If a person is sued and has liability coverage, his or her insurance company has a duty to defend and indemnify against the claim, if it is covered. The duty to defend isbroader than the duty to indemnify, requiring the insurance company to defend where the claim “potentially seeks damages within the coverage of the policy.” (Gray v. Zurich Ins. Co. (1966) 65 Cal.2d 263, 275.) In contrast, there is only a duty to indemnify (i.e., pay to settle) if there is actual coverage.
The distinction between a duty to defend (potential coverage) and a duty to indemnify (actual coverage) means that an insured will often be defended against a third party lawsuit, but the insurance company will resist settling the lawsuit because it disputes the existence of actual coverage.
A recent decision by the California Court of Appeal illustrates the dilemma this can create for an insured. On September 10, 2015, in 21st Century Insurance Company v. Superior Court, — Cal.Rptr.3d —, 2015 WL 5285822, the California Court of Appeal addressed a case where an insured was sued for negligence in connection with a car accident that resulted in a death. The insurance company defended the insured, but allegedly did not accept an offer to settle within policy limits because it disputed actual coverage. In response, the insured agreed to a stipulated judgment above policy limits, assigned his rights against the insurance company to the claimant, and the claimant promised not to execute the judgment against the insured.
Settling a claim and assigning the insured’s rights to the claimant is a relatively common occurrencewhere an insurance company denies coverage. The idea is that the claimant can then pursue and litigate the coverage issue directly with the insurance company, and the insured is protected from having the judgment executed against him or her.
In 21st Century, however, the Court of Appeal drew a distinction where the insurer is defending the insured, but refuses to settle within policy limits, and the insured nevertheless settles the case for an amount above policy limits, with an agreement not execute it against the insured. The problem with this, according to an earlier case, is that it attempts to bind an insurance company to a settlement it did not consent to, “without any actual commitment on its insured’s part to pay the judgment.” (Hamilton v. Maryland Casualty Co. (2002) 27 Cal.4th 718, 730.) 21st Centurydisapproved of this maneuver because the agreed upon judgment is “relied upon to prove damages.” (21st Century Insurance Company, supra, at *3.) Thus, 21st Centuryheld the insurance company was not liable for damages above the policy limits. In doing so, however, 21st Century emphasized that the insurance company was actually defending the claim, and the outcome would have been different had the insurer breached its duty to defend. (Id.)
As 21st Century acknowledged, this ruling places the insured “in an awkward situation.” (Id.) If the lawsuit goes to judgment, and the insurance company is correct that there was only a potential for coverage (duty to defend) but not actual coverage (duty to indemnify), the insured will be responsible for the entire judgment. On the other hand, the case cannot be settled unless the insured pays the money, which he or she may not have, because the insurance company is disputing actual coverage.
The result is that many cases where an insurance company is defending its insured, but will not settle within policy limits, cases may be forced to verdict, with a substantial risk to the insured. Under such circumstances, the insured should make every effort to convince the insurance company of its duty to indemnify, and the potential liability the insurance company faces if it is incorrect in its coverage assessment.