Reservation-Of-Rights Letters: A Risk Manager's Guide

Reservation-of-rights letters often leave risk managers scratching their heads in shock and anger. What does the insurer mean? How should the risk manager react to the letter? How does one deal with gray coverage areas? This article examines some key facets of reservation-of-rights letters and discusses ways to react when one is received.

'Does a reservation of rights mean I have no coverage?' Not necessarily. It does suggest that a cloud hovers over your coverage. It signals that the insurer thinks there might be grounds to deny coverage for at least part of the claim. A claim can allege some counts that the policy may or may not cover, such as intentional torts, financial loss with no property damage or bodily injury, or a matter clearly outside the policy scope. A claim may include both covered and excluded matters.

Months may pass before an insurer knows enough to tell whether coverage exists. Only a full investigation or trial might determine if facts support a denial of coverage. In the meantime, the clock ticks. Insurers must enter an appearance, hire a defense lawyer, and file an answer to the lawsuit.

If an insurer does not reserve rights and defends a claim, but later discovers that 'questionable' allegations raise coverage issues, the insurer may be estopped from raising a coverage defense. Courts could say that by its acts, an insurer waived its right to deny coverage. Rather than deny coverage outright-a high-stakes gesture that might trigger a bad faith lawsuit- or proceed as though nothing was awry, the insurer seeks middle ground by ending a reservation-of-rights letter. The latter says in effect, 'We are investigating this claim but preserve our right to later deny coverage if investigation shows that it is not a covered loss.' Insureds cannot claim that the insurer, by its actions, led the policyholder to believe that coverage existed.

As confrontational as reservation-of-rights letters tend to be, they steer insurers between the twin perils of total acceptance or total denial of coverage. Reservation-of-rights letters allow the insurer to keep its options open. If no strong coverage defenses emerge, it has not lost face. Reservation-of-rights letters give insurers more time to investigate a claim or unearth facts through the discovery process. Erring on the side of caution, an insurer can disclaim coverage if investigation reveals that the facts do not support coverage.

There are several options for risk managers who receive reservation of rights letters.

• Ignore it. Maybe the insurer is correct in reserving its coverage rights.

• Dispute the reservation. If you disagree with the reservation of rights, promptly go 'on record,' advising the insurer of your reason(s). This paper trail will be helpful if the case ends up in court. Maybe the insurer has misinterpreted a state law regarding insurance coverage for punitive damages. Or perhaps its interpretation of 'occurrence' is unduly narrow in light of policy language. Spell out your rationale, send it to the claims rep via certified mail return receipt requested, and set a deadline for a response. This turns up the heat on an insurer to reassess its position, or provide further insight as to whether you are on solid footing.
• Press for specifics. Some insurers believe that reservation-of-rights letters should be vague. The rationale is that this leaves the insurer with more options. Policyholders and risk managers should counterattack vaguely worded reservation-of-rights letters. Do not tolerate fuzzy letters that do not specifically refer to policy language and policy provisions, chapter and verse. Press for particulars.
• Start your stopwatch. Once an insurer has reserved its rights, it must eventually declare whether or not it is covering the claim. In other words, reservation-of-rights letters have limited shelf lives. An insurer must eventually get off the fence. If not, a court may decide the issue or an insurer may be estopped (through inaction) from using its coverage defenses, notwithstanding its reservation. Moral to risk managers: after receiving a reservation of rights, keep after the insurer periodically to either disclaim or accept coverage. Seize the initiative. Advise the insurer that after a reasonable amount of time you are entitled to a definitive stance as to coverage, or else the carrier is estopped. Be a nag!
• Recognize what new doors and options this opens. If the insurer reserves its rights, you may be entitled to hire a lawyer of your choice-not the insurer's-at the insurer's expense. When an insurer hires the lawyer and reserves rights, it creates a potential conflict of interest: the lawyer hired by the insurer may uncover some facts that if disclosed to the insurer might cloud coverage. To avoid putting lawyers in this position and to minimize the odds of mischief to policyholders, many courts allow insureds to retain their own counsel when an insurer reserves its rights. In California, for example, this has created a whole cottage industry of Cumis counsel, taken from the name of the court case. A reservation of rights might be a blessing in disguise, to the extent it opens the door for you to hire a lawyer who works for you and is not beholden to any insurer, but whose fee is still paid by the insurer! Insurers don't like this, but it may work out better for you in the long run.
• Seek a declaratory judgment action. This will get the coverage issue settled before proceeding on with the merits of the underlying claim. Do you need a lawyer? Again, the answer is, 'It depends.' If a company has an in-house legal department and has knowledge of the issues involved in the claim, maybe not. For a small business, seeking the advice of a lawyer may be prudent. If you and your lawyer feel strongly that coverage exists, you may want to seek a declaratory judgment. In fact, if the insured seeks a 'D.J.,' it can often influence the state, jurisdiction or forum where the court will hear the case. This is key, since some parts of the U.S. are much more congenial to policyholders and hostile to insurers. Thus, seeking a preemptive strike via a D.J. action may make sense to force an insurer's hand. The prospect of spending more legal fees to handle a D.J. action may also inspire an insurer to reconsider its coverage position, and it may even relent, seeing things your way.
• Sue the insurer for coverage and for additional damages. Consider this the 'nuclear warhead response.' First, though, make sure that you're actually in a war. An understandable question arising for policyholders receiving reservation-of-rights letters is, 'Do I need to seek legal counsel?' In lawyerly fashion, the answer is both yes and no. If you feel an insurer's position is groundless, capricious, or done simply to harass, then you can sue your insurer for bad faith, punitive damages, and breach of contract. Seek legal advice to determine whether you have a strong case. If your lawyer says yes, then raise the ante.

Simply threatening to play this card may make the insurer sweat. Insurers do not make sympathetic defendants in courtrooms. They know this, and will often avoid the specter of a whopping jury hit and publicity black eye. If the reservation of rights is genuinely premised on a 'gray area' in insurance policy interpretation, then a suit against the insurer for money damages may not be viable. Still, recall that insurance policies are adhesion contracts, and courts usually interpret reasonable ambiguities in the policyholder's favor. Your idea of a reasonable ambiguity and the insurer's may not coincide, though.

If you and your attorney feel the issue is black-and-white and that the insurer is reserving rights on specious grounds, consider a suit rooted in breach of contract and/or bad faith claims handling. Or perhaps-better yet -- threaten such action. Sabre-rattling will, at least, likely get the claim file bucked up the corporate hierarchy and may inspire some agonizing reappraisal on the insurer's part over its coverage stance. This is a use-only-in-emergency remedy, not one to deploy cavalierly. Once used, it may get your claim file off the desk of that adjuster trainee and into the domain of the V.P. of Claims, where cooler and more seasoned heads might prevail- in your favor. As drastic as this step is, it should be within any astute risk manager's armory.

• Look to your broker. Another question insureds may have is, 'Why didn't my broker notify me that this was coming?' Good question! Astute brokers will be attuned to coverage issues and will forewarn you of the possibility of an insurer reserving rights. Conscientious brokers will err on the side of caution in reporting a loss to a carrier if there is any chance of coverage. Acting otherwise might create an E&O exposure for the broker.

Astute brokers will add value to their service by

• Forewarning insureds as to the possibility-or likelihood-of a reservation of rights
• Discussing such letters with the insurer-preferably before they are issued
• Explaining to insureds in clear, understandable terms the meaning and import of a reservation-of-rights letter
• Functioning as the insured's advocate in the coverage matter, if the facts support that stance
• Advising the insured as to its options (see above) -- Extracting lessons from this episode to repair coverage holes and gaps in a pro-active way, come next renewal time
• Deciding whether a switch of insurers may be warranted

One frustrating issue is that all insurers do not use uniform criteria when issuing reservation-of-rights letters. While in theory, any gray area coverage topic should trigger one, one insurer's ambiguity is another's clear issue. Some insurer claim departments or adjusters may neglect to issue such letters out of oversight, overwork, inexperience or plain difference of opinion. Other carriers are aggressive in staking out any coverage issue, challenging insureds or testing the outer limits of the coverage envelope. In fairness to insurers, it is no more realistic to expect all carriers to take the same position than it is to expect all attorneys to agree on a certain point of law or all doctors to agree to one diagnosis in the face of certain symptoms.

An experienced insurance broker should be able to help alert you to those carriers that are hard-nosed on coverage matters and those that accommodate policyholders. When in doubt, the broker should practice preventive brokering by zeroing in on possible ambiguities and excising them from policies via endorsements, manuscript forms, or collateral letters of understanding. Unfortunately, in the zeal to sell, brokers can often gloss over possible sources of coverage strife and silently hope that they won't arise or that everything works out.

Reservation-of-rights letters are a symptom of a possible coverage gap. To that end, wise clients will treat them as 'red flags' and opportunities to diagnose the health of their own insurance and risk management programs. New challenges bring new opportunities and, in this light, the policyholder can transform the coverage issue into a plan to patch up a possible 'hole' in coverage or consciously decide to retain or self-fund.

In the Chinese language, the character for the word 'danger' connotes a double meaning of 'opportunity' as well. In a similar vein, reservation-of-rights letters carry overtones of danger, the danger of an uncovered loss. Viewed in a more positive light, however, such letters may flag an opportunity for companies to strengthen their own insurance and risk management programs, learning from the past to avoid future perils.