As noted, the liability coverage of a homeowners policy includes two primary promises by the insurer—the duty to defend (to provide you with a legal defense to lawsuits seeking covered damages) and the duty to indemnify (to pay covered judgments or settlements on your behalf). These two related duties are governed by different standards in a number of respects. The existence of the duty to defend is determined at the outset of the lawsuit against you and depends on whether there is a potential for an award of damages against you that would be covered by the policy. Under the ISO HO 3 homeowners policy, the insurer is expressly obligated to provide you with a defense to lawsuits that are groundless, false, or fraudulent, as well as lawsuits that have some actual or potential merit. In some jurisdictions, whether a duty to defend a suit exists is determined solely by comparing the allegations of the complaint in the lawsuit against you with the terms of the policy. This is done without regard to any facts known at the time of the lawsuit that are extrinsic to (that is, not alleged or stated in) the complaint. This approach can cut both ways. In some cases, the insured may be aware of and communicate facts to his or her insurer that are extrinsic to the complaint and that suggest that coverage exists. However, the insurer need not consider them and can deny a duty to defend if the allegations of the complaint do not bring the lawsuit within coverage. On the other hand, there may be a situation in which the complaint alleges facts that trigger a duty to defend and the insurer knows of facts extrinsic to the complaint that would otherwise negate a duty to defend. In this case, the insurer cannot consider those facts and must provide a defense solely on the basis of the complaint’s allegations. In a growing number of jurisdictions, facts extrinsic to the third-party claimant’s complaint that are known at the outset of the lawsuit can be considered by the insurer in determining whether a defense is owed. The costs of defense are covered in addition to the policy limit, meaning that the insurer pays for the fees and costs incurred by the lawyer who defends you in the lawsuit as well as a resulting judgment or settlement. These costs can 106 The Complete Book of Insurance include filing fees for motions, photocopying charges, costs of obtaining evidence with which to defend the lawsuit, court reporter and deposition costs, etc. Because legal fees and costs can be prohibitively high for most persons, the law in most states requires that the duty to defend be construed broadly and that the insurer makes its coverage decision promptly. Generally, any doubt as to whether a duty to defend exists is resolved in the insured’s favor. Sometimes the facts alleged in the third-party claimants complaint suggest the possibility of liability on the insured’s part both for damages that would be covered and damages that would not be covered. Under most states’ laws, the insurer is obligated to defend the entire lawsuit, not just the claims that are potentially covered. A common example is a bodily injury suit based on a physical altercation in which the claimant alleges that the defendant’s conduct was either accidental or intentional. Another common example is a libel or slander suit that suggest that the defendant uttered the libel or slander with knowledge of the falsity of his or her statements. In such cases, the insurer will generally defend a subject to a reservation of rights. In a reservation of rights letter, the insurer informs the insured that it will be providing a defense, and points out the factual and legal grounds as to why coverage may not exist. It then reserves the right to refuse to pay a judgment or settlement if the facts adjudicated in the lawsuit establish one or more grounds under the policy for denying coverage. Sometimes, insurers also reserve the right to withdraw from the defense of a lawsuit if facts become known before the lawsuit is concluded that establish that no coverage exists. In many states, when an insurer issues a reservation of rights that creates a conflict of interest between the insured and the insurer, the insured may be entitled to be defended, at the insurer’s expense, by counsel of the insured’s own choosing, rather than by counsel hired by the insurer. The insurer may also be required to relinquish control over the defense and settlement of the suit to the insured and the insured’s selected counsel. If you find yourself in a situation in which your insurer has issued a reservation of rights with respect to a lawsuit against you, consult an attorney. You must find one at your own expense to advise you whether, under your Liability Coverages 107 state’s local law, you are entitled to a defense by counsel of your own choosing. Next, you must determine whether you should exercise that right. Some homeowners policies’ liability insuring agreements state that the insurer has no obligation to pay for a defense by counsel selected by the insured due to a coverage dispute between the insurer and the insured. Such provisions are likely to be held unenforceable. What may be permissible is for the insurer to include a provision that permits the insured to select his or her defense counsel from a list of law firms supplied by the insurer in the event the insurer issues a qualifying reservation of rights. While an insurer has the right to investigate and settle claims, it only has an obligation to defend suits—that is, formal court proceedings. As a practical matter, many, if not most, insurers will hire defense counsel if a claim is made that shows serious potential to evolve into a suit. Second, a duty to defend arises upon notice by the insurer to the insurer of the suit. Such notice is also referred to as tender of the defense of the lawsuit to the insurer. Termination of the duty to defend can be a more complex issue. First, the policy expressly provides that the duty to defend ends when the insurer has paid the full liability policy limits and settlement of the suit or in satisfaction of the judgment entered in the lawsuit. Full payment of the policy limit is also termed exhaustion of the limits of the policy. The duty to defend also terminates if the suit is concluded and no damages are awarded against the insured, unless the claimant takes an appeal. In this case, the duty to defend continues and requires the insurer to defend on appeal too. Finally, insurers sometimes unilaterally withdraw a defense upon learning facts that, in their view, negate coverage. This is a permissible action under the law of most jurisdictions. If the insurer is mistaken, however, the consequences of an erroneous unilateral withdrawal of a defense can be substantially the same as those consequences of an erroneous denial of a defense at the outset of the lawsuit against the insured. For this reason, insurers often will withdraw a defense only after a court has ruled that no coverage exists in a declaratory relief action. When there is a coverage dispute between the insured and the insurer, either may institute a declaratory judgment lawsuit in order to have the coverage issues decided by a judge. 108 The Complete Book of Insurance DUTY TO INDEMNIFY The existence of a duty to indemnify is determined at the end of the thirdparty claimant’s lawsuit against the insured based on the facts as adjudicated in that lawsuit. If the insurer has made a decision to settle the case and not let it go to trial, its payment of the settlement is covered under the policy’s indemnity coverage. Virtually all settlements include denials of liability, even if one of the reasons for the insurer’s decision to settle may have been that the case was one of probable liability. Insurers settle cases brought against insureds for a lot of reasons, including a weighing of whether the costs of defense and the risks of an adverse justify proceeding with trial. Insurers have to be coolheaded and practical. The more money they can save through judicious settlements, the lower their costs of doing business are and, ultimately, the lower the costs of insurance for all their policyholders will be. Unlike the potential for coverage standard for deciding whether a duty to defend exists, a duty to indemnify is determined by an actual coverage standard. Often, this is clear—when the jury rules for the plaintiff in the lawsuit against the insured, it is implicit from the jury’s decision that they have decided that the facts determine the coverage issues and thus the insurer’s obligation to pay. Sometimes, however, the facts as adjudicated in the action against the insured leave the coverage issues unclear. Any number of things can happen. The insurer can simply agree to pay the judgment to conclude the lawsuit. Or, the insurer will sometimes pay the judgment subject to a reservation of rights to litigate the coverage issues in a separate lawsuit called a declaratory relief action. A declaratory relief action is a lawsuit by an insured or an insurer in which the court is asked to review the facts and the policy and to decide whether the claim is or is not covered. When a homeowners policy provides personal injury coverage, the same issues relating to the existence of a duty to defend and duty to indemnify exist as is with the bodily injury and property damage coverage. The only real difference is the nature of the insured’s conduct and resulting injury for which the claimant is suing the insured for damages

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