October 28 – 29, 2013

Mary E. McPhersonTressler LLP

Marla H. KanemitsuDickstein Shapiro LLP

Faced by both policyholders and insurance companies

SIR: A dollar amount specified in a liability insurance policy that must be paid by the insured before the insurance policy will respond to a loss. Under a policy written with an SIR, the insured (rather than the insurer) would pay defense and/or indemnity costs until the SIR limit was reached. After that point, the insurer would make any additional payments for defense and indemnity that were covered by the policy.

Deductible: Insurer pays the defense and indemnity costs up front and seeks reimbursement of deductible payment from the insured.

- IRMI Risk and Insurance Glossary of Terms

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Things are seldom black and white, even when we wish they were and think they should be, and I like exploring this nuanced terrain.

- Emily Griffin

Who Owes / Can Pay the SIR? What are the Insured’s Obligations

to Its Insurer Under an SIR? Impact of Insureds Who Can’t Pay the SIR

◦ Duty to Defend: The “Morton’s Fork” Dilemma◦ Duty to Indemnify: When Does the Insurer Have

to Pay?◦ Public Policy = Protecting Claimants

How Many SIRs / Deductibles are Owed?◦ Continuous trigger◦ All sums states / multiple layers

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Is it a single or multiple policy event? Are different types of policies – GL, E&O,

EPL – triggered? What does the policy language say?

◦ Your policy and all other potentially implicated policies and all related “claim handling agreements”

◦ Who can pay the Deductible or SIR? Only the Named Insured?

◦ Does it apply “per claim” or “per occurrence”?

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Increasingly, SIR endorsements state that the retention can be satisfied only by the “Named Insured.” Payments by others, e.g. additional insureds or other insurers, may not satisfy the SIR if the SIR provision requires the “Named Insured” to exhaust the SIR. Forecast Homes, Inc. v. Steadfast Ins. Co., 181 Cal. App. 4th 1466 (2010)

A deductible may be collected from any “Named Insured,” even if the Named Insured is not involved in the claim. Northbrook Insurance Co. v. Kuljian Corp.,690 F.2d 368 (3d Cir. 1982)

Some policies still contain “you” or “your” language requiring analysis of who = “you.”

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Retention Endorsement: “you [insured] must pay all self-insured retention expenses”Bankruptcy provision: the “bankruptcy of any insurer, or any other person” does not relieve the insured of its obligation to satisfy the retentionCourt: Retention language, when considered together with Bankruptcy provision, implied that the Retention could be paid by other insurers or other persons and, at the very least did not “clearly require the hotel [insured] to satisfy the SIR out of its own pocket.” National Fire Ins. Co. of Hartford v. Federal Ins., 843 F. Supp. 2d 1011 (N.D. Calif. 2012)

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Underwriting Note: Consider impact of all policy language vis-à-vis SIR and Deductible endorsements as almost all jurisdictions require policy to be “read as a whole.”

Underwriting Note: Consider impact of all policy language vis-à-vis SIR and Deductible endorsements as almost all jurisdictions require policy to be “read as a whole.”

The Insured has no duty to look out for the insurance company’s pecuniary interests.

California: Commercial Union Assur. Co. v. Safeway Stores, 26 Cal. 3rd 912 (1980)

Texas: Int’l. Ins. Co. v. Dresser Indus., Inc., 841 S.W. 2d 437 (Tx. App. 1992)

New York: Employers Mut. Cas. Co. v. Key Pharm., 817 F. Supp. 657 (1994)

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Coverage for multi-million dollar award against the Insured County arising out of an automobile accident turned on language of SIR.

SIR endorsement obligated the County to “provide an adequate defense and investigation of any action for . . . actual, potential or alleged damages.”

The SIR endorsement also stated that in the event the County failed to provide that defense and investigation, the insurer “shall not be liable for any damages or costs or expenses resulting from” the “underlying occurrence.”

Federal court concluded the endorsement had the “essential character” of a condition precedent meaning that the County, as the insured, bore the

burden of proving that it provided itself with an “adequate defense.” If the County cannot satisfy that burden, it could not recover under its policy.

- State National Insurance Company v. County of CamdenNo. 08-5128 (D. New Jersey Dec. 19, 2012)

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Underwriting Note: Consider including specific language in SIR Endorsement that as a condition precedent to coverage insured must provide a certain level of defense or that insured must consult with insurer on choice of defense counsel or similar language. Check recent case law to see what language courts have upheld!

Underwriting Note: Consider including specific language in SIR Endorsement that as a condition precedent to coverage insured must provide a certain level of defense or that insured must consult with insurer on choice of defense counsel or similar language. Check recent case law to see what language courts have upheld!

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HYPOTHETICAL An Insured School is sued by a minor who was

sexually abused by same teacher over several years.

The suit settled for $2 million and the School demanded reimbursement from Insurance Company which provided primary insurance during 7 of the years of the alleged abuse.

Each of the Insurance Company’s policies had a limit of $750,000 subject to a $250,000 SIR “per occurrence.”

The Policyholder’s Argument Even though multiple policy years applied, a

policyholder is entitled to target one policy and pay only one policy’s deductible.

One ongoing cause, the abuse, even if in different policy periods.

Insurance Company’s Arguments The claims constituted multiple occurrences

as there were multiple acts committed against claimant in different years.

The School had chosen to purchase policies with high SIRs in exchange for lower premiums for each policy and should be required to pay an SIR for each policy.

One Court’s Answer Each act of abuse was a separate

“occurrence” requiring payment of a separate deductible… but also exposed limits above SIR for 7 different policies.

Although coverage was effectively nullified by this ruling, the court did not appear to take this result into consideration.

-Roman Catholic Diocese of Brooklyn v. National Union

Fire Insurance Company 87 A.D. 1057 (N.Y. 2013)

THE “CONSTRUCTION DEFECT” HYPOTHETICAL

Insured Developer had a policy with “First Insurance Company” followed by a policy issued by “The Other Insurance Company”

8 of the 43 homes fell under First Insurance Company’s policy, with the other 35 homes under The Other Insurance Company’s policy.

First Insurance Company’s policy had a $25,000 “per claim” SIR which states:

“The self-insured retention applies to each and every claim . . . regardless of how many claims arising from a single ‘occurrence’ are combined in a single ‘suit.’”

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First Insurance Company’s Arguments

Even if they all arise from the same “occurrence,” i.e. defective construction, each home qualifies as a separate claim

The SIR Endorsement clearly states a separate SIR applies to each claim even if all in one suit

Therefore, Insured should pay $200,000, i.e. a separate $25,000 SIR x 8 homes

The Policyholder’s Argument The defective construction claim is the basis

for all the claims. We only have to pay one $25,000 SIR for

the lawsuit as a whole.

COURT’S RULING One SIR applied to the suit: Policy language did not

unambiguously inform the insured that the SIR would be applied on a per-home basis.

Court found it “unlikely” that the insured contemplated paying a $404,320 premium plus an SIR on a per home basis (e.g. 450 homes times $25,000 per home would total $11.25 million) before NAC had a duty to defend in exchange for a policy with a $2 million limit.

- Clarendon Amer. Ins. Co. v. North American Capacity Ins. Co., 186 Cal. App. 4th 556 (2010)

What Position Does the Other Insurance Company Take?

Does it agree with the Insured’s position in order to trigger Insurance Company A’s duty to defend?

What if it is now writing policies with similar SIR “per claim” wording?

Two insurers issued policies to same insured who were sued in dozens of lawsuits for bodily injury due to exposure to benzene.

Insurer #1 defended; Insurer #2 argued it had no duty to defend because Insured had a 100% “duty to pay” costs of its defense under a negotiated “Insurance Program.”

“Insurance Program”: "Standard General Liability Policies” with separate Side Agreements detailing SIRs/claim handling/reimbursement and indemnity obligations with Insured having "duty to pay" defense costs.

Insurer #1 Pays Millions in Defense Costs and Sues Insurer #2 for Contribution

Who Wins?21

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Underwriting Note: Don’t assume “Side Agreements” or “Claim Handling Agreements” will govern application of SIRs/deductibles in the policy. If insurance company intends to have no duty to defend, make clear in policy and in related agreements. Make sure language in all related documents is consistent.

Underwriting Note: Don’t assume “Side Agreements” or “Claim Handling Agreements” will govern application of SIRs/deductibles in the policy. If insurance company intends to have no duty to defend, make clear in policy and in related agreements. Make sure language in all related documents is consistent.

• Duty to defend is distinct from “duty to pay” defense costs • The policies issued to the Insured “plainly imposed” the duty

to defend on the Insurer • Although Insured ultimately bore the obligation to “pay

defense costs” under the Insurance Program, Insurer retained the duty to defend in the Policies: none of the program documents eliminated the duty to defend provision in the policies.

- Continental Cas. Co. v. Nat’l. Union Ins. Co. of Pittsburgh PA.U.S. District Court Minnesota 2013 U.S. Dist. LEXIS 45217 (Reconsid. Denied)

(2013)

+ = ?

HYPOTHETICALClaims against policyholder trigger ten years of coverage, all with SIRs.Policyholder in “all sums” jurisdiction picks Insurer A as the targeted insurer to provide coverage, and pays the SIR for that coverage year.Insurer A seeks contribution from other non-targeted insurers.Is policyholder required to pay SIRs for non-targeted years? If not, are the non-targeted insurers relieved of liability?

Policyholder’s ArgumentUnder “all sums” rule, a targeted insurer is liable for the entire amount of the policyholder’s liability, up to the policy’s limitsInsurer is not allowed to undermine this rule, and force the policyholder to shoulder more liability than it otherwise should.

Non-Targeted Insurers’ ArgumentsPolicies specifically state that the SIRs must be satisfied before they provide coverage.The “all sums” allocation rule allowing a policyholder to target one insurer and pay one SIR does not trump the policy language.

Insurer A’s ArgumentIn an “all sums” jurisdiction, a targeted insurer is permitted to seek contribution from other triggered policies.Unfair to Insurer A to cut-off contribution rights because of unsatisfied SIRs in other policy years.

Possible OutcomesInsurer A may not require the policyholder to pay the other SIRs.

◦ Supported by Weyerhaeuser Co. v. Fireman’s Fund Ins. Co., No. C06-1189MJP, 2007 WL 4420938 (S.D. Wash. Dec. 17, 2007) (dealt with fronting policies and held that targeted insurer could not seek contribution from fronting policies).

Where does that leave Insurer A?◦ Insurer A may obtain contribution with an off-set for

SIRs.◦ Insurer A may obtain contribution if it pays the SIR

itself.◦ Non-targeted insurers off the hook.

What Can You Do?

Confirm the other insurer’s policy language Insurer may try to convince insured to pay

SIR (not always as difficult as it may seem) so insured has access to more policies

Query: Can/should the triggered insurer “give” the insured money to pay that SIR, thus triggering entire vertical column of coverage?

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Duty to Disclose SIR on Certificate of Insurance?

Ninth Circuit says no, not yet . . . but could this be one of the next battlegrounds?

- Multicare Health System v. Lexington Ins. Co., No. 12-35436 (9th Cir. 2013)

SIRs in Excess Layers May Be Owed After aggregate limit in first-layer excess policy

has been exhausted, an insured must satisfy an additional SIR per occurrence for subsequent claims under second- and higher-layer excess policies.

 - Phase III Tentative Ruling and Proposed Statement of Decision

Deere & Co. v. Allstate Ins. Co., Case No. CGC-03-420927, Superior Ct. of California, County of San Francisco (Sept. 18, 2013)

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STATUS DOES MATTER!

Filed for Bankruptcy? Suspended Corporation? Corporation in Good

Standing, but Insolvent or Out of Business?

Dissolved?

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Claimant or policyholder may seek relief from stay to pursue insurance proceeds

-or-

Insurer might have to file a petition with the bankruptcy court for relief from the automatic stay before issuing any payments under the policy

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When policy includes duty to defend, insurer is generally obligated to defend insured while attempting to recover deductible amount from insolvent insured (solvent or insolvent!)

Generally, Named Insured, not Additional Insured, is obligated to pay it

Insurer usually bears the risk of the unpaid deductible.

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Courts have generally refused to relieve insurers of obligations when SIR not met

Policies provisions collide: state that bankruptcy would not necessarily relieve insurer of its payment obligations which conflict with the SIR provisions

Public policy to protect tort victims often a factor◦ Phillips v. Noetic Specialty Ins. Co., 919 F. Supp. 2d 1089 (S.D. Cal. 2013)◦ Continental Cas. Co. v. North Amer. Capacity Ins. Co., 683 F.3d 79 (5th Cir.

2012)◦ Rosciti v. Insurance Co. of State of Pa., 659 F.3d 92 (1st Cir. 2011)

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Texas Insured’s actual payment of an SIR is a precondition

to coverage, regardless of its ability to pay. ◦ Associated Elec. & Gas Ins. Serv. Ltd. v. Border Steel

Rolling Mills, Inc., 2005 U.S. Dist. LEXIS 32198 (W.D. Tex. September 27, 2005)

◦ Pak-Mor Mfg. Co. v. Royal Surplus Lines Ins. Co., 2005 LEXIS 34683 (W.D. Tex. November 3, 2005)

BUT: Insured free to pay SIR in whatever form it liked,

including a promissory note to its judgment creditor, which note was not dischargeable in bankruptcy (Pak-Mor)

Insurer may still be liable to contribute to defense if SIR satisfied by other insurers! (Continental v. North Amer. Capacity)

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What if insurer has no contractual obligation to defend, but potentially significant financial interest in outcome of suit?

Court referred to this dilemma as a “Morton’s Fork”:A choice between two equally unpleasant alternatives.

Thus, it held that insurer had no obligation to defend, but was entitled to make voluntary decision to defend to protect its financial interests.

Admiral Ins. Co. v. Grace Ind., Inc., 409 B.R. 275 (Bankr. E.D.N.Y. 2009)

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The Insurer’s EquallyUnappealing “Morton Fork” Options

Voluntarily fund insured’s defense within SIR, while having little realistic chance to recover payments from insured.◦ Obtain a Promissory Note?

Allow the claim to go undefended and run risk of large default judgment in excess of SIR amount.◦ Are you in a Direct Action jurisdiction?

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What is the amount of the SIR -- $10,000 or $250,000?

What is the likelihood the claim will exceed the SIR?

What is the likelihood that other claims will be made against the insured (i.e., claim at issue could serve as precedent for future claims)?

Will defense counsel withdraw? What is the likelihood of recovering defense

costs within SIR from the insured? What is the likelihood a judgment will be

significantly larger if claim is left undefended? Public policy considerations

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Most courts find an insurer has an obligation to pay indemnity amounts above the amount of the SIR, even if SIR not exhausted.

  The claimant bears the risk of the

unpaid SIR.

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Lexington Ins. Co. v. Lexington Healthcare Group, Inc.,

309 Conn. 1 (2013)

13 negligence lawsuits sought damages for injuries caused by a fire set at a Hartford Nursing Home by another resident.

Nursing home policy had a $250,000 SIR “per occurrence” as described in one endorsement with a $500,000.00 “per medical incident” coverage limit set forth in another endorsement, subject to a $1 million per location aggregate.

Insured became insolvent.Connecticut Supreme Court held:

Coverage did not “drop down” due to the unsatisfied SIR even though insured was insolvent, and

However, the SIR did not act to decrease the separate $500,000 medical payment limit: insurer was responsible for $500,000 for each medical incident above the $250,000 SIR.

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Peloquin v. Haven Health Center, 61 A.3d 419 (R.I. 2013)

A patient died while in the care of Haven Health Center after a nurse had mistakenly administered a lethal dose of morphine. Estate sued.

Insured Haven filed for bankruptcy. Amended complaint named Columbia Casualty (RI statute permits

an injured party to sue insurer when insured has filed for bankruptcy.)

Columbia issued professional liability policy with limits of $1M per claim/$3M aggregate subject to an SIR. SIR required Insured to pay first $2M of all “damages” and all “claim expenses”.

Policy stated insurer’s obligations were excess of this SIR regardless of the insured’s “financial ability or inability to pay” the SIR and “in no event are we [insurer] required to make any payments within the SIR.”

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Trial court ruled insurance company owed nothing; default judgment ($364,422.00) was less than SIR.

Plaintiff argued on appeal that the SIR was “void and unenforceable” as being against public policy because R.I. statute requires nursing facilities to maintain a professional liability insurance minimum level of $100,000 per claim $300,000 and the aggregate.

Relied on regulations issued by Department of Business Regulation (“DBR”)

Rather than declaring that self insurance in general is void as against public policy, Supreme Court interpreted statute as only allowing self insurance to extent allowed by DBR. As the DBR had not issued any such regulations to date, the court refused to give effect to the SIR provisions in the Columbia policy.

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Are entities related to insolvent insured liable for SIR or deductible?◦ Is it possible to pierce the corporate veil?◦ Successor entities generally not obligated to pay

the SIR or deductible, except:(1) purchaser assumed successor liability;(2) merger; (3) purchaser operates as a “mere continuation” of

seller; or(4) fraudulent transaction to avoid liability for debts.

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OPTIONS FOR INSURERS Obtain a Promissory Note or

Letter of Credit from insured before making the payment.

Institute collection proceedings.◦ Cost-benefit analysis

File unsecured bankruptcy claim.

Seek payment from successor or related entity.

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Policy language and case law = directions on how SIR/Deductible will apply.

While enforcing policy language as written, don't throw common sense out the window when negotiating settlement.

The Morton's Fork “Insureds Who Can't Pay” Dilemma: Whether you are the Policyholder or the Insurer, identify this problem as early as possible, evaluate the law and public policy of applicable state and come up with your own “direction” of how to proceed, so a court won't force you to take the less attractive road.

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Mary E. McPherson949.336.1224

mmcpherson@@tresslerllp.com

Marla H. Kanemitsu202.420.4859

kanemitsum@@dicksteinshapiro.com