By C. Scott Rybny, Esq., Rebar Bernstiel and Andrea Procton, Esq., Timoney Knox
To recap, the ALI’s Restatement of the Law on Liability Insurance is a project six years in the making. Its stated objective is to “cover the law of contracts in the liability insurance context, liability insurance coverage and the management of insured liabilities.” Critics of the Restatement point to statements by its authors that suggest an alternate purpose: to incentivize insurers to defend and settle more cases.
Section 15 of the Restatement addresses an insurer’s reservation of rights to contest coverage, including timing the required content. The authors identify four specific principles they believe to be necessary for an insurer to reserve its right to contest coverage. Those are as follows:
- An insurer that undertakes the defense of a legal action may later contest coverage for that action only if it provides timely notice to the insured, before undertaking the defense, of any ground for contesting coverage of which it knows or should know.
- If an insurer already defending a legal action learns of information that provides a ground for contesting coverage for that action, the insurer must give notice of that ground to the insured within a reasonable to reserve the right to contest coverage for the action on that ground.
- Notice to the insured of ground for contesting coverage must include a written explanation of the ground, including the specific insurance policy terms and facts upon which the potential ground for contesting coverage is based, in language that is understandable by a reasonable person in the position of the insured.
- When an insurer reasonably cannot complete its investigation before undertaking the defense of a legal action, the insurer may temporarily reserve its right to contest coverage for the action by providing to the insured an initial, general notice of reservation of rights, in language that is understandable by a reasonable person in the position of the insured, but to preserve that reservation of rights the insurer must pursue that investigation with reasonable diligence and must provide the detailed notice stated in subsection three within a reasonable time.
The Restatement’s proposed approach to reservations of rights differs in several significant aspects of existing Pennsylvania law. For decades, Pennsylvania’s courts provided clear and straightforward guidance concerning reservations of rights. To be effective, a reservation of rights must clearly communicate the insurance carrier’s coverage position to the insured, and be timely. Courts viewed this as an objective standard. The “reasonable person” standard only applied where an ambiguity existed in the writing. Even where Pennsylvania courts looked to the reasonable person, they considered that person to be of reasonable intelligence and a member of the general populace.
The Restatement takes a different view. The authors believe that insurance carriers must write reservations of rights in accordance with a “reasonable person in the position of the insured” standard. There are several dangers with this approach. First, it is too general to serve as a guide for insurers. Second, it is highly subjective in comparison to Pennsylvania’s objective standard. The Restatement offers little insight into what renders a reservation of rights deficient. Must an insurance carrier explain the connection between the facts and the policy language, or is a recitation of the facts within the letter is sufficient?
The consequences proposed by the Restatement on insurance carriers who fail to adhere to its standards are dire. Under the Restatement, an insurer that fails to follow its standards automatically waives its coverage defenses. This draconian approach is inconsistent with Pennsylvania law. Where insureds challenged an insurer’s Reservation of Rights, Pennsylvania law is equally clear. Courts’ required clear, precise and unequivocal evidence that an insurance carrier waived its right to rely on a particular coverage part. That analysis involved a three-step process:
- An inducement whether by act, representation or silence, that causes an insured to believe the existence of certain facts.
- Justifiable reliance on the inducement.
- Prejudice to the insured. Stated differently, Pennsylvania historically required more than an insured’s subjective interpretation of the insurer’s reservation of rights to find a waiver.
The ALI is still slated to vote on the final draft of this Restatement during its May 2018 meeting. That vote aside, there are at least seven instances where courts looked to this Restatement as authoritative. In states like Pennsylvania where insurance law is well developed, insurers should continue to follow the law as it currently exists. Pennsylvania requires both liability and property insurers presently to provide clearly communicated coverage issues to the insured as soon as reasonable. That said, the Restatement is not something that insurers should ignore, particularly in those parts of the state that historically favor policyholders over insurance carriers.
This article was featured in the PAMIC Pulse.
- A. Hugh Scott, “ALI’s Proposed Insurance Law Restatement: A Trojan Horse?” Law360 (February 9, 2017) (available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2631123, at 1.
Andrea Procton is an associate with Timoney Knox’s Insurance Industry Law Group. Her practice focuses on commercial and insurance litigation. She routinely handles coverage disputes and analyses including homeowners, commercial property, general liability, builders’ risk, construction defect, motor vehicle and E&O's.
Mr. Rybny has substantial trial, arbitration and appellate experience in representing regional and national insurers. He has particular experience handling first-part property insurance and special investigations. His experience also covers commercial general liability, directors and officers, fiduciary liability, property, business interruption (including extra expense and contingent business interruption), commercial crimes and credit risk insurance, among others. He has the practical and legal experience to assist clients in managing risks and solving problems, and is a frequent lecturer in the area of insurance litigation and coverage.