Make Sure You’re Covered – Know Your Rights When an Insurance Company Reserves Its Rights

Many employers with employment-practices liability insurance (EPLI) and directors and officers liability insurance (D&O) policies know too well that they often face a frustrating struggle when reporting the fact that a lawsuit has been filed to their insurance company.

As an employer, being faced with employment litigation is challenging enough, but then being told that you have to work with an attorney you have never met, who may not be locally located, is extremely frustrating. Employers are frequently told they have to use the attorney their insurance company tells them to use. This, however, is contrary to Massachusetts law when an insurance company reserves its rights. In fact, under Massachusetts law, the insured can choose its own counsel in that scenario.

The insurance company will frequently reserve its rights upon initial receipt of a claim. It will then send a reservation-of-rights letter, advising its insured (you) that it will provide a defense of the claim while simultaneously reserving its right to deny coverage of the claim. This means that, while the insurance company will provide a defense right now, it is reserving its right to deny coverage of the claim after it learns additional information, which could leave you exposed to liability with little or no insurance coverage at a later date.

Many employers know that one issue that periodically arises with insurance companies is their insistence on having the insurance company’s attorneys defend a claim, even when the insurance company is reserving its rights. The insurance company you are dealing with could be located in another state, where the laws governing insurance companies may be different, and the insurance company could try to bully you into selecting an attorney that the insurance company selects. That attorney could be at a big firm in a big city, and you may prefer to be represented by a local attorney who knows your business.

If your attorney has been representing you in the matter prior to litigation being filed, it may also not be in your best interest for the insurance company’s attorney to become involved from the standpoint of cost and familiarity with the claim. In a reservation-of-rights scenario, you have the right to choose your own counsel. Massachusetts courts have ruled that an insurance company cannot insist on using its own attorneys to defend a case when it is reserving its right to deny coverage, as it has the potential to adversely affect the insured’s rights.

When an insurance company says it is going to fund a defense, it means it will pay the legal fees and costs associated with defending the claim. Depending upon the language of your individual insurance policy, your company will likely be responsible for paying legal fees until your deductible is reached. The insurance company would pay all legal fees once the deductible is exceeded.

Let’s assume your insurance company is providing you a defense under a reservation of rights, and then decides to deny coverage based upon facts it learns as the case develops. What happens to your company? In this scenario, timing is key. Massachusetts courts have ruled that an insurance company can be barred from denying coverage in a scenario where the insurance company learns of facts upon which it could deny coverage, then takes no action to inform its insured it will deny coverage until months, or years, later.

Many employers are also familiar with their insurance company trying to force the settlement of a claim during litigation. The insurance company recommends settlement of the claim based upon its bottom line by performing a financial analysis of the potential settlement amount against the cost of paying the legal fees and costs associated with the continued defense of the claim and the risk to its insured.

However, if the insured believes the claim is meritless, a settlement may not be in the insured’s best interest. If a settlement is paid, then the insured’s premiums will increase, whereas, if the claim was taken to trial and the insured prevailed, its premiums would not increase.

Often, employers think they are at the mercy of the insurance company when it comes to decisions made in litigation. As an employer, it is important to know your rights under EPLI and D&O insurance policies. Decisions made in litigation have an impact on your business, your employee relations, your reputation, and your bottom line.