Cumis Counsel - Cumis, Before and After

Cumis, Before and After

After a number of pioneering insurance bad faith cases in the 1950s and 1960s, it became common for U.S. insurers to reflexively issue reservation of rights letters in response to practically every tender of a third party claim by an insured. Under those earlier cases, it was held that if an insurer withdrew a defense after failing to reserve their rights, they could be (and were actually often held to be) liable for all damages suffered by the insured, even in excess of the policy amounts. Therefore, insurers wanted to always reserve their right to withdraw if facts were later discovered precluding coverage (e.g., evidence that the insured was guilty of an intentional tort, which is uninsurable).

The Cumis decision changed that practice significantly. Now, in California and several other states, an insurer faced with a new tender has three options: (1) deny the tender completely and either risk an immediate bad faith lawsuit by the insured or having to sue the insured first to obtain a judicial declaration of no coverage (a "race to the courthouse"); (2) accept the tender without a reservation of rights and thereby commit to defending the insured to a final judgment (unless the policy is expressly designed so that defense costs "eat away" at policy limits); or (3) accept the tender but issue a reservation of rights letter, which will usually cause the insured to promptly exercise his or her right to Cumis counsel. In turn, the third option jacks up the insurer's costs because the insurer now has to pay for independent counsel and counsel of its own to monitor the case at arm's length (so that privileged information never reaches the insurer).

The advantage of the second option is that by assuming complete responsibility for the defense of its insured, the insurer has more control over defense costs. Most insurers operate so-called "captive" law firms (carefully designed to avoid the ban on the corporate practice of law) and also maintain "panels" of preferred defense law firms who agree to carefully negotiated rate structures. In contrast, because independent counsel is separate from the insurer, their billing rates will be somewhat higher since they merely must bill the "reasonable" rate for their defense services. But if the insurer accepts the defense without a reservation of rights, it must defend completely and loses the right to recover the cost of defense from the insured even if it later discovers that the entire claim was uninsurable to begin with.

Because of all these issues, reservation of rights letters are issued today by adjusters only after careful consideration and discussion with experienced insurance coverage counsel.