Opinion ID: 1796233
Heading Depth: 1
Heading Rank: 6

Heading: The Sphere Drake Policy

Text: The policy at issue is what is commonly know as a wasting asset or defense within limits (DWL) policy because the available indemnity limits may be consumed or wasted by the costs of defense. [14] Such policies include all defense costs and litigation expenses within the applicable limits of liability. Under such policies, the insureds' costs of defense, including attorneys' fees, expert witness fees, and other litigation expenses, are paid by the insurance companies and deducted from the policy limits as they are incurred, thereby reducing the amount of insurance coverage available to pay settlements or satisfy judgments. See Shaun McParland Baldwin, LEGAL AND ETHICAL CONSIDERATIONS FOR DEFENSE WITHIN LIMITS POLICIES, 61 Def. Couns. J. 89 (1994). In short, every dollar spent on defense reduces the amount available to satisfy potential judgments. DWL policies were first adopted in the 1980s. Since then, there has been an ongoing national debate as to whether DWL policies actually benefit insurance consumers. The cause for concern is the interest conflict that arises in every case between the insured and the insurer when dollars spent on defending claims result in fewer dollars being available for settlement of the claims or satisfaction of judgments. The parties are conflicted when the insurer is focused on a defense on the merits, and the insured wants assurance that the limits of liability will be available. The end result may be claims for bad faith and excess exposure to liability. Gregory S. Munro, DEFENSE WITHIN LIMITS: THE CONFLICTS OF WASTING OR CANNIBALIZING INSURANCE POLICIES, 62 Mont. L.Rev. 131, 144-45 (2001). Some states have enacted laws which limit or prohibit the use of DWL policies. For example, a Minnesota statute provides, No insurer shall issue or renew a policy of liability insurance in this state that reduces the limits of liability stated in the policy by the costs of the legal defense. However, the statute excepts large commercial risks, defined as an insured with gross annual revenues of $10 million or more. See Minn.Stat. § 60A.08, subd. 13 (1992). [15] New York allows defense within limits for (1) a policy issued to a large commercial insured with net worth of $15 million, gross assets of $50 million and net worth of $3 million, or generating annual gross revenues over $50 million and a net worth of $3 million or (2) primary policies with limits of at least $5 million or with a deductible or self-insured retention of at least $100,000. See N.Y.Comp.Codes R. & Regs. Tit. 11, § 107 (1992). An Arkansas statute requires a separate limit for defense costs to prevent the depletion of indemnity limits. The statute forbids the approval of any policy in which defense expenditures deplete policy limits, unless a separate limit for defense costs equal to 100% of the annual aggregate limit of liability stated in the policy for judgments or settlements is offered for defense costs or claims expenses to the insured. See Ark.Code Ann. § 23-79-307(5)(A). [16] Additionally, some state insurance commissioners have expressly retained the right to disapprove policies that include defense costs within limits, as well as policies that do not clearly disclose the effects of the policy. For example, Colo.Rev.Stat. §§ 10-4-419 provides that the Colorado Insurance Commissioner may disapprove claims-made policies which do not provide that defense costs are covered but excluded from the aggregate limit. Mont.Code Ann. §§ 33-1-502 mandates that the Montana Insurance Commissioner disapprove policies which incorporate inconsistent, ambiguous or misleading clauses, including provisions in casualty insurance forms that permit defense costs within limits. Additionally, an Oregon statute provides that a liability policy that includes defense costs within policy limits may not be delivered or issued for delivery unless approved by [the] director, and mandates the inclusion of a statement disclosing that costs of defending claims are included in policy limits. See Or.Rev.Stat. §§ 742.063. Our review of the statutory provisions concerning surplus lines insurance leads us to conclude that Louisiana has no statutory restrictions concerning DWL policies. There is no statutory provision that expressly grants or limits Sphere Drake's right to project all costs onto its insureds. In fact, the Louisiana Insurance Code provides little regulation of surplus lines insurance. At the post-trial hearing in this case, Kathleen Hennigan, the Director of Property and Casualty Division of the Louisiana Department of Insurance, testified the Department of Insurance regulates surplus lines insurance, but not in regards to policy terms and conditions. The Department is mainly concerned with the insurers' financial solvency and claims practices. Indeed, to achieve approved unauthorized status, surplus lines carriers need only demonstrate financial soundness and meet other consumer protection requirements mandated by the Insurance Code and/or the Commissioner of Insurance. More importantly to this case, there are no regulations at all regarding defense costs provisions in surplus lines policies. Section I, Paragraph 1 of the Sphere Drake policy at issue provides in relevant part: 1. Insuring Agreements a. We the Underwriters will pay on behalf of the Named Insured those sums, in excess of the Underlying Insurance... that the Insured becomes legally obligated to pay as damages because of bodily injury, personal injury or property damage ... which is caused by any person whilst acting within the course and scope of their employment by the Insured. b. We the Underwriters will have the right, but not the duty, to participate in the defense of claims or suits against the Insured seeking damages because of injury or damage to which this insurance may apply. This right to defend is limited as set forth in paragraph 3, below. Section I, Paragraph 3 provides: 3. Defense of Claim or Suit a. Should the Underwriters defend any claim or suit after the Underlying Insurance has been exhausted by payment of judgments, settlements and Defense Costs and Expenses, Underwriters will be liable, subject to the Limits of Liability set forth herein, for Defense Costs and Expenses and may make any investigation of such claim or suit as they deem appropriate. In the event that the Underwriters provide defense of any claim or suit, whether or not obligated to do so, Underwriters may make any investigation of such claim or suit as they deem appropriate, Underwriters may settle such claim or suit within the Amount of Insurance available at the time of settlement. b. The Underwriters [sic] right to defend shall cease when the Amount of Insurance has been exhausted through payment of any combination of judgments, settlements or Defense Costs and Expenses as provided under SECTION IILimits of Liability. c. Wherever Underwriters assume the sole control of defense in respect of any claim or suit, Underwriters will be liable, subject to the Limit of Liability for Defense Costs and Expenses. d. If by mutual agreement or court order the Insured assumes control of such defense prior to the exhaustion of the applicable Amount of Insurance, Underwriters will reimburse the Insured for reasonable Defense Costs and Expenses.    The section contained within the policy entitled, Section IILimits of Liability, provides in pertinent part:    4. All Defense Costs and Expenses paid by Underwriters shall be added to judgments and settlements paid by Underwriters to determine the exhaustion of Underwriters applicable Limit of Liability. 5. Each payment made by Underwriters for damages because of injury or damage to which this insurance applies and for Defense Costs and expenses reduces, by the amount of such payment, the applicable Limit of Liability of this policy. Each such payment reduces, by the amount of such payment, the applicable Annual Aggregate Limit of this policy. The limits thus reduced will be the Amount of Insurance available for further payments of claims or expenses. 6. Annual Aggregate Limit[ [17] ] is the maximum amount Underwriters will pay for all damages because of injury or damage to which this insurance applies including all Defense Costs and Expenses. 7. Subject to 5. above, the Limits of Liability stated as respects any one person and any one incident are the maximum Underwriters will pay for the sum of all damages because of injury or damage to which this insurance applies and all Defense Costs and Expenses because of all injury or damage arising out of any one claim or series of claims arising out of one Circumstance of Event.    Section IV(3) of the policy embodies the deduction of defense costs and expenses and provides: 3. Defense Costs and Expenses means payments allocated to a specific claim for its investigation, settlement or defense, including: (a) Attorney fees and all other litigation expenses;    (d) reasonable expenses incurred by the Insured at Underwriters request to assist Underwriters in the investigation or defense of a claim or suit, including actual loss of earnings up to $100 a day because of time off from work;    (g) fees and expenses of independent adjusters and investigators hired by Underwriters; Defense Costs and Expenses does not include: Salaries and expenses of Underwriters employees or the Insured's employees, other than: (1) that portion of Underwriters employed attorney's fees, salaries and expenses allocated to a specific claim or suit; and (2) the expenses described in d. above. In this case, the trial court was clearly concerned about the deduction of two sets of attorneys fees from the policy limits. The colloquy was as follows: THE COURT: The contract policy required you to provide a defense to the Sheriff. Of course, you had to represent the insurance company. I've got a little bit of a problem with such a large amount of money going for legal fees and not going to the, notwithstanding what the policy required, not going to the plaintiffs. I've just got a problem with that.    SPHERE DRAKE COUNSEL: Judge, that's going to be a legal issue that you're going to have to wrestle with. When they filed that supplemental petition, they made some claims against Sphere Drake for [penalties under the Direct Action Statute]. Sphere Drake was only one of several insurers. The loyalty of Sphere Drake was not only to Sheriff McElveen but for 60 something other Sheriffs. THE COURT: Yes, to the Sheriff's Association.    SPHERE DRAKE COUNSEL: [T]he Direct Action Statute plays a role here. This is a Direct Action Statute and that policy says that when underwriters are required to hire lawyers under that Direct Action Statute, that comes out of the policy. That's an agreement that they had with the Sheriffs and we're going to hear that from the witnesses. Nevertheless, despite its expressed concern, the trial court concluded that the policy provided for the deduction of all defense costs and expenses. A plain reading of the above referenced provisions of the policy reveals that the LSRMP entered into a contract with Sphere Drake for All `Defense Costs and Expenses' to be added to judgments and settlements. Attorneys fees and all other litigation expenses were included in the definition of defense costs and expenses. The policy also states that, while Sphere Drake is not obligated to defend any claim or lawsuit, it has the right to defend should it elect to do so, and the policy would cover defense costs and expenses, should Sphere Drake defend any claim or suit. While Sphere Drake, as the surplus lines insurer, was not primarily obligated to defend the LSRMP, it provide[d] defense of the claim by paying the attorneys fees for the Sheriff, as permitted by the policy. [18] Thus, although the policy did not obligate Sphere Drake to defend the LSRMP, pursuant to the express provisions of the policy, the costs of doing so may be deducted from the policy limits. See, Board of Comm'rs of the Port of New Orleans v. M/V Rachael Guidry, 425 F.Supp. 661 (E.D.La.1977) (recognizing that where an insurer has no independent duty to defend, and the policy specifically provides for the deduction of costs, fees, and expenses, the insurer may deduct the costs of defense from its policy limits). However, in addition to deducting the costs of defending the LSRMP, Sphere Drake seeks to deduct the cost of defending itself. For defense costs of expenses to be credited towards the limits of the policy, it must be authorized by the policy. As indicated above, Section I, Paragraph 1, subpart b of the policy sets forth Sphere Drake's defense obligation as follows: We the Underwriters will have the right, but not the duty, to participate in the defense of claims or suits against the Insured seeking damages because of injury or damage to which this insurance may apply. This right to defend is limited as set forth in paragraph 3, below. (Emphasis added). Thus, the policy clearly contemplates that the defense to be provided is a defense of the insured. The policy makes no mention of a defense separately provided to the insurer to defend direct actions arising out of the occurrence; nor does it mention a defense of claims for penalties brought directly against the insurer and arising out of the insurer's conduct. In fact, in the Definitions section of the policy, Section IV, Paragraph 3 as outline above, the defense costs authorized by the policy are defined as follows: Defense Costs and Expenses means payments allocated to a specific claim for its investigation, settlement or defense, including: (a) Attorney fees and all other litigation expenses;    (Emphasis added). A Claim is, in turn, defined as a written demand (including service of suit or instigation of arbitration) received by an Insured for money damages. (Emphasis added). Given this clear limiting language in the policy, it is evident that the policy contemplates the deduction of attorney's fees incurred in the defense of the insured, and not as Sphere Drake contends, in defense of the insurer for claims asserted against the insurer alone. Such a construction is consistent with the terms of the Insuring Agreement, by which the insurer agrees to pay on behalf of the Named Insured those sums, in excess of the Underlying Insurance ... that the Insured becomes legally obligated to pay as damages because of bodily injury, personal injury or property damage ... which is caused by any person whilst acting within the course and scope of their employment by the Insured. (Emphasis added). Defense costs and expenses incurred directly by the insurer are neither sums that the insured is liable to pay nor that it should pay. Any other construction of the language would result in absurd consequences. For example, if the insured had sued the insurer for malpractice in handling the claim, the insurer should not be allowed to deduct the cost of its legal defense from the $1,000,000.00. Yet, under the broad interpretation urged by Sphere Drake, it could be argued that such defense costs arise from any claim or suit and are therefore deductible. At the very least, the presence of this limiting language in the policy creates an ambiguity, which must be strictly construed against the insurer. LSA-C.C. art. 2056. In LSA-R.S. 22:655(D), the legislature expressly announced our state's public policy regarding liability insurance by stating that liability policies are issued for the benefit of all injured persons and that it is the purpose of all liability policies to give protection and coverage to all insureds. LSA-R.S. 22:655(D); Marcus v. Hanover Ins. Co. Inc., 98-2040 (La.6/4/99), 740 So.2d 603, 606. Given this overriding public policy, if an insurer intends to deduct from its agreed limits of liability the defense costs expended on its own behalf, in addition to those expended on behalf of the insured, it must state its intention to do so in the policy in clear and unequivocal terms. In the instant case, we find no language that clearly and unequivocally authorizes the deduction from the amount of money allocated to protect the insured entity and to satisfy claims against the insured the additional sums expended by the insurer's own attorneys in defending and protecting the interests of the insurance company, as opposed to those of the insured. As a result, we hold that Sphere Drake may not deduct attorney's fees assessed by its separate counsel from the insured's policy limits.