agreement. The court denied PURE’s equitable subrogation claim against the homeowner’s policy because PURE had “volunteered its settlement funds and waived the right to seek subrogation” against the homeowners’ policy.

Likewise, a Colorado appellate court dismissed an excess insurer’s equitable subrogation claim because it was not brought as derivative of the insured’s right and did not plead bad faith (see Preferred Professional Insurance Co. v. Doctors Co., 419 P.3d 1020 (Colo. 2018)). When the primary insurer refused to pay the settlement demand within the primary limits, based on its contractual right, the excess insurer stepped up and settled within the primary limits on the insured’s behalf. The excess insurer later sought reimbursement from the primary insurer. The court noted that the excess insurer’s equitable subrogation claim is derivative of the insured’s rights and looked to what, if any, claim the insured could have asserted against the primary insurer. In this case, the claim would be for bad faith failure to settle. But without an excess award, because the excess insurer had paid the primary limit settlement demand, the excess insurer could not recoup its settlement payment from the primary insurer.  The primary insurer had a contractual right to control settlement that the excess insurer could not override. Allowing the excess insurer to recoup from the primary insurer would nullify the primary insurer’s right simply because the excess insurer disagreed with the risk of exposure, which the court would not do. So here the excess insurer’s willingness to protect its policyholder boomeranged and could lead other excess insurers to hesitate to step in when the primary insurer fails to honor its coverage obligations.

Although more jurisdictions are permitting excess insurers to bring equitable subrogation claims against primary insurers, even in the absence of an excess award, the claim can only be sustained if it is derivative in nature – the insurer must be “stand[ing] in the shoes of the insured” and assert bad faith against the primary insurer. In addition, it is incumbent on excess insurers to act to preserve their subrogation rights, including raising a priority of coverage defense and signing a subrogation agreement. As always, policyholders too must be vigilant to protect their rights under their primary and excess insurance policies to avoid facing financial exposure of their own.