You May Not Have All the Coverage You Think You Have

Arming yourself with knowledge ahead of time can help you to develop strategies and create records that maximize coverage, facilitate resolution of current disputes, and eliminate potential future disputes.

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Misunderstanding the language contained in the self-insured retention ("SIR") in an insurance policy can cost policyholders millions of dollars.

SIRs, which appear in many liability policies, are similar to deductibles but require the insured to bear responsibility for a certain amount of the loss (including damages and defense costs) "before there is any coverage under the policy."1  (A deductible is generally a sum the insured "'must pay before the insurer owes its duty to indemnify the insured for a covered loss'" and generally refers "only to the 'damage for which the insured is indemnified, not to defense costs'").2   The language of the SIR, which varies from policy to policy, ultimately controls when and how an insured's coverage is triggered.

Some policies contain language that preclude anyone other than the named insured from satisfying the SIR—which can catch companies by surprise.

In a 2010 case, Forecast Homes, Inc. v. Steadfast Insurance Company3  ("Forecast"), a housing developer faced a construction defect lawsuit filed by several homeowners.4   The developer argued that its subcontractors' insurer, Steadfast, should provide coverage for the lawsuits, pursuant to contracts that required the subcontractors to provide additional insured coverage for the developer.5   But the courts disagreed because the named insured subcontractors, who were not parties to the construction defect lawsuits, did not satisfy the SIR in the Steadfast policies, a prerequisite for coverage.6   And, the developer could not satisfy the SIR itself as an additional insured.7

There were several Steadfast policies invoked in this lawsuit, but these policies contained essentially two versions of the SIR.8   Version one provided that "you [the named insured] shall be responsible for payment of all damages and defense costs for each occurrence or defense, until you have paid [SIR] amounts and defense costs equal to the [p]er [o]ccurrence amount shown in the Schedule[.]"9   Version two contained this same language but added explicit language precluding anyone other than the named insured from satisfying the SIR.10   The court held the plain language of version two clearly barred the additional insured developer from satisfying the SIR.11   But the court also found that the less explicit version one precluded anyone other than the named insured from satisfying the SIR, relying on the section providing that "you"—defined as the named insured—are responsible for payment of defense and damages until the SIR is satisfied.12   Developer Forecast Homes, to its surprise, could not satisfy the SIR to trigger coverage as an additional insured.

Under different language, though, courts have allowed insurers, additional insureds, or others to satisfy the SIR.  For example, in National Fire Insurance Company of Hartford v. Federal Insurance Company ("National"),13  National Fire Insurance Company of Hartford ("NFIC") paid its policy limits to settle a suit on behalf of its named insured (a restaurant) and its additional insured (a hotel).14   NFIC then sought reimbursement from the hotel's insurer, Federal Insurance Company ("Federal").15   Federal argued that it was not obligated to pay a portion of the hotel's defense or indemnity because the hotel had not satisfied the $250,000 SIR, and the SIR could not be satisfied through NFIC.16   The court disagreed.17

Similar to version one of the policy at issue in Forecast, the Federal policy provided "[w]e have no obligation or liability under such Coverages unless and until the applicable [SIRs] . . . . are exhausted by payments you make . . . .  You must pay all [SIR] expenses."18   But the Federal policy at issue in National contained language that "'bankruptcy, insolvency or the financial impairment of any insurer or any other person or organization does not relieve the hotel of its obligation to satisfy the SIR," unlike the language in Forecast that referred "only to the insured's own bankruptcy or solvency."19   The language in National, combined with the absence of explicit policy language prohibiting another insurer from satisfying the SIR, compelled National to find that there was no bar to NFIC satisfying the SIR in the Federal policy on behalf of the hotel, the named insured.20

What does this mean if you are an insurer considering settlement?  And how can insureds use this information to facilitate settlement or avoid future disputes?

  • Know your policy language ahead of time.  Make sure you look at your policy and other potentially relevant policies before entering settlement negotiations and understand exactly who can satisfy the SIR.  If the SIR must be satisfied by the named insured and you are an additional insured, make sure that topic is part of the negotiations.  If the named insured is not a party to the action, consider whether you have grounds to bring the named insured into the action.  If the SIR can be satisfied by other insurers or co-defendants, then you have more flexibility in negotiating.
  • Consider sharing your knowledge.  Knowing how to satisfy the SIR not only protects you in settlements but may help facilitate settlements.  For example, if your insurer is reluctant to contribute because it is taking the position that other insurers should be at the settlement table, look at the relevant policies and determine whether the other parties can satisfy the SIR in these other policies.  If so, pointing this out to the insurers and increasing their comfort level with their chances for contribution may compel the insurers to tender additional policy funds that allow for settlement. 
  • Spell it out.  Think about potential coverage disputes and explicitly state relevant terms that could help resolve any disputes that have arisen or may arise.  For example, if the named insured is required to satisfy the SIR and, in fact, does so, state that in the mediation or settlement briefs, or otherwise memorialize it, so that the issue is clear and does not lead to disputes.  Understanding the disputes that may arise can help insureds create records that will allow for quick resolution or avoid the disputes altogether.

These recommendations are particularly important to insureds in the construction industry, where contractors frequently require subcontractors to name them on their insurance policies as additional insureds and are frequently contractually required to name others on their own policies as additional insureds.  Similarly, these recommendations are also important to corporations that face large-exposure lawsuits that exceed the limits of their primary coverage and need to trigger coverage under their excess policies to resolve matters.  In these circumstances, knowing who can exhaust an SIR can be critical to securing potentially millions in coverage. 

For all insureds, arming yourself with knowledge ahead of time can help you to develop strategies and create records that maximize coverage, facilitate resolution of current disputes, and eliminate potential future disputes.

1 Hon. H. Walter Croskey, Hon. Rex Heeseman and Christina J. Imre, California Practice Guide: Insurance Litigation (The Rutter Group 2013) ¶7:384.

2 Id.; see also Forecast Homes v. Steadfast Insurance Co. (2010) 181 Cal.App.4th 1466, 1474 (internal citations omitted, original italics).

3 (2010)181 Cal.App.4th 1466.

4 Id. at 1470.

5 Id. at 1469-1470.

6 Id. at 1470.

7 Id.

8 Id. at 1470.

9 Id. at 1471.

10 Id. at p. 1472.

11 Id. at 1476-1478.

12 Id. at 1480-1481.

13 (2012) 843 F.Supp.23 1011.

14 Id. at 1012.

15 Id. at 1012-1013.

16 Id. at 1016.

17 Id. at 1017.

18 Id.

19 Id. at 1017, italics added; Forecast, supra, 181 Cal.App.4th at 1472.

20 National, supra, 843 F.Supp.23 at 1017.

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