Should Failure to Defend Imply Forfeiture of Coverage Defenses?
Abstract: In liability insurance, the duty to defend is broader than the duty to cover. It is possible that an insurer which breaches its duty to defend may not have an actual duty to cover the policyholder's losses. However, if the penalty for a breach of the duty to defend is limited to actual legal costs spent by the defendant, the insurer may have an incentive to refuse to defend, even when the duty to defend is clear. This occurs because the insurer will not internalize the consequences of an inadequate defense when it ultimately can avoid covering the claim. If the penalty for a breach of the duty to defend also includes a forfeiture of the right to contest coverage of the claim, the insurer will never refuse to defend when the duty to defend is clear, but such a penalty may induce an insurer to defend even when it has a good legal argument against the duty to defend. We argue that tying a forfeiture of the right to assert any defense of coverage to a bad faith refusal to defend can improve incentives.