Chapter Seven
| Jurisdiction | New York |
Chapter Seven
Insurers’ Liability in Excess of Policy limits
Arnold Stream, Esq.*
* This chapter was previously updated by Lawrence W. Pollack, Esq., and Alexander Kayne, Esq.
I. Introduction
In the national legal landscape, several jurisdictions recognize an independent claim against an insurer known as a “bad faith” claim. In some states this claim sounds in tort. In others, it is based on particular statutes. Or, in others, the claim derives from the insurance contract. In all of these instances, the permissible damages recovery exceeds the insurance contract itself.
New York law does not recognize such an independent “bad faith” claim. But there are certain situations under New York law in which an insurer may be required to pay an amount in excess of the policy limits, as first articulated in 1972 by the Court of Appeals.862
New York jurisprudence takes a strict approach to such claims. New York, unlike other states, requires intentional or reckless action by the insurer to state a “bad faith” claim. Generally, this happens where an insurer wrongfully abandons defense of a claim, fails to settle a claim for a sum within policy limits, or fails to inform the insured of a possible settlement offer.863
To assist the practitioner, this chapter will trace the means by which New York law authorizes insurer liability beyond policy limits—through the insurance contract, through general unfair claim practice statutes, or through punitive damages.
II. Discussion: The Means By Which Insurer Liability in Excess of Policy Limits is Imposed Under New York Law
A. Through the Insurance Contract
1. General Insurance Contract Principles
Under a standard insurance contract, an insurer has two fundamental duties. One is to defend the insured. The other is to indemnify the insured against loss. The two duties are not coextensive.
The insurer’s duty to indemnify derives from the wording of the insurance contract. The typical agreement provides the following:
The company shall pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies, caused by an occurrence.
“The insurer’s duty to furnish a defense is broader than its obligation to indemnify.”864 The insurer’s duty to defend typically arises from succeeding language in the same clause:
[T]he company shall have the right and duty to defend any suit against the insured seeking damages on account of such bodily injury or property damage, even if any of the allegations of the suit are groundless, false or fraudulent, and may make such investigation and settlement of any claim or suit as it deems expedient. 865
As such, the duty to defend is wholly dependent on the language of the policy. In the absence of an express provision requiring the insurer to provide a defense, no duty to defend arises.866
Whether the duty to defend has been triggered is determined by the allegations in the complaint.867 The duty to defend arises whenever the allegations state a cause of action that gives rise to the “reasonable possibility of recovery under the policy.”868 Unless the insurer can demonstrate that the insured’s allegations fall squarely outside the policy coverage (by, for example, falling entirely within an exclusion), or can establish as a matter of law that there is no factual or legal basis upon which it might eventually be obligated to indemnify the insured, then the insurer will be required to defend the insured.869 Additionally, the four corners of the complaint are not the end of the inquiry. If the insurer has acquired information outside the complaint indicating that a covered claim exists, then the insurer must provide a defense.
An insured may bring a claim against its insurer where the insurer breaches the contractual duties set out in the policy. For example, where an injured third-party brings a claim against an insured defendant, an insurer may breach the express terms of the insurance contract by failing to defend and indemnify its insured. If the insurer’s action is not justified by the facts and the law, New York requires the insurer to honor the policy as written.870
Because the duty to defend is broader than the duty to indemnify, breach of the duty to defend does not necessarily lead to coverage for the loss itself. “[A]n insurer’s breach of duty to defend does not create coverage and . . . , even in cases of negotiated settlements, there can be no duty to indemnify unless there is first a covered loss. . . . The duty to defend is measured against the allegations of pleadings but the duty to pay is determined by the actual basis for the insured’s liability to a third person.”871
The initial burden of showing that a claim falls within the insuring agreement generally lies with the insured.872 On the other hand, the insurer has the burden of proof to prove the terms of an exclusion.873 Thus, where an insurer has refused coverage on the basis that the claim does not fall within the insuring agreement, the burden of proof in a subsequent coverage action should be borne by the insured. But, where the insurer’s denial is based upon an exclusion, the burden of proof lies with the insurer.
For an ordinary breach of contract, the insured generally will recover the sum that the insurer would have paid but for the breach. For example, if the insurer breaches the duty to defend, “the measure of damage is the cost of defense to the insured and the amount of recovery, if any, against the insured within the policy limits.”874 Defense costs are considered separately—and thus are not generally limited by the policy limits.875 Still, an insured who defends himself or herself does not have carte blanche. Reimbursement from the insurer is limited to “reasonable counsel fees and necessary expenses.”876
In the same vein, if the insurer breaches the duty to indemnify, the insurer is ordinarily liable for indemnification up to the policy limits—that is, the sums it would have paid but for the breach. For example, if the insurer reasonably refuses to settle a claim within the policy limits and the insured is found liable for more, “damages are measured by the policy limits.”877 Similarly, if the insurer breaches by wrongfully denying a first-party claim by an insured against its insurer, the insurer is generally liable up to the policy limits.878
Every insurance policy, like any contract, includes an implied covenant of good faith and fair dealing.879 The insurer’s duty of good faith centers around its power to control the defense of a claim.880 The standard is “equal consideration”—“that the interests of the assured must be given at least equal consideration [by the insurer] in evaluating the propriety of a settlement.”881
Under New York law, an insurer’s duty to act in good faith is also owed directly to any excess insurers.882 In the context of a claim by an excess insurer against a primary insurer, the courts recognize the inherent conflict between the primary insurer’s desire to settle the claim for as little as possible, and the excess carrier’s desire to avoid liability.883
2. Breach of an Insurance Contract Can Lead to Imposition of Insurer Liability in Excess of Policy Limits
While the covenant of good faith and fair dealing derives from contractual principles, the remedy for its breach is derived from tort principles of damages.884 The liability of an insurer who breaches the good-faith covenant, and thus acts in bad faith, will not be limited to the terms of the insurance policy—that is, the costs of defense and the policy limits—but can be expanded to the extent that the insurer’s conduct caused the insured to incur a financial obligation in excess of the policy limits. This element of causation is critical. In the absence of a nexus between the insurer’s misconduct and the insured’s enhanced exposure, the insurer will not be liable for damages in excess of the policy limits.885 In order to satisfy causation, the insured will have to establish that in the absence of the insurer’s bad faith, the case could have been settled within policy limits.886
In the context of first-party claims by an insured against its insurer, New York has traditionally not allowed “bad faith” claims in excess of policy limits. A 2001 First Department decision, Acquista v. New York Life Insurance Co.,887 reversed course, allowing a first-party “bad faith” claim to proceed.888 No published New York cases have followed its reasoning.889 Federal courts have criticized Acquista as inconsistent with Court of Appeals precedent and declined to follow it.890
The prevailing standard for “bad faith,” articulated in Pavia v. State Farm Mutual Automobile Insurance Co., is “a ‘gross disregard’ of the insured’s interests—that is, a deliberate or reckless failure” to provide “equal consideration.”891 Ordinary negligence will not support a finding of bad faith.892 “[A] bad-faith plaintiff must establish that the defendant insurer . . . evinc[ed] a conscious or knowing indifference to the probability that an insured would be held personally accountable for a large judgment if a settlement offer within the policy limits were not accepted.”893
New York’s standard is stricter than that of some other states.894 For example, California requires only a showing that the insurer acted “imprudently.”895 New Jersey has gone one step further, holding that any failure to settle within policy limits constitutes a presumption of bad faith to be rebutted by the insurer.896
a. “Bad-Faith” Conduct—Failure to Defend
A bad-faith denial of the duty to defend may render the insurer liable for defense costs, but not necessarily indemnity costs. This is because the duties to defend and to indemnify are not co-extensive. Thus, for the insurer to be liable to indemnify, there must be some showing that the judgment or settlement at least included a claim actually covered by the insurance policy.
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