Introduction

Insurers are frequently asked to satisfy their duty of good faith and fair dealing by entertaining reasonable settlement offers within the combined limits of the policies. However, primary and excess insurers do not always agree whether a particular claim presents a significant exposure to their mutual insured. Even when insurers agree on the settlement value of a claim, there may be disagreement regarding how the exposure is best avoided or limited. Excess insurers often issue “hammer letters” to those underlying insurer(s) when a claim presents exposure to their policy.

The Purpose Of A Hammer Letter

Initially, it is important to acknowledge that both primary and excess insurers are tasked with completing an initial investigation into the facts and circumstances surrounding a claim to determine whether their policy is potentially implicated. When a claim appears likely to impact a policy, the insurer owes certain duties to the insured, including, the duty to settle covered claims within the limits of the insured’s policies. This extends to an insurer’s duty to advise the insured as to coverage afforded by the policy, to respond to reasonable settlement offers and to notify an insured with respect to any claim with potential excess exposure to the insured. Excess insurers’ policies usually require exhaustion of the underlying insurance or self-insured retention prior to affording any coverage under their own policy. Thus, excess insurers use hammer letters to demand that an underlying insurer(s) accept a reasonable settlement demand within the limits of the underlying policy if there is no meaningful dispute as to the insured’s liability.

Excess insurers also employ hammer letters as a means of encouraging underlying insurer(s) to tender the remaining limits of the underlying policy and cede control of settlement negotiations to the excess insurer. Upon a tender of the remaining limits of the underlying policy, the excess insurer may then negotiate to settle the matter within the combined limits of liability.

Some jurisdictions, like California, have allowed underlying insurers to enter into settlements in excess of the limits of their policies without the excess insurer’s consent. Specifically, these courts have enforced settlements as binding on excess insurers whose policies contemplate the assumption of the defense in circumstances where the excess insurer failed to undertake and participate in negotiations despite having been provided notice and opportunity to do so. Thus, in California, an excess insurer may be prevented from withholding consent where a settlement is found reasonable, absent some evidence that the settlement was fraudulent or collusive. The reasoning underlying these decisions seems to be the courts’ rejection of express “no-action” clauses in order to promote public policy in favor of settlements.

Key Effects & Limitations Of Hammer Letters

While hammer letters often include assertions regarding an excess insurers’ right to pursue claims against underlying insurer(s) who fail to settle a claim or tender their limits, a claim based upon the excess insurer’s equitable right of subrogation only extends to those causes of action available to the insured stemming from their rights under the policy. An excess insurer cannot pursue claims against the underlying insurer(s) for breach of its implied duty to settle a claim if the underlying insurer never received any offer to settle. Further, an underlying insurer will not be liable to an excess insurer for damages in excess of the limits of underlying insurance absent some indication that the underlying insurer’s conduct adversely impacted the value of the claim to the detriment of the insured (and any excess insurer). For example, where a claimant’s undisputed damages total $3 million, an underlying insurer’s conduct would not have caused the damages to exceed its primary $1 million limits of liability and there would be no claim available to an excess insurer. However, the excess insurer may have a claim against the underlying insurer where the same claimant’s damages initially totaled $750,000 but increased to $3 million after the underlying insurer failed to provide any response to an $800,000 pre-suit settlement demand prompting the claimant’s decision to more than double the amount of the demand.

Each insurer is charged with exercising good faith in responding to settlement offers based upon the terms of their policy as applied to the particular facts and circumstances of the case. An excess insurer is subject to the same limitations as the insured with respect to its ability to pursue a cause of action for bad faith failure to settle a claim where the underlying insurer(s) was never given a reasonable opportunity to settle within its limits. It follows that the excess insurer may not pursue a cause of action against the underlying insurer for failure to settle where no such cause of action would be available to the insured against the underlying insurer. Stated differently, all insurers owe duties of good faith and fair dealing in responding to potentially-covered claims but a failure to settle alone does not equate to bad faith. The general rule is that insurers must give equal or greater consideration to the insured’s interests when evaluating reasonable settlement offers for covered claims.

Practical Considerations for Hammer Letters

In some states, insurers may not take any coverage defenses into account when evaluating the reasonableness of a settlement offer. Instead, these jurisdictions require the insurer to give equal or greater consideration to the insured’s interests in determining whether settlement is appropriate under the particular facts and circumstances of the case. As a result, all insurers may be susceptible to bad faith where the failure to entertain a reasonable settlement offer ultimately leads to entry of a judgment or settlement in excess of the limits of liability available under their particular insurance policy.

In the context of an excess policy, the issuance of a hammer letter usually stems from one of three scenarios:

(1)       A settlement demand or offer of judgment within the underlying limits;

(2)       A lawsuit with a scheduled trial date or anticipated date for alternative resolution, such as mediation or arbitration, or time-limited demand wherein the damages sought are in excess of the available limits of liability of the underlying policy such that the excess insurer seeks a tender of the remaining underlying limits towards a potential settlement; or

(3)       A lawsuit involving disputed liability claims wherein the excess insurer disagrees with some aspect of the underlying insurer’s claims investigation or handling of the defense such that the excess insurer believes it may be prejudiced by the underlying insurer’s refusal to tender its limits of liability towards settlement.

The first two scenarios most often resolve shortly after the excess insurer’s issuance of a hammer letter detailing the limits of liability and exhaustion requirements of the excess policy together with its reasoning that the damages will likely exceed the limits of the underlying policy.

Preserving Equitable Rights of Subrogation After An Underlying Insurer’s Refusal To Tender Underlying Limits Upon Receipt of a Hammer Letter

Issues arise under the third scenario when an underlying insurer’s refusal to tender its limits towards settlement has the potential to fully derail settlement discussions despite the excess insurer’s willingness to contribute towards settlement upon exhaustion of the underlying policy. In these circumstances, an excess insurer risks waiver, through its payment under the excess policy prior to exhaustion of the underlying policy. We take this opportunity to outline methods by which excess insurers may best preserve their claims for equitable subrogation against underlying insurer(s) following an unsuccessful hammer letter.

First, the excess insurer should monitor the underlying litigation for significant events such as amended pleadings, third-party practice, and other rulings for opportunities to revisit settlement. The excess insurer should issue supplemental hammer letters regarding any new events that impact or support the insured’s exposure. By monitoring the excess insurer will also be able to jump right in in the event the underlying policy is exhausted by pre-trial settlement. Additionally, updated hammer letters avoid any appearance that the excess insurer sat idly by despite its concerns with the underlying insurer’s handling of the defense.

Second, the excess insurer should similarly provide supplemental evaluations to the insured regarding any events that impact coverage. Even the most sophisticated insureds have a tendency to “check out” once the underlying insurer has agreed to provide a defense. This further protects the excess insurer against any subsequent claims that the insured was not adequately informed of the potential excess exposure or that the failure to exhaust the underlying policy prevented application of the excess policy to any reasonable settlement offer rejected by the underlying insurer(s).

Third, it is essential to review and evaluate any statutory protections and notice requirements prior to pursuing a claim of equitable subrogation against an underlying insurer. This includes compliance with notice requirements under local consumer protection statutes that may provide additional statutory damages where the excess insurer has made every effort to settle the dispute without instituting legal proceedings. For example, under Massachusetts General Laws Chapters 93A and 176D (commonly referred to simply as “93A” and “176D”, or collectively, as the “Massachusetts Consumer Protection Act” (MCPA), a claimant is required to send a demand letter to the business alleged to have committed an unfair or deceptive business practice(s). While 93A merely provides the method by which claimants may pursue heightened damages after full compliance with notice prerequisite, 176D specifically defines “unfair settlement practices” to include “[f]ailing to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear”, among other claims handling practices. Upon receipt of such notice with details regarding the nature of the complaint, the harm suffered, and the resolution sought for any such alleged unfair or deceptive business practice(s), an insurer is permitted a minimum of thirty (30) days for its good faith response before the claimant may file suit under the MCPA.

Under this framework, an excess insurer may have the opportunity to plead additional claims against the underlying insurer in the litigation. These claims may also enable the excess insurer to negotiate a settlement around the underlying insurer(s) by assigning these MCPA claims against the underlying insurer to the plaintiff.

Finally, in the event the excess insurer must ultimately pursue litigation against the underlying insurer(s), it is important to note that some jurisdictions require the insurer to wait until the underlying litigation has concluded by way of settlement or final judgment; whereas others require the insurer to preserve its rights contemporaneously through a declaratory judgment filed prior to or in conjunction with the underlying litigation.

Conclusions

While primary and excess insurers may not always see eye to eye on settlement value, insurers usually work together for the benefit of their mutual insured in negotiating the settlement of matters involving significant exposure. When a disagreement regarding settlement value does arise, close monitoring of the litigation for any significant developments impacting coverage; supplemental coverage evaluations and hammer correspondence; and awareness of consumer fraud statutes are of the utmost performance for purposes of protecting an excess insurer’s equitable rights of subrogation.