2.2.4 Discharge of Duty Through Exhaustion of Policy Limits

JurisdictionArizona

Standard insurance policies contain an exhaustion of coverage clause which limits the insurance company's duty to defend. A typical exhaustion clause provides:

We will settle or defend, as we consider appropriate, any claim or suit asking for these damages. In addition to our limit of liability we will pay all defense costs we incur. Our duty to settle or defend ends when our limit of liability for this coverage has been exhausted.

In Continental Casualty Co. v. Farmers Insurance Co. of Arizona,[424] the court considered whether the insurance company's duty to defend was extinguished upon the exhaustion of policy limits. The court observed that courts in other jurisdictions have ruled that an insurance company's tender of policy limits did not end its duty to defend absent a judgment or settlement.[425] Other courts found that a tender of policy limits without a release in favor of the insured is not an actual settlement, and, therefore, exhaustion provisions are ineffective to discharge the duty to defend.[426] The court in Continental Casualty Co., implicitly adopted the foregoing general principles. These principles were relied upon by the court in California Casualty Insurance Co. v. State Farm Mutual Automobile Insurance Co.,[427] where the court held that a primary insurance company's payment or tender of policy limits without obtaining a release of the insured or full or partial satisfaction of a judgment will not discharge the duty to defend.[428]

A primary insurance company's duty to defend is discharged under the policy's exhaustion clause when the company pays its policy limits and secures a covenant not to execute in favor of its insured. In Continental Casualty Co., the court held that while a covenant not to...

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