The Nature of a Liability Insurer’s Duty to Settle: Part I

January 13, 2014

Insurance LawCourts in California and elsewhere have long recognized an implied common law duty on the part of liability insurers to protect their insureds against the risk of liability in excess of policy limits, even though the insurance contract contains no language imposing such a duty. However, although the seminal California decisions imposing a duty to settle are now well over 50-years-old and the earliest decisions nationwide are approaching 90-years-old, the nature of the duty remains unsettled.

Insurers view the duty as an obligation to respond to settlement offers which does not arise until the claimant makes a formal settlement demand. Several California appellate courts have adopted the insurance industry’s understanding of the duty to settle.

Policyholders, on the other hand, maintain that the duty is a duty to attempt to effectuate settlement. Under this view, the duty is an affirmative duty that arises whenever the insurer’s investigation reveals a likelihood of liability in excess of policy limits. In such circumstances, the insurer must initiate settlement negotiations and may not sit back and wait for a demand from the claimant. Authority for the policyholder view of the duty to settle exists outside California. The California law supporting the policyholder point of view is either no longer citable, or not directly on point.

The Second Appellate District’s recent decision in Reid v. Mercury Insurance Company, 220 Cal.App.4th 262, 162 Cal.Rptr.3d 894 (2d Dist. 2013), adopts neither view. The Reid decision rejects the position that bad faith liability can be based solely on an insurer’s failure to initiate settlement negotiations, but also backs away from language in previous California decisions stating than a formal demand from the claimant is a prerequisite to an insurer’s duty to settle. Under Reid, the insurer’s liability for an excess judgment depends on proof either that the claimant conveyed to the insurer an “interest” in discussing settlement, or that the insurer did something to foreclose the possibility of settlement.

At least as applied by the Reid court, this approach is likely to benefit insurers more often than policyholders or their assignees. Although an expression of “interest” in settling is enough to trigger the insurer’s duty to negotiate, the expression must be substantive; the claimant must communicate to the insurer that settlement may “feasibly be negotiated.”—which is not much different substantively from a settlement demand. 220 Cal.App.4th at 272. The Reid court found that the claimant’s inquiries about the amount of the insured’s policy limits did not qualify as an expression of “interest” in discussing settlement. Moreover, the Reid court found that the insurer’s repeated insistence on taking a recorded statement from the claimant and refusal to discuss settlement without that statement despite knowing that the claimant was in intensive care did not give rise to a triable issue of fact regarding whether the insurer foreclosed the possibility of settlement.

The Reid court held that the insurer was entitled to summary judgment on the bad faith failure to settle cause of action arising from a $5.9 million excess judgment even though the insurer’s claims records showed that the insurer recognized shortly after the accident that the insured’s liability for the claimant’s injuries was likely to exceed the insured’s $100,000 policy limit, but did not communicate its conclusion to the insured or open settlement negotiations with the claimant. The fact that insured’s liability was never in dispute—the accident occurred when the insured failed to stop at a red light and collided with the claimant’s car—and the insurer knew the claimant had suffered catastrophic life-threatening injuries in the collision, resulting in an extended stay in intensive care did not obligate the insurer to initiate settlement negotiations.

My next post will critique the Reid court’s analysis of the theoretical underpinnings of the tort of bad faith failure to settle.