New York Codes, Rules and Regulations
Title 11 - INSURANCE
Chapter III - Policy and Certificate Provisions
Subchapter B - Property and Casualty Insurance
Part 71 - Legal Defense Costs In Liability Policies
Section 71.0 - Preamble

Universal Citation: 11 NY Comp Codes Rules and Regs ยง 71.0

Current through Register Vol. 46, No. 39, September 25, 2024

(a) Prior to the original promulgation of this Part in 1983, the Insurance Department had approved a limited number of personal injury and property damage liability insurance policies in which legal defense costs were permitted to reduce the stated limits of liability when such legal defense costs were incident to a claim of legal liability covered under the policy. Further, the department had also approved certain policies that permitted legal defense costs to be applied against the deductible.

(b) Other than those limited circumstances, personal injury and property damage liability insurance policies generally provided that legal defense costs incident to a claim of legal liability and incurred in defending a claim of legal liability under the policy were covered by the policy independent of the stated limits of liability. Those policies placed no limit on defense costs and the stated limits of liability were used solely to pay the amount of damages, up to those liability limits, as ultimately determined by judgement or settlement. In such policies, any deductible was also applied only against the amount of a judgement or settlement.

(c) This Part was originally promulgated to provide rules restricting the lines of business wherein legal defense costs could be offset against the liability limits or against the deductible, and to provide for adequate disclosure to the insured in such cases. At that time, the department was advised by insurers that legal defense costs for directors and officers liability and media, publishing and advertising liability, where reputational interests are of significant concern to the insured, were relatively high compared with actual loss payments. With the legal defense costs offset, insurers can more easily estimate their maximum potential losses, provide such specialized coverages, and determine appropriate rates for such coverages.

(d) Subsequent amendments to this Part arose out of this department's concern with the proliferation of liability policies containing legal defense cost offset provisions for other types of risks. While these policies contained the required notification to insureds the department was concerned with the escalating use of these legal defense cost offset provisions, for the following reasons:

(1) Widespread usage of legal defense cost offset provisions represents a substantial change in traditional insurance coverage, whereby the insurer generally has a duty to defend any liability suit covered under the policy in which damages are sought. This duty to defend typically has been separate and apart from the obligation to pay damages under the policy and, accordingly, an insurer must provide a proper defense regardless of cost. The duty to defend is broader than the duty to pay and extends to any action, even if groundless, false or fraudulent, in which facts are alleged within the coverage of the policy.

(2) In the majority of the policies containing legal defense cost offset provisions filed with the department, insureds are offered neither the option of selecting the defense attorney nor the right to consent to any settlement. Insureds are unable to control how legal defense costs were spent, despite the insured's potentially large financial risk in view of the possibility that legal defense costs may have approached, or even exceeded, the stated liability limits. In such instances, the insured would become responsible for legal defense costs, as well as for damages on the liability claim itself, that exceed policy limits. As respects the deductible, depending on its size, a significant portion of initial legal defense costs could have become the insured's responsibility.

(e) The superintendent concluded that the public interest demanded that legal defense cost offsets against liability limits or deductibles be permitted only with respect to such lines, sublines, classes or subclassed where:

(1) legal defense costs represented a significant portion for monies paid out by insurers;

(2) the need to incorporate legal defense costs within liability limits could be demonstrated; and

(3) such offset provisions were approved by the superintendent.

(f) In amending this Part, the superintendent considered such factors as:

(1) industry-wide experience detailing legal defense costs expended in proportion to actual loss payments;

(2) availability and type of coverage;

(3) ability to establish appropriate rates for the coverage;

(4) rate impact of the offset;

(5) degree to which reputational interests of the insured are at stake; and

(6) level of sophistication of the insured.

(g) These amendments set forth limitations on the type of risk or coverage for which legal defense costs would be permitted to be offset against liability limits or policy deductibles, as well as the dimensions of any such offset, and specified minimum liability limits for any policy containing these offsets.

(h) Large insureds, as evidenced by their financial size or the level of insurance coverage obtained, tend to be more knowledgeable insurance consumers than smaller, usually less sophisticated insureds and, therefore, are more typically in a better position to protect themselves or to negotiate protections for themselves from their insurers. Given their larger size and greater sophistication, these insureds should be more able to respond to claims out of their own resources if their insurance coverage is depelted by defense cost offsets. In turn, insurers warrant more flexibility in tailoring their policies to the individual needs of larger, more sophisticated insureds in order to provide coverage to them efficiently and effectively. In recognition of these factors, amendments to this Part exempt policies issued to large insureds from a number of the requirements of this Part, thus permitting defense cost offsets in liability policies in the event that the insured exceeds specified size criteria set forth in section 71.3(e) of this Part.

(i)

(1) Federal Environmental Protection Agency (EPA) financial responsibility requirements, for owners and operators of underground storage tanks (USTs), took effect in April 1991 for those with 13-to-99 USTs, and are scheduled to take effect December 31, 1993 for those with less than 13 USTs. Under these Federal UST requirements, insurance policy limits must be fully available for first-party clean-up as well as third-party liability, and cannot be reduced by defense costs. Given the potential for high defense costs, however, insurers have been unable or unwilling to provide pollution liability policies unless defense costs are somehow limited.

(2) In order to encourage the availability of insurance within these Federal mandates, while at the same time allowing a finite limit on insurers' defense obligations, this Part authorized policies containing defense limits separate from liability limits, subject to the standards set forth in section 71.4 of this Part, for environmental impairment and pollution liability policies issued to UST owners or operators in order to meet EPA financial responsibility requirements.

(j) Marketplace developments since this Part was originally adopted have resulted in the widespread use of policies with defense costs offset against the limits of liability and the increase in knowledge and sophistication of insureds and insurance agents and brokers with respect to this type of policy. Accordingly, this Part is amended to add employment practices liability to the list of coverages that may be written on a defense within limits basis; lower the financial threshold requirements for large commercial insureds; and allow for alternative disclosure statement requirements.

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