What's a "Reservation of Rights" Letter?
And what should you do if you get one?
Your organization has just been sued, and you've notified your liability insurer as required by the policy. You think all's taken care of…when you receive a reservation of rights letter from the insurer. What does this mean, and what should you do?
Practical Risk Management defines a reservation of rights as "an insurer's notification to an insured that coverage for a claim may not apply. This allows for an investigation by the insurer without waiving its right to later deny coverage."
When the insurer sends you a reservation of rights letter, it is telling you that it has doubts whether your policy covers some or all of the claims. In a liability lawsuit, the plaintiff often makes several claims. The policy might cover some and exclude others. When a claim is first filed, the insurer might not know whether coverage applies with the facts at hand.
When you buy a liability policy, your insurer agrees to pay for your legal defense costs in addition to any damages you might be legally obliged to pay. Most states recognize this "duty to defend" as fairly broad under a commercial general liability policy. If there is a possibility that coverage might apply, the insurer must provide your legal defense.
When an insurer receives a claim that might be covered only partially by its policy or not at all, it can do one of the following:
- Refuse the duty to defend. If the insurer does this and the court later finds that coverage applied, the insurer must reimburse your defense costs, along with settlement costs over which it had no control.
- Investigate the claim and begin your legal defense. Insurers like to avoid this due to the principle of estoppel, which bars an individual from "denying or alleging a certain fact…because of that individual's previous conduct, allegation, or denial" to the detriment of another. (Black's Law Dictionary) In other words, if your insurer begins investigating or defending your claim, this could lead you to assume it will cover your claim.
- File a declaratory action, in which the insurer asks the court to determine whether it is obligated to defend the claim. An insurer will seldom do this when it first receives notice of a claim.
- Send the insured, by certified mail, a reservation of rights letter and proceed with its investigation. This allows the insurer to gather more facts before deciding whether to deny coverage, while preserving its right to do so. Thus, your insurer might defend your liability claim but later deny indemnification (or paying settlements or judgments) if its defense is unsuccessful.
Attorneys Veronica M. Bates and Renee C. Callantine caution that different rules apply, depending on location. "In many jurisdictions, the reservation of rights may allow the insurer to withdraw from the defense when there is no potential for coverage under the policy. The ROR letters allow insurers to decline indemnifying the insured for any portion of a judgment not covered under the policy."
The liability policy also either explicitly or implicitly obligates you to cooperate with the insurer in its conduct of your defense. This allows the insurer to direct your legal defense, including giving it the right to settle. But investigations can also give it facts needed to deny you coverage. For these reasons, a reservation of rights letter indicates a conflict between you and your insurer.
Here's what to do if you receive a reservation of rights letter: Protect your coverage rights by doing the following:
- Read the reservation of rights letter and the policy to which it applies carefully.
- Respond to your insurer, saying that you disagree. The experts with the John Liner Review recommend asking the insurer to commit to coverage before it begins its investigation.
- Arrange for your own counsel.
Some reservation of rights letters will state the insurer reserves the right to recoup defense costs if the insurer does not owe a defense. Depending on the facts of the case and the jurisdiction, you could indeed be obligated to reimburse your insurer for defense costs if it was later determined coverage did not apply.
In a straightforward claim, you have no cause to worry. A reputable insurer will provide a quality defense. It's the gray areas, where coverage might or might not apply, that can cause conflicts. For this reason, we recommend thoroughly reviewing your liability coverage on a regular basis. A review can point out gaps in coverage, outdated forms and language, and other problems. For more information, please contact us.
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Do You Need Professional Liability Insurance?
What's a "Reservation of Rights" Letter?
What's a "Reasonable Accommodation"?