What Every Lawyer Should Know about Insurance Law
by Heather Stern
(County Bar Update, February 2008, Vol. 28, No. 2)

What Every Lawyer Should Know about Insurance Law

By Heather Stern of Cox, Castle & Nicholson LLP. Stern is a commercial litigator with experience handling business, real estate, and insurance litigation.

1. What is the difference between first party and third party insurance coverage?
First party coverage in an insurance policy provides coverage for losses sustained directly by the insured. For example, a fire insurance policy is designed to provide coverage for fire loss to the insured’s own property.

In contrast, a policy’s third party coverage (also known as liability insurance) provides coverage for losses sustained by other persons, not the insured, but for which the insured may be legally responsible. For example, a commercial general liability (CGL) policy may provide coverage for losses sustained by others as a result of the insured’s business operations. Third party coverage is generally only available where a “suit” has been commenced against the insured claiming damages that fall within the scope of coverage. The insurer generally has both a defense and an indemnity obligation to the insured pursuant to the policy terms.

A single insurance policy can contain both first party and third party coverages. However, in analyzing a client’s rights and duties under the policy, it is important to distinguish between these two types since different legal principles can apply depending on whether first party or third party coverage is at issue.

2. What is the difference between claims-made and occurrence-based policies?
Third party coverage is further subdivided into two other main categories: claims-made coverage versus occurrence-based coverage. Occurrence-based coverage insures for liability from a wrongful act, offense, injury, or damage that occurs during the policy period independent of when a claim is asserted against the insured for that occurrence.

In contrast, claims-made coverage usually only insures for liability from an actual or potential claim that is both made against the insured during the policy period and reported to the insurer within the time period set forth in the policy for reporting claims. Professional liability insurance policies are typically claims-made policies.

To determine whether a particular policy may provide a defense and indemnity to a client who has just been sued, it is important to understand that an insurer providing occurrence-based coverage will look to the dates of the events alleged within the lawsuit to determine if any of those events occurred within the policy period. In contrast, an insurer providing claims-made coverage will examine when the claim underlying the lawsuit was first made against the insured and when the insured first gave notice of the claim to the insurer.

It is also important to note that under claims-made coverage, an insured typically has a duty to report potential claims to the insurer, i.e., any act or omission that might reasonably be expected to form the basis of an actual claim later. If the insured fails to do so, the insured may find the insurer denying any duty to defend or indemnify with respect to a lawsuit subsequently brought relating to that potential claim. If the insured does report a potential claim, the policy will generally provide coverage for that claim even if the actual claim is not brought until after expiration of the policy period (called “tail” coverage). A lawyer whose client has claims-made coverage should understand that potential claims against the insured should be brought to the attention of the insurer even if no lawsuit has yet been filed.

3. What is the duty to defend versus the duty to indemnify?
Liability insurance usually imposes a duty on the insurer to indemnify the insured against third party claims covered by the policy, such as by settling the claim or paying any judgment against the insured. This is in contrast with the insurer’s duty to defend the insured, which is much broader. The insurer’s duty to defend generally means that if a lawsuit is brought against the insured that seeks damages on any theory that, if proved, would be covered by the policy, then the insurer has an obligation to defend the insured by selecting and paying defense counsel to do so. Gray v. Zurich Ins. Co. (1966) 65 Cal. 2d 263, 275. This duty generally applies even if the claim against the insured is without merit. Moreover, if any one claim in the lawsuit is potentially covered by the policy, then the insurer generally has a duty to defend the entire action, including noncovered claims (though the insurer may choose to do so under a reservation of rights that includes the right to later recoup defense costs from the insured for noncovered claims). This duty to defend can be very important to a client since the cost to defend even a frivolous claim can be substantial.

4. How do you tender your client’s defense to an insurer?
A lawyer whose client has been sued (whether by a complaint or a cross-complaint) should consider whether there might be an insurance policy providing liability coverage to the client for that suit. The lawyer should first identify all policies that might provide coverage. This can include not only those policies that the client purchased directly but also any policies on which the client may be named as an “additional insured.” For example, a tenant may name the landlord as an additional insured on the tenant’s insurance policy. Before tendering, a lawyer should advise the client of important consequences that may follow a tender of the defense, including 1) increased insurance rates and 2) the loss of control over the defense if the defense is accepted by the insurer.

With client consent, the lawyer should tender the defense of the client to all insurer(s) providing potential coverage by sending a letter to the insurer(s) giving formal notice of the lawsuit and a formal tender of the client’s defense, enclosing a copy of the summons and complaint (or cross-complaint). It is important to note that generally the duty to defend does not arise until this tender letter is sent, so the timing of this letter is important.

5. What is insurance bad faith?
An insurer that mishandles a claim can face liability for insurance bad faith. Bad faith is a tortious breach of the implied covenant of good faith and fair dealing by the insurer. In a first party context, an insurer can face bad faith liability if, e.g., the insurer unreasonably withholds policy benefits, unreasonably delays in paying or processing the claim, or fails to thoroughly investigate the claim. In a third party context, an insurer can face bad faith liability if, e.g., the insurer improperly refuses to defend the insured or fails to settle the action for a reasonable settlement demand that is within policy limits. If the insurer is found to have acted in bad faith, then the insurer can be held liable for damages exceeding the amount of the policy limits and may also face punitive damages. Except for duty to defend cases, there can be no action against the insurer for bad faith if there is no coverage under the policy. Waller v. Truck Ins. Exch., Inc. (1995) 11 Cal. 4th 1, 36.

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