Robert J. Usinger, Esq. is a graduate of Brooklyn Law School, a member in good standing of the New York Bar, and an assistant vice president of Professional Liability claims at Intact Insurance Specialty Solutions. Barry R. Temkin is a partner at Mound Cotton Wollan & Greengrass LLP, and an adjunct professor of law at Fordham University School of Law. The views expressed in this article are the authors alone, not those of Intact, Mound Cotton or Fordham.
Barry R. Temkin is a partner at Mound Cotton Wollan & Greengrass LLP, and an adjunct professor of law at Fordham University School of Law. Robert J. Usinger, Esq. is a graduate of Brooklyn Law School, a member in good standing of the New York Bar, and an assistant vice president of Professional Liability claims at Intact Insurance Specialty Solutions..
As we previously have written, choice of counsel issues may arise when a liability insurance carrier sends an outcome-determinative reservation of rights letter to a policyholder on a duty to defend policy.[i] And while most of the law in these so-called “Cumis” situations is judicial, California has enacted a statute that embodies these principles.[ii]
But leaving California aside for the moment, is there a general exception in the insurance regulations to the carrier’s duty and right to select counsel in defending professional liability claims? Some policyholder advocates have argued that, at least in New York, choice of counsel is implicit with respect to errors and omissions insurance policies to the extent that that policy limits are eroded by defense costs. But a closer examination reveals that New York insurance regulations provide carriers with a choice for certain specified coverages. Carriers can either accept limitations on the percentage of policy limits that can be eroded by defense costs, or, alternatively, turn over control of the defense, including selection of counsel, to the insured.
In the first instance, New York Insurance Regulations provide that eroding policy limits, which are diminished by defense costs, are only permissible for certain designated coverages and for certain designated amounts. See, 11 NYCRR Section 71.3. For example, there can be no eroding policy limits for an architects and engineers’ liability policy unless the policy limits are at least $500,000, and no medical malpractice policy erosion unless the policy limits are at least $1 million.[iii] Another exception is for “large commercial insureds.”[iv]
Moreover, unless control of the defense is handed over to the policyholder, there is a fifty percent limit on erosion of liability policy limits by defense costs. Thus, a hypothetical $1 million architects and engineers’ defense policy would be subject to the fifty-percent defense cost limitation unless control of the defense is ceded to the policyholder. According to the Office of General Counsel of the New York State Department of Financial Services, which regulates the insurance industry, ” [a] greater than 50% offset provision is permitted only when the insured has the right to exercise all three of the conditions specified in 11 N.Y.C.C.R.R. § 71.3(c)(1).”[v] These three conditions are set forth in the regulations as follows:
c) The percentage limitation specified in subdivisions (a) and (b) of this section may be omitted if the policy provides that the insured shall have the option to:
(1) select the defense attorney or to consent to the insurer’s choice of defense attorney, which consent shall not be unreasonably withheld;
(2) participate in, and assist in the direction of, the defense of any claim; and
(3) consent to a settlement, which consent shall not be unreasonably withheld.[vi]
According to the New York State insurance regulation: ” [u]nless the policy provides the insured with control of the defense, as specified in subdivision (c) of this section, legal defense costs charged against the stated limits of liability shall not exceed 50 percent of such limits, and except for the offset against the deductible authorized by subdivision (b) of this section, the insurer shall assume any legal defense costs over the amount or percentage specified in the policy.”[vii]
While the above-quoted provision restricts the carrier from charging defense costs against the stated limits of liability in excess of 50%, it does not require insurers to include such language in the policy itself. Thus, a carrier that assigns counsel must simply absorb any defense costs in excess of 50% of the policy limits; it need not include such language in the policy itself. This limitation does not apply where the insured selects counsel.
The purpose of the regulation is to protect policyholders from the erosion of their policy limits by over 50% when the insurer selects defense counsel. The question remains whether the insured has the right to select counsel in all situations where its policy contains eroding limits. A plain reading of the regulatory language demonstrates that the policyholder is not afforded such a right even in situations where the policy contains eroding limits. Rather, the regulation merely caps the percentage of erosion of policy limits in situations where the carrier selects counsel. For example, if an errors and omissions policy contains a $1 million limit, Regulation 71.3 merely provides that the policy limits may not be eroded by more than 50% for the costs of counsel selected by the carrier. Conversely, where the policyholder selects its own counsel, the policy limit can be eroded in its entirety by defense costs, although doing so would hardly benefit the policyholder.
Four other states—Minnesota, Arkansas, Montana and Oregon—have regulations that limit the erosion of policy limits by defense costs.[viii] Oregon, for example, broadly prohibits liability policies that include defense costs within policy limits. Minnesota prohibits erosion of policy limits by defense costs as a general rule, but permits exceptions for certain risks, such as environmental impairment liability insurance, and professional liability policies with aggregate limits of over $100,000, including directors’ and officers’ liability policies.[ix]
Some courts have narrowly interpreted policy language in eroding policy limits cases, holding that the policy language must clearly place the insured on notice that defense costs will erode the policy limits. For example in Illinois Union Insurance Co. v. North County Ob-Gyn Medical Group, 2010 WL 2011522 (S.D. CA 2010), the court held that an ambiguity in the policy definition should be interpreted against the carrier in order to exclude defense costs from eroding the policy limits. But, in Essex Ins. Co. v. Doe, 511 F.3d 198 (D.C.Cir. 2008), the carrier was permitted to reduce the policy limits by the costs of investigating a sexual abuse allegation.
Many duty to defend policies now contain choice-of-counsel endorsements whereby the insurance contract provides for the defense of claims by a pre-selected firm designated by the insured. These endorsements complicate control of the defense component of duty to defend policies for insurance carriers. In certain instances, pre-selected counsel may be non-responsive to the insurance carrier as they feel loyal only to the policyholder who selected them. This can sometimes lead to negative impacts on the case itself that are often to the detriment of the policyholder as well as the insurance carrier. However, most pre-selected counsel endorsements do contain several requirements for pre-selected counsel, such as compliance with the carrier’s litigation guidelines. While changing counsel is not a preferred option for any of the parties involved, even in the context of a pre-selected counsel endorsement, it is possible for the carrier, at least in New York, to remove pre-selected counsel where they are not adhering to the carrier’s guidelines.
Absent a conflict of interest imposed by an outcome-determinative reservation of rights, New York insurance law does not afford a policyholder the right to select defense counsel. The regulations merely require the insurance carrier to choose whether the policy limits may be eroded more than 50% by defense costs. In the event that the carrier selects counsel, the policy limits may not lawfully be eroded by more than 50% by defense costs, with the remaining half to be assumed by the insurer. Should the policyholder be afforded the ability to select its own counsel, then the 50% cap on erosion of legal fees no longer is applicable.
[i] See Barry Temkin and Robert Usinger, Conflicts of Interest and Choice of Counsel in Insurance Policies, PLUS Journal, August 2012, Vol. XXV, No. 8, available at https://works.bepress.com/barry_temkin/78/.
[ii] See Barry Temkin and Robert J. Usinger, Conflicts of Interest and Choice of Counsel in Duty to Defend Insurance Policies: Should There Be Goldfarb Miranda Warnings?, Mealey’s Emerging Insurance Disputes, Vol 17 No. 9 (May 3, 2012), available at https://works.bepress.com/barry_temkin/77/.
[iii] See New York Insurance Reg. § 71.3(d).
[iv] Id; see In re September 11 Liability Insurance Coverage Cases, 03 civ. 332 (S.D.N.Y. March 1, 2003) (Hellerstein, J.), https://www.casemine.com/judgement/us/591479dbadd7b049343ff90b
[v] See NY Office of General Counsel Op. No. 03-01-02, https://www.dfs.ny.gov/insurance/ogco2003/rg030102.htm
[viii] See David S. Wilck, Coverage Concerns in Burning Limits Policies, https://www.rivkinradler.com/publications/coverage-concerns-in-burning-limits-policies/ (accessed on November 26, 2021).
[ix] See Minnesota Regulation 60A. 08, cited at https://www.rivkinradler.com/publications/coverage-concerns-in-burning-limits-policies/