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An improperly drafted reservation of rights letter — the easiest way for an insurer to waive policy coverage defenses.

In my most recent blogs (“Do you really need a court to tell you what the insurance policy covers? Litigating insurance coverage issues? When and how to turn to the courts”Part 1 and Part 2), I addressed the various reasons and methods for an insurer to litigate coverage issues. Of course, for an insurer to litigate coverage issues presumes that the insurer has properly preserved the coverage issues and notified its insured of what those issues are.  This is typically achieved through a reservation of rights letter, and it is increasingly important that insurers take the time to properly draft such letters, lest they be found to have waived the coverage defenses.  This blog will provide some suggestions for a detailed and thorough reservation of rights letter.

A reservation of rights letter:

  1. Must be sent as soon as reasonably possible.
  2. Must be clear and specific.
  3. Must be plain and unambiguous.
  4. Must include all the facts and information necessary to allow the policyholder to understand the company’s position and be able to take exception to it, if necessary. These facts should include: a summation of the complaint and other pleadings, the facts relied upon from outside the pleading, the policy number, policy limits as to time and liability, and the specific policy provisions, quoted verbatim, relied upon by the insurance company in its claim for reservation.
  5. Must set forth the policy holder’s right to counsel retained at the policy holder’s expense (in jurisdictions where this is permitted).
  6. Should request the continued cooperation of the policyholder, especially if any further facts come to light or if new or amended pleadings are served upon the policyholder.
  7. Must advise the insured what is being reserved by the insurer –specifically, the right to later withdraw from the defense of the insured and/or disclaim indemnity to the insured.
  8. Must “fairly inform” the insured why coverage may be in jeopardy (i.e., a detailed explanation of the insurer’s position on coverage referencing actual facts from the claim investigation and allegations from the complaint).

Keep in mind that the last requirement I listed above, to “fairly inform” the insured, has recently been incorporated into the ALI Liability Insurance Restatement, and is likely to be the basis for future challenges by insureds to reservation of rights letters.  It will be increasingly important for insurers to take the time to craft detailed, thorough reservation of rights letters to insureds to avoid any potential later claim of waiver of policy coverage defenses.

Authored by: A. David Fawal