The duty of the insurer to defend the insured under the terms of the commercial general-liability coverage form is an accepted part of the form's insuring agreement.

Insurers have generally had no problem with the judicial interpretation that this duty to defend is separate from and broader than the duty to indemnify. And, insureds take it for granted that once the insurer assumes the defense of the insured, the insurance company will pay the legal expenses involved in defending the insured.

What may surprise an insured is that the insurer can get reimbursement from the insured for some of those legal costs expended.

A majority of jurisdictions that have faced the reimbursement issue have decided that the insurer does have a right of reimbursement against the insured; examples come from California, Florida, Montana and the 6th Circuit. These courts have found a common thread in their pro-reimbursement decisions: The claim against the insured is one that is not covered under the terms of the policy, and the insurer has told the insured up front that it has the right to seek reimbursement of certain defense costs.

In addition, these courts have said that if the insurer did not get reimbursement, the insured, who did not bargain for a defense of noncovered claims, would receive a windfall and would be unjustly enriched.

Of course, the minority position also exists.

These courts say that a rule permitting recovery of defense costs would be inconsistent with the legal principles that induce an insurer's offer to defend under a reservation of rights. The reasoning is this: Faced with uncertainty as to its duty to indemnify, an insurer offers a defense under a reservation of rights to avoid the risks that an inept or lackadaisical defense of the underlying action may expose it to if it turns out that there is a duty to indemnify. At the same time, the insurer wishes to preserve its right to contest the duty to indemnify if the defense is unsuccessful. Thus, such an offer is made at least as much for the insurer's own benefit as for the insured's.

If the insurer could recover defense costs, the insured would be required to pay for the insurer's action in protecting itself against the estoppel to deny coverage that would be implied if it undertook the defense without reservation. In other words, the insurer is protecting itself as much as the insured by providing a defense, so there is no reason why the insurer should get any reimbursement; it is benefitting as much as the insured.

More recent court rulings on the subject have centered on the point that, absent an express provision in the insurance policy that the insurer is entitled to reimbursement of defense costs in the event that a court determines that the insured has no coverage, the insurer has no right to later attempt to amend the insuring contract by claiming a right to reimbursement in a reservation of rights letter. Cases from Illinois, Pennsylvania, Minnesota and the 4th Circuit Court of Appeals support this idea.

Regardless of the legal view of reimbursement of defense costs, those in the insurance industry have to consider a nonlegal issue: the attitude of the insured. Not many insureds expect to pay a premium for insurance coverage, and then pay again to reimburse the insurance company for defending the insured. Insureds could consider this a double hit—just another tactic by insurance companies to get more money out of the insurance consumer. In such a case, the insured would either file a lawsuit or drop the insurer, either way a losing course for the insurance industry.

Is there a way to avoid this problem? The answer, as with so many other things, is education.

If it has decided to seek reimbursement as a matter of business, the insurer has to take the responsibility to inform the insured of this decision. And, this disclosure should be within the insuring agreement of the policy. The insurer should tell the insured before a claim or lawsuit arises that any money spent on defense costs for losses that are not covered by the policy will have to be paid back to the insurer. This may not make the insureds think better of the insurance industry, but it certainly would remove the surprise of reimbursement—and thus, maybe avoid more resentment (and more lawsuits).

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Defense Cost Reimbursement: A Surprise for the Insured?

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