This is the final article in a six-part series on early "issue spotting" in construction claims and litigation. Previous articles in this series can be found here: Part 1, Part 2, Part 3, Part 4, and Part 5.
This article in the series addresses issues which arise during a pending claim or suit.
Once the parties' positions have been staked out, the case against the insured develops. Three exposures develop simultaneously as evidence is gathered and the liability brought into focus: (1) the insured's exposure to the plaintiff in the underlying or liability case; (2) the insurer's exposure on the policy; and (3) the insured's exposure for uncovered damages.
In theory, the insured and the insurer each seek to minimize the collective exposure to the plaintiff, then sort out the coverage arguments later. In practice, how and what discovery is conducted, what litigation positions are taken, and how exposure and case status is reported to the carrier and the policyholder drive settlement decisions and evaluation. If a global settlement of the liability and coverage issues is feasible, the discovery and evidence from the liability case become the foundation for later insurance litigation.
Traps To Avoid Respecting Evidence In Insurance Litigation When The Liability Case Settles
It is no surprise that in insurance litigation, the rules of evidence apply. However, many clients and lawyers fall into one of two common traps. The first one is to not develop facts necessary to litigate the coverage case later, such as where a case settles because of off-the-record and/or protected communications. The second, related, trap is to assume that a coverage determination against a nonparticipating carrier will be favorable simply because the settlement seemed favorable. An insurance case is, quite simply, a new lawsuit; the liability case is the earth where the evidentiary seeds are planted.
The Case Within A Case And Problems Created By Settlement
Follow-on insurance litigation after settlement is, in many respects, similar to professional liability matters where the issues are tried as a "case within a case." In a professional liability case, the foundational fact is whether there is an injury to the plaintiff, measured by a settlement or judgment that would not have been necessary but for the negligence of the defendant; similarly, in insurance coverage litigation, the fundamental question is whether the settlement by the insured or unsatisfied judgment against it would not have occurred had the carrier recognized coverage under the policy. If the insured receives a defense verdict or pays nothing, there are no damages aside from defense costs; if there is a settlement or judgment on an uncovered claim against the insured, there are no damages for an action against the carrier.
The concept of litigating a "case within a case" is less difficult where the underlying case proceeds to trial, because the basis for the insured's liability is documented. While insurance coverage must be kept in mind when considering settlement with certain parties or the form of the verdict (discussed below), a settlement raises several difficult questions regarding evidence in a subsequent case, including:
- Where defense counsel in the liability case opines that liability is likely and that a settlement can be obtained on more favorable terms, what is the admissibility and weight of counsel's opinion in the insurance case?
- Are the discovery responses by the insured, or letters sent to other parties by the insured or its lawyer, admissible in subsequent insurance litigation, and for what purpose?
- Are discovery responses and letters sent by other parties in the liability case (not insureds or parties to the insurance litigation) admissible under any circumstances?
- If the liability case settles at mediation, what effect does that have on admissible evidence in the subsequent insurance litigation?
Jurisdictions differ as to whether the issues may be handled in a single lawsuit. For example, under California law, common issues between the liability and coverage case are tried and determined in the liability case. Thus, for example, if an insured is sued for bodily injuries arising out of an assault, and the matter proceeds to trial and judgment, the insurer may not later force the insured to prove its liability to the plaintiff and the amount of damages. Rather, in subsequent insurance litigation, the issue is limited to whether that liability is covered by the insurance policy under an estoppel theory.103
However, what if the liability case settles, and the insurer has denied coverage, or refused to contribute to the settlement? In that case, there is no adjudication of the insured's liability or the amount thereof. Since most cases settle, early recognition of coverage issues — and handling them — are critical.
This is the fifth article in a six-part series on early "issue spotting" in construction claims and litigation. Previous articles in this series can be found here: Part 1, Part 2, Part 3, Part 4, and Part 6.
This article in the series begins to address the question of what to do when an insurance dispute is likely.
Choice Of Law
Choice of law can be outcome-determinative on many substantive issues in insurance coverage litigation, including litigation over coverage for construction defect claims. Sections below will highlight a number of key substantive issues on which the determination often depends on what state's law applies.
Because choice of law can be outcome-determinative on key issues, both the policyholder and insurance carrier must analyze this issue early on. The first question is: what choice-of-law rule will the court apply? Different approaches to choice of law can lead to vastly different results. Generally speaking, courts follow one of three approaches to choice of law in insurance coverage disputes: (1) the traditional lex loci contractus approach (First Restatement); (2) the most significant contacts approach (Second Restatement); and (3) statutory approaches.
Lex Loci Contractus (First Restatement)
The traditional lex loci contractus rule applies the law of the place (state) where the insurance policy (contract) was formed. In insurance cases, the place where the contract was formed is usually considered to be the place where the policy was issued or the place where the policy was delivered to the insured.70
Most Significant Contact (Second Restatement)
Most jurisdictions have rejected the lex loci contractus rule as antiquated and inflexible.71 A majority of states have adopted the Restatement (Second) choice-of-law rule. This approach focuses on which state has the greatest interest in the dispute.
Issue-by-Issue Analysis: An introductory note to the Restatement (Second) explains that "the applicable law is now said to be the local law of the state which, with respect to the particular issue, has the most significant relationship to the transaction and the parties."72
Principles and Factors that Guide the Restatement (Second) Analysis: Section 6 of the Restatement (Second) outlines seven principles designed to help a court determine which state has the most significant relationship to the dispute in a given case:
- the needs of interstate commerce;
- the relevant policies of the forum;
- the relevant policies of other interested states and the relative interests of those states in the determination of the particular issue;
- the protection of justified expectations;
- the basic policies underlying the particular field of law;
- certainty, predictability, and uniformity of result; and
- ease in determining and applying the law.73
In applying the Section 6 principles, courts are guided by factors set forth in Section 188:
- the place of contracting;
- the place of negotiating the contract;
- the place of performance;
- the location of the subject of the contract; and
- the domicile, residence, nationality, place of incorporation, and place of business of the parties.74
These five factors must be "evaluated according to their relative importance with respect to the particular issue."75 In other words, courts do not simply add up the number of factors that point to a given state and apply the law of the jurisdiction with the most contacts.76
Location of the Insured Risk is the Key Factor in Insurance Coverage Disputes: In insurance coverage disputes, the most significant contact is the location of the insured risk as long as the insured risk is located, at least principally, in a single state.77 On the other hand, if the risk moves from state to state or the policy covers risks that are located in two or more states, this factor is less significant.78
What Has Held Claims Back?
In every domain where statistical rigor has been brought to bear, old paradigms steeped in years of certainty have crumbled overnight. Claims is one of the few remaining significant institutions that have yet to undergo this transformation. In fact, it is the perpetuation of the myth that claims is different and that introducing statistical rigor is dangerous, that has kept claims from experiencing the benefits of significant investments in technology.
There certainly are dangers inherent in claim handling, especially bad faith actions because they can create painful financial and reputational damage. Even general litigation can be extremely expensive and outcomes are never certain. But the job of the astute claim leader is to find the sweet spot where legitimate claims are quickly honored and inflated claims identified and resisted. Litigation does not happen out of thin air — a claim adjuster and then several others in the chain of command have made conscious decisions not to accede to what is perceived to be an excessive settlement demand. The litigation process does not occur swiftly so there are many opportunities to settle cases in advance of an actual trial, and again, any decision not to should be well thought out. Plaintiff attorneys typically cite bad faith as a way of ratcheting up the pressure, but astute claim professionals understand what does and does not constitute bad faith.
This current upcoding problem is an example of where many claim leaders will cite bad faith potential as a reason not to offer resistance. But when a qualified physician undertakes an unbiased evaluation of a peer and arrives at a different conclusion that is strongly supported by empirical evidence, it does not constitute bad faith. If a claim adjuster introduces such an evaluation in the course of settlement negotiations, allowing the claimant to provide evidence to rebut it, and giving it due consideration, that also does not constitute bad faith. The objective should be to get as close as to the truth as possible.
This really boils down to the question of whether an adjuster armed with empirical evidence of upcoding will generally achieve a more accurate settlement outcome than without one and whether the cost benefit of that evidence is justified by its impact on the settlement. Anyone who really thinks about this, and certainly anyone who tests and measures it, will find that the answer to both questions is, absolutely. But for those who rely on traditional high-level claim measures and see in them what they want, there is no impetus to engage in continuous improvement.
The problem is really one of perspective because claim leadership has far greater exposure to outlier cases than to those that flow seamlessly through the system. Having been immersed in outliers for many years and lacking measures that would reveal them as outliers, decisions are made on the basis of the 5% population of outliers rather than the 95% population of more typical claims. Claim leaders experience the world paradoxically as if outliers somehow represented the majority and hyper-caution is a logical consequence, but at the cost of operational stagnation and significant leakage.
Looking Beyond Standard Claim Measures
The medical industry uses ICD-9, "diagnostic codes" to represent the nature and severity of injuries within their electronic medical records systems. The parameters for each code are spelled out clearly to promote consistency and they form the baseline for treatment plans. Unique circumstances, such as preexisting conditions do influence medical treatment but, theoretically, if all else were equal among patients, the same diagnostic code should lead to similar treatment regimens and outcomes. This is another example of how seemingly immeasurable phenomena have given way to measurement.
Hospital administrators seeking to optimize treatment facilities and Medicare, Medicaid and private health insurers, seeking to vet electronic billing, all rely on diagnostic codes as their baseline. Things are not so dissimilar in the Property & Casualty industry where medical bill repricing and bodily injury evaluation software also rely on diagnostic codes as a baseline. The designers of all of these systems employ diagnostic codes as common machine language to efficiently convey the nature and severity of injuries on an interindustry basis and as the foundational data element for financial computations.
Property & Casualty claim departments all rely on medical bill re-pricing software to programmatically compare the accumulating CPT (treatment codes) from medical bill data to the claimant's diagnostic code(s) to discern whether the treatment type is reasonable for the diagnosis. A second set of algorithms compares accepted treatment codes against a table of reasonable and customary charges to vet pricing. Nearly every claim department can easily access the data from the medical bill repricing software even when the service is provided by an external carrier.
Seeing the Forest
As a data set, diagnostic codes are subject to the law of large numbers so when aggregated and profiled with basic statistical tools, they reveal valuable insights. A simple example would be a chart of the distribution of diagnostic codes that points to the frequency with which each code appears in the overall population. Comparing such a distribution over several consecutive years reveals whether any significant changes to the distribution are occurring. With the nature of injuries remaining static or, arguably, diminishing, the more significant the evolving migration toward higher severity diagnostic codes within each yearly distribution, the more certain it is that diagnostic coding is the means by which claim deterrents are being defeated.
For simplicity, the above example condenses numerous diagnostic codes into five classification ranges based on diagnosis severity from low (A) to high (E). While the data is fictitious, the author believes that actual data would reflect a change of the magnitude depicted, resolving any uncertainty about whether diagnostic upcoding was a causal contributor to the cost shift.
This is a very simple and inexpensive data analysis exercise and even if it demonstrated that diagnostic upcoding is not the driver of the cost shift, ruling it out would advance understanding.
The Insurance Research Council reports a huge unexplained increase in medical costs. Claim leaders are all confident that it is not happening in their shops, yet it is happening to the industry to the tune of billions.
The objective of this series is to:
- Continue to create awareness of the significant change in the complexion of loss costs resulting from artificial medical cost inflation
- Educate Property & Casualty executive leadership about how to discern whether and to what extent this issue is affecting their company
- Demonstrate how measurement and data analysis should be used by claim departments to vet this issue and many others like it
A Summary Of The Problem
As the Insurance Research Council reported in 2008, in spite of a significant decline in automobile accident frequency and incidences of serious injury, loss costs have not only held steady, but have increased. The Insurance Research Council has discerned that medical costs associated with minor to moderate injuries have undergone substantial inflation and pointed to "hospital cost shifting" as the source. That phrase doesn't necessarily mean that hospitals are intentionally making up for government fee reductions and declining private health enrollment by deliberately charging more for auto accidents. But the effect is the same because as hospitals struggle with the major players (government and private insurers) the Property & Casualty industry is incurring collateral damage as it stands on the sidelines.
This cost shift is occurring virtually undetected by Property & Casualty claim departments by evading recognition by the principle software programs designed to vet medical bills, medical bill repricing software. There is very good reason to believe that this is occurring via a methodology known as "diagnostic upcoding" and for the purposes of this series, I will assume this to be the case.
A Lopsided Competition
Hospital administrators have become financially sophisticated and technologically savvy while claim departments have traded technical acumen for cost efficiency. The widest performance gap between the new generation hospital administrators and the current claim leaders exists in the data analytics space, where the hospital administrators are light years ahead. Hospital administrators have scored a coup as billions in artificial costs are pouring into the Property & Casualty industry without claim leadership being aware.
This series will identify available untapped claim data and explain how it can be cultivated and leveraged to achieve a level of strategic deterrence sufficient to detect, arrest, and reverse the upcoding problem cost. It will also demonstrate the importance of bringing far more statistical rigor imbued with requisite technical acumen to a claim profession in decline, in spite (or because) of, a multi-year technology spending binge.
During a recent webinar on the topic of managing corporate crises, consultant Jim Lukaszewski identified seven behaviors that spell trouble when it comes to crisis management. In a different context, we can adapt these headings and apply them to the realm of product liability. While the headings are adapted from Lukaszewski, the application to corporate product challenges are mine.
Denial is not just a river in Egypt. Among management teams, this often manifests in comments such as,
- "We didn't do anything wrong ..."
- "Our products are the best ..."
- "None of our competitors incorporate those features in their products ..."
- "We've never paid that much before on a claim ..."
C-suite execs may react to a serious product liability claim by denying that there is a problem. They may deny that a claim has any merit. They may insist that the company could have designed a product differently, incorporating heightened safety factors. They may deny that prior notices of adverse consumer outcomes constituted any kind of notice of a developing safety problem.
This is not to say that executive teams should reflexively be alarmist. Over-reaction has its own perils. The latter, however, is rarely the biggest risk or most typical corporate reaction to product meltdowns. More often, corporate group-think can lead management teams to marginalize the significance of an incipient product liability problem. This can blind companies to the reality of what they are facing and forestall needed steps to address problems.
In a product liability claim, who is the victim? A jury often sees the injured plaintiff as a victim. By the time the case goes to court, you typically have a consumer who suffered an adverse outcome associated with a product. The manufacturer may be perceived as a big, out-of-state corporation. Chances are, it provides no local employment.
That doesn't necessarily mean the product was defective, but few plaintiff attorneys will let a case get to a jury unless they feel they can make at least a prima facie case for defect. However, many C-suite staff have a tough time wrapping their heads around this reality. They may think that they are the victims.
They feel victimized because they have been sued, in their eyes sued unjustly. They feel victimized due to the money they must spend, either directly or indirectly, to defend the claim and possibly even to settle. They feel victimized by the amount of time they must spend huddled with lawyers and the insurance company on defending the claim, time that could be better used running their business.
Rest assured, no jury or jurors will view the targeted corporation as the victim. No matter how sympathetic, no matter how worthwhile the company's efforts have been, they often see a corporation versus an injured patient. Viewing the corporation as the victim can blind executives to the genuine dangers of a court and courtroom setting, creating the risk of substantial financial penalties.
The landscape of punitive damages for maritime employers is changing. Punitive damages have, in the past, been generally available under general maritime law but rarely implemented since the 1990 Supreme Court decision in Miles v. Apex Marine Corp., 498 U.S. 19 (1990).1 Developments arising out of the litigation from the BP/Transocean disaster leave maritime employers with an increased exposure to punitive damages under other maritime causes of action.
On August 26th, 2011, the Federal judge managing the litigation on the Deepwater Horizon blowout and subsequent oil spill disaster ruled that punitive damages are payable under general maritime law.
The judge stated: "These Plaintiffs assert plausible claims for punitive damages against Responsible and non-Responsible parties."2 This ruling was made regarding the economic and environmental claims and may possibly be applied to crew injury and death claims in future litigation.
On October 21, 2011, BP was denied their appeal against the punitive damages ruling made on August 26, 2011. The plaintiff's attorney arguing against the BP appeal stated to the Federal judge in charge: "Everything we know from the Supreme Court is that there will be punitive damages no matter what."3
The BP/Transocean disaster has brought much attention to compensation for injured or killed employees working in the maritime environment. There have been a number of bills submitted to Congress requesting that punitive damages also be payable under the Jones Act. While at least one of these bills has been passed in the House, none have made it through the Senate or have been passed into law as of the time of this advisory. The BP trial starts in late February 2012, and it is possible new rulings regarding punitive damages and the Jones Act will be made.
The SIU Evolution
The term Special Investigations Unit (SIU) is often used as a synonym for fraud, and that is a very unfortunate circumstance. Special Investigations Units have become largely detached from general claim departments while fraud has not.
In their early days Special Investigations Units were often integrated with and working in close proximately and partnership with the general claim population. Their presence and influence helped keep a universal focus on fraud. In many instances the general claim adjuster retained the claim and the Special Investigations Unit acted as a partner, an excellent training mechanism.
The formula was SIU + informed general claim adjusters = fraud deterrent
The former situation was not perfect because adjuster ability to identify and refer suspect cases varied. In time, rules-based intelligence and predictive modeling tools evolved to strengthen detection and referral. Early on, the new tools alerted the general adjuster who decided whether to refer. But over time alerts were increasingly elevated to the Special Investigations Unit directly because the tools increased referral activity and Special Investigations Unit managers needed a mechanism to control the volume and ensure that the cases with the highest potential were retained.
As the paths of the Special Investigations Unit and the general claim department increasingly diverged, the latter was also becoming increasingly specialized and downsized as automation and production became the top priority. The "need for speed" took an even greater toll on general claim fraud focus and today Special Investigations Units and general claims live in different worlds.
This is the fourth article in a six-part series on early "issue spotting" in construction claims and litigation. Previous articles in this series can be found here: Part 1, Part 2, Part 3, Part 5, and Part 6.
This article in the series begins to address the question, "The Claim Occurs - Now What?"
What Carriers Should The Claim Be Tendered To?
Insurance policies and programs serve one fundamental purpose: to transfer the risk associated with a loss. When confronted with unexpected delays and ever-changing management concerns on the jobsite, one can easily forget that insurance is available for many losses. Policyholders must be hypersensitive to potential claims and involve available insurance as soon as possible.
Think carefully about the nature of the claim — more than one policy may be implicated.
Identifying an insurance claim can often be difficult in the construction setting. Consider, for example, a construction manager on a building construction job that is half complete. A portion of the progressing structure collapses and destroys most of the completed work. As a result of the damage and ensuing delay, a subcontractor that is already on-site cannot proceed with its work and must store materials and equipment, as well as reassign labor, until the damage is cleared and the project resumes.
The reason for the collapse is unclear, but may involve a combination of design error and contractor negligence. Once work resumes, the subcontractor submits a change order to the construction manager, indicating that the original contract price of $1 million is inadequate in light of costs caused by the collapse and must be increased to $1.2 million. The construction manager approves the change order, assuming responsibility for the loss. In this situation, the subcontractor's cost increase resulting from the property damage is potentially covered by insurance; however, it can be overlooked as a business expense. Instead of absorbing this cost, the construction manager could potentially have transferred it to available insurance. Moreover, because of the nature of the damage, it may implicate both commercial general liability coverage and professional liability coverage.
It is important, at the onset of a loss or a potential claim, to consider all available insurance (Commercial General Liability, Professional Liability, Builders Risk, Environmental and Excess/Umbrella; see Section II., B., supra) and think critically about how the loss may require insurance to respond.
The new year brings with it a host of laws that were signed by Governor Brown this past fall. In fact, there were 750 bills that were sent to the Secretary of State and chaptered in 2011. Most of these became effective January 1. A number of new laws reflect intensified efforts by policymakers to address the abuses in the underground economy. Given the state of the "above ground" economy, and the State of California's fiscal distress, getting all businesses to play by the rules has a new sense of urgency in Sacramento and across the State.
To aid in the ramping up of this effort, Governor Brown signed Assembly Bill 469 (Swanson), the Wage Theft Prevention Act of 2011, and Senate Bill 459 (Corbett). AB 469 requires a new notice by an employer at time of hire that sets forth certain basic wage and hour information as well as contact information for the employer and the employer's workers' compensation insurer. This new form is available at the Department of Industrial Relations (DIR) website. While many of us may think this is standard operating procedure for all businesses, one influential study done by UCLA, "Wage Theft and Workplace Violations in Los Angeles" (2010) documented widespread violations of California's wage and hour laws, workers' compensation laws, and employment classification laws (independent contractors). AB 469 allows an employee to recover attorneys fees for actions to enforce a court order for unpaid wages.
SB 459 creates significant new liabilities for the willful misclassification of an employee as an independent contractor. These liabilities include joint liability for any non-attorney who advises an employer to misclassify an employee as an independent contractor. Among the law's provisions, the Labor and Workforce Development Agency is now required to report to the Contractors State License Board any contractor who is fined under this new law. Also, an employer who has been found to have committed a serious violation is required to post a notice either on its website or in a place visible to all employees and the general public, signed by an officer of the business, that it has violated this new law and provide a number for any other employee who feels they have been misclassified to contact the Labor and Workforce Development Agency.