In 36 years of defending policyholders against claims and suits, I've seen a lot of reservations of rights letters, and as coverage counsel for carriers in other circumstances, I've written my share of them, too.

Such letters may baffle policyholders. Let's demystify things:

Why do insurers write these letters?

Under most states' laws, a liability insurer that provides its insured a defense against a claim must notify the insured of limitations on the coverage available. For example, in a suit against an insurance broker that seeks damages for underinsurance on a piece of property, alleging both negligence and fraud, the fraud claim would be excluded under typical broker errors and omissions liability policies. The insurer must advise the policyholder that if the judge, jury or arbitrator finds that fraud was committed, the broker will not have coverage for the resulting liability.

In some states it's a “use it or lose it” proposition for the carrier: If it doesn't reserve its right to deny coverage in the event, however unlikely, that a jury finds the insured committed fraud, and the fraud verdict is rendered by the jury, the carrier cannot retroactively deny coverage.

Why are the letters typically so long?

Because a reservation of rights letter is meant to explain to the insured the policy's terms that may affect the carrier's payments under the policy, the letter will be fairly long if several provisions are at issue in a given case. When only one policy term — for example, an exclusion for claims seeking return of commissions — may cause part of the claim to not be covered, the letter may be relatively short. Insurers also sometimes reserve rights on subjects that aren't alleged in the claim, but might be if it the claimant amends it.

Why quote entire sections of the insurance policy?

Although courts usually deem policyholders to have read their insurance policies, in real life few people do so, cover to cover. Also, if the insurer inaccurately paraphrases the policy provision in the letter, it may create confusion. Something as simple as typing the phrase “the insured” as “any insured” may make a difference in the policy's meaning.

Kinds of reservation letters

Reservation of rights letters are not outright denials, but they may include partial denials as to certain items in a claim. A reservation of rights letter might be issued if it also seeks other damages.

Here are some reservation of rights letters that I've seen or written:

General reservation: These are often written soon after a claim or lawsuit has been reported. At this stage the insurer knows little about the case, and it is writing to say that it is investigating the facts, and that, pending the results of the investigation, it is reserving all rights under the terms of the policy and applicable law. The letter may also remind the policyholder of the policy limit, encourage him or her to also give notice to other carriers who may afford coverage, and say whether a defense to the lawsuit will be provided while the investigation is underway.

Indemnity: Some coverage issues can't be determined until a judge, jury or arbitrator makes a decision. Fraud claim is a good one: Did the policyholder act negligently or with fraudulent intent? The insurer could reserve its right to deny indemnification for the damages awarded against the insured in the event such a finding is made.

Indemnity and defense: Insurers may reserve their rights to deny a defense — or withdraw from providing a defense — as well as to deny other payments. The outcome of some coverage issues may result in the policy providing no coverage at all. As an example, under a claims-made policy the lawsuit may have been filed and served while the policy was in force, but the claim might have been first made via a letter demanding payment or other relief months before the policy became effective.

Allocation or reimbursement: Some liability policies provide that when covered and noncovered claims or relief are jointly alleged in lawsuit, defense fees and costs must be allocated between the insurer and the insured. Even without such a provision, some states' laws allow an insurer that is providing a defense to reserve its right to seek reimbursement for defense fees and costs that are solely attributable to the noncovered claims or relief.

Under most states' laws, a liability insurer that provides its insured a defense against a claim must notify the insured of limitations on the coverage available. (Photo: iStock)

Responding to a letter

Brokers and agents may be asked to advise their clients about how to respond to reservation of rights letters. There is no single “right” way to do so.

Some letters are purely precautionary and do not request or require a response. Others do ask the insured to provide specific information to aid in the insurer's investigation, or to reply if the insured disagrees with anything in the letter. Requests for information should be responded to promptly so as to comply with the insured's duty to cooperate, and other duties stated in the policy.

Brokers may suggest that insureds respond to reservation of rights letters, even those that don't request a response, to confirm receipt of the letter and state that they are likewise not waiving any of their rights under the policy. And, if the carrier's letter gets an important fact wrong, it's better to get that cleared up at the outset.

This general introduction to reservation of rights letters does not cover all the topics, laws and permutations of the subject. There are several online resources to aid agents, brokers and policyholders in understanding and responding to these letters. My search for the phrase “reservation of rights letter” plus the word “broker” retrieved 4,450 results. There is no shortage of advice out there.

Helping policyholders deal with reservation of rights letters can help reduce the stress that naturally accompanies a claim or lawsuit.

Louie Castoria is a partner in the Woodbury, New York-based law firm of Kaufman Dolowich & Voluck LLP, and directs the its West Coast professional liability practice goup in San Francisco. He chairs the Insurance Agent/Broker Committee of the Professional Liability Defense Federation.

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Why do insurers write 'reservations of rights' letters?

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