🌸 Spring 2025
In this edition: splitting of claim files, criminal acts, settlement demands, policy interpretation, ineffective disclaimer letters, and more.
Greetings to everyone in Insurance Land. Here is the Spring 2025 edition of my Coverage Review newsletter with the top six things that I want you to know about insurance right now.
This newsletter is 2,872 words, a 12.1-minute read.
1. ䷖ New York Federal Court Indicates Good Faith Does Not Require Bifurcation
A federal district court in New York held that an insurer did not commit bad faith by failing to split a liability matter into separate defense and coverage claim files.
Why this matters: Insureds often argue that an insurer commits bad faith when it does not bifurcate a liability claim file when there are coverage issues. This decision rejects that argument.
The procedural history: A legal malpractice suit was filed against the insurer’s insureds.
The insurer agreed to defend the insureds against the malpractice action under reservation of rights.
It did not split the claim file into separate defense and coverage files.
The insurer later filed an action for declaratory judgment on coverage.
It then split the claim file into separate defense and coverage files.
The insureds argued that the insurer acted in bad faith by not bifurcating the file at the outset of the claim.
The holding: The federal court held that the insured failed to offer a “scintilla of evidence in support” of their charge that the insurer breached the implied covenant of good faith and fair dealing.
“Defendants … cite no authority for proposition that an insurer is required to create an internal wall between its coverage investigation and the underlying liability defense at the first sign that the insurer might ultimately disclaim coverage. The Court is not aware of any authority for that proposition under New York law” (emphasis in original).
“Rather, Defendant’s position incorrectly implies that an insurer has a conflict of interest any time it undertakes to defend its insured, even though the insurer is not persuaded that the claims are actually covered. That is not the law, nor could it be given the breadth of the duty to defend under New York law.”
“None of the relevant cases hold, or comment in dicta, that the insurer is required to split its file (i.e., implement a conflict screen) when it issues a reservation of rights. Moreover, the New York Court of Appeals has made clear that an insurer does not have a conflict of interest ‘in every case’ where it defends the insured subject to a reservation of rights.”
Go deeper: Very little, if any, caselaw exists requiring insurers to bifurcate their claim files. In this author’s view, the debate over whether to do so is a more practical one. The insurer may want to consider several questions:
Will the insurer avoid “conflicts of interest” by bifurcating the claim file?
Does the jurisdiction require independent counsel for the insured?
Will splitting a file make it easier for the “defense adjuster” to focus on the defense of the case?
Will bifurcating a file create a better record of good faith claim handling?
Will a jurisdiction allow the insurer’s failure to bifurcate to serve as evidence in a bad faith case?
Will splitting the claim file better preserve the insurer’s attorney-client privilege with its coverage counsel?
2. 🦹 Court Shows Resistance to Insurance For Criminal Acts
The Third Circuit suggested that a liability carrier did not have a duty to defend an insured’s criminal conduct because doing so would violate Pennsylvania public policy.
Why it matters: The appellate court went beyond the policy language and used public policy considerations to suggest that coverage did not apply.
The facts of the claim: A man shot and killed his twenty-two-year-old former classmate at his parents’ house.
The killer’s parents allegedly delayed discovery of the murder weapon and the victim’s body.
The parents had a homeowner’s insurance policy and an umbrella policy.
The victim’s mother sued the parents for intentional infliction of emotional distress.
The homeowner’s policy provided coverage for “bodily injury” caused by an “occurrence,” which the policy defined as an “accident.” The intentional infliction of emotional distress claims obviously did not meet that requirement.
The umbrella policy, however, defined “occurrence” as “an accident or accidental event, including continuous or repeated exposure to conditions, which results in bodily injury or property damage neither expected nor intended from the standpoint of the insured” (emphasis added).
The Third Circuit commented that the unexpected-or-unintended injury component in this definition of “occurrence” “injects subjective considerations into the meaning of that term.”
Nonetheless, the appellate court stated: “But it is not necessary to assess the effect of those subjective considerations here: the District Court alternatively held that any duty to defend would not be enforceable in this instance because Pennsylvania law forbids insuring criminal acts as contrary to public policy.”
“And on appeal, the [parents] did not develop an argument to contest that ruling…. Because they abandoned any challenge to that independent basis for the District Court’s decision, the [parents] cannot prevail on their appeal of the District Court’s judgment in favor of [the umbrella carrier].”
Between the lines: Although the parents waived their right to appeal the issue, the decision shows a trend by some courts, at least in Pennsylvania, to consider whether public policy prohibits insurance for certain claims, even if insurance policy language might otherwise cover them.
The Pennsylvania Supreme Court is considering this very issue in a series of sex trafficking cases.
3. 🗂️ Internal Insurer Evaluation Can Show Bad Faith
The Colorado Supreme Court held that an insurer’s internal settlement evaluation was not admissible to prove the amount owed in an underinsured motorist claim but could be admissible to show bad faith.
Why it matters: The decision shows how an insurer’s internal claim file documentation may become relevant in later litigation over that claim.
The rationale: Colorado courts previously held that reserves, settlement authority, and internal evaluations were not discoverable regarding the amount owed for a first-party claim.
Reserves are accounting entries that statutes require insurers to “to maintain … to assure the insurer’s ability to satisfy its possible obligations under its policies.”
Settlement authority is just “an agent’s ability to accept a settlement offer that binds the insurer up to and including a particular amount.”
“Neither reserves nor settlement authority reflect an admission by the insurance company that a claim is worth a particular amount of money.”
Rather, “[s]tatutory requirements, limitations in the evaluation, and bargaining tactics limit the usefulness of reserves and settlement authority as valuations of a claim.”
These courts further held that “it would be absurd to protect the end result of the insurance company’s initial evaluation process—the reserves and settlement authority—without also protecting the assessments that led to those numbers.”
In its new opinion, the Colorado Supreme Court extended the rationale of these prior discovery decisions to the admissibility of evidence at trial.
But not so fast: While the Colorado Supreme Court held that an insured could not use an insurer’s internal settlement evaluation to prove the amount owed for a first-party claim, the court suggested that the trial court could admit the claim evaluation into evidence to “show an insurer’s good or bad faith.”
Prior Colorado decisions held that the “establishment of reserves and settlement authority could be relevant and discoverable as to whether an insurer adjusted a [first-party] claim in good faith or properly investigated, assessed, or settled a claim.”
Between the lines: Beyond meeting statutory and internal requirements, insurers should keep in mind how their reserves, settlement authority and documentation of same could play out in extra-contractual litigation.
4. 👬 Insurers Can Insist On Release of All Insureds in California
The Ninth Circuit held in an unpublished memorandum that an insurer did not commit bad faith under California law by rejecting a policy limits settlement demand that refused to release all potential insureds.
Why it matters: By upholding the insurer’s rejection of the settlement demand, the court gave deference to the insurer’s decision to provide coverage to all potential insureds rather than require the insurer to effectively rule out coverage for one of them.
The deets of the claim: Two plaintiffs brought a wrongful death claim against the driver who allegedly killed the plaintiffs’ decedent in an auto accident.
The driver was operating a vehicle owned by his father-in-law at the time of the accident.
Because its investigation showed that the driver lived with his-father-in-law and used the vehicle with his father-in-law’s permission, the driver’s auto insurer extended liability coverage to both the driver and his father-in-law.
The settlement demand: The plaintiffs demanded policy limits for a release of the driver only.
The driver’s insurer agreed to pay policy limits but refused to settle without a release of the driver and his father-in-law.
The driver assigned his rights against the insurer to plaintiffs.
The plaintiffs obtained an excess judgment against the driver and filed a suit against the insurer for bad faith.
The plaintiffs argued that a “competent investigation” by the insurer “would have revealed that [the father-in-law] was not living with [the driver] at the time of the accident, had not given [the driver] permission to drive the vehicle, and therefore did not qualify under the policy as an additional insured.”
The holding: The Ninth Circuit agreed as a matter of law that the insurer did not act in bad faith.
“Under California law … an insurer ‘cannot favor the interests of one insured over the other,’ and thus an insurer does not act in bad faith by making a policy limits offer on behalf of all insureds and rejecting a counteroffer for policy limits that releases only one.”
“[T]he cases that Plaintiffs cite concerning the insurer's duty to conduct an adequate investigation … involve the denial of coverage. Plaintiffs have provided no California authority holding that an insurer acts in bad faith to its named insured by agreeing to extend coverage to a relative of the named insured as an additional insured, and we are aware of no such case.”
Beyond the headlines: The rule that liability insurers do “not act in bad faith by making a policy limits offer on behalf of all insureds and rejecting a counteroffer for policy limits that releases only one” is very specific to California.
Not all jurisdictions follow this principle, so parties need to consult the law of the particular jurisdiction at issue in any given claim.
That said, usually insurers get into trouble for not finding coverage for a party. Here, the plaintiffs tried to argue the opposite: the insurer somehow acted in bad faith by not eliminating coverage for a potential insured. The court thankfully rejected that argument.
Although sometimes no good deed goes unpunished, the case does give some support to the notion that insurers that err on the side of providing more coverage are generally better off than those that provide less.
5. 📖 Functional Approach to Policy Interpretation On Display
By examining the differences between builder’s risk and commercial general liability policies, the Eleventh Circuit held that a completed project exclusion applied to a property damage liability claim under Florida law.
Why it matters: The decision contains as candid of an admission as one will see that courts sometimes apply a functional approach to policy interpretation.
Facts of the claim: JM Family Enterprises hired a contractor to build its new corporate campus in South Florida.
The campus was to consist of three office buildings, a training and conference center, a sports and recreation building, a dining hall, an amphitheater, a central energy plant, a parking garage, and various landscaping and water features.
The construction was to be completed in two phases.
The contractor apparently finished construction of the first phase.
A tropical storm hit South Florida, causing water to leak into the completed buildings and resulting in about $3.3 million in damage.
JM Family informed the contractor that it was responsible for mitigating the damage.
The coverage issue: The contractor’s commercial general liability policy had a Course of Construction Exclusion (“COCE”) that removed coverage for “[a]ny ‘property damage’ at or to any project insured under this policy during the course of construction until the project is completed” (emphasis added).
The policy did not define “project” or “completed.”
The policy’s description of the project (apparently in the policy declarations) included work from both phases.
The insured’s policy application clearly broke the project down into the two phases.
The insurer declined coverage on account of the exclusion and filed a declaratory judgment action.
The Eleventh Circuit first said the insurance policy must be interpreted “in accordance with the plain language of the contract.”
“Generally, insurance coverage must be broadly construed in favor of the insured, while exclusions must be narrowly construed against the insurer.’”
“Furthermore, ‘[a]mbiguous policy provisions are interpreted liberally in favor of the insured and strictly against the drafter who prepared the policy,’ and ‘ambiguous insurance policy exclusions are construed against the drafter and in favor of the insured.’ ”
But then the appellate court noted that “it is helpful to begin by understanding what sort of policy is at issue.”
“A builder's risk policy ‘provide[s] protection for the building[s] under construction. Just as there are standard forms of property insurance used to insure existing buildings, builder's risk policies are used to insure the building[s] while [they are] in the process of being built.’”
“In contrast, a general commercial liability policy protects the insured from liability for damage or harm to others from its own defective work or products.”
“The policy issued by [insurer] to [contractor] is a general commercial liability policy and not a builder's risk policy. With that in mind, we turn to the language of the COCE in the policy.”
The appellate court ultimately held that the exclusion applied.
“We agree … that the phrase ‘until the project is completed’ means that the COCE precludes coverage until the entire project is finished. Regardless of whether we view the term ‘project’ as the policy currently describes it or as the two distinct phases set out by [contractor] in its application, the COCE’s meaning is the same. Even if the first phase was finished at the time of the water damage, is undisputed that the entire project had not yet been completed. As noted, some remaining buildings for the new campus were still under construction and the old buildings had not been completely demolished.”
“It would have been better, of course, for [insurer] to draft the COCE to expressly state that there is no coverage unless and until the ‘entire project’ is completed. But [insurer’s] failure to adhere to the standards of impeccable draftsmanship here does not result in ambiguity.'“
The contractor “asserts that the COCE is ambiguous, but we disagree. In Florida, the insured's ‘application ... becomes a part of the agreement between the parties and the policy together with the application form the contract of insurance.’ As a result, Florida courts have sometimes looked to the insurance application to resolve a possible ambiguity in the policy. Here [the insured contractor’s] application—which sets out the two phases of the project—states that the ‘project start date’ is May 1, 2018, and that the ‘project completion date’ is June 1, 2021. So the project encompassed both phases and would be completed only when those phases were finished.”
The big picture: This newsletter previously has discussed how courts can apply a textual approach to interpret insurance provisions literally as they are written on the page, or they can use a functional approach to take into account consumer and industry expectations and norms. By stating “it is helpful to begin by understanding what sort of policy is at issue” and also looking at statements in the insured’s policy application, the Eleventh Circuit’s decision candidly acknowledges that courts sometimes will employ, at least in part, a functional approach to policy interpretation. You can read more about these approaches in my article on the topic here.
6. ✍🏽 New York Court Says Disclaimer Letter Lacks Specificity
A New York appellate court held that a liability insurer’s disclaimer was not “sufficiently specific” under New York’s Insurance Law § 3420 to preserve the coverage defenses asserted.
Why it matters: The decision is a reminder that many jurisdictions require insurers to outline their coverage defenses in some detail in declination of coverage or reservation of rights letters.
The claim: A claimant alleged that the named insured’s youth group leader committed acts of “sexual harassment, sexual abuse, and violence” against claimant.
The coverage letter: The insurer sent an email to the named insured within eight days that stated that “it does not appear there was any misconduct coverage added to the policies” and that the policies “includ[ed] a specific exclusion for any misconduct or any type of allegation relating to misconduct.”
The holding: The New York appellate court held that the disclaimer email “lacks the required specificity and was thus insufficient to satisfy [insurer’s] obligation under Insurance Law § 3420 (d).”
The court noted that a notice of disclaimer under New York law “must promptly apprise the claimant with a high degree of specificity of the ground or grounds on which the disclaimer is predicated”.
A later email from the insurer issued within 54 days and with more detail as to the coverage defenses was deemed untimely, according to the appellate court.
Go deeper: More jurisdictions are requiring insurers’ coverage letters to insureds to contain some detail as to the coverage defenses asserted. For a discussion as to how this plays out in my home state of Missouri, see here.
Coverage Review is written by Michael L. Young, an award-winning litigation partner at Reichardt, Noce & Young LLC in St. Louis, Missouri. For over twenty years, Michael has focused his practice on insurance coverage and extra-contractual matters and currently represents insurer clients in Missouri and Illinois. He also serves as Adjunct Faculty at Saint Louis University School of Law and teaches a course in Insurance Law.