Generally third party insurers have good reason to believe that if they don't commit bad faith, the most they will have to pay for indemnity is the amount of the insurer's policy limit. Numerous cases, of course, have held that where an insurer breaches the duty to settle, though, it will be on the hook for the full amount of any subsequent judgment.
Illinois courts have long followed the estoppel doctrine, holding that if an insurer has a duty to defend and fails to either file an action seeking a declaration that it has no duty to defend or defend the insured subject to a reservation of rights, it is estopped from denying coverage. However, typically, breaching the duty to defend, as opposed to the duty to settle, does not mean that the insurer is stuck for the full amount of the judgment. In Conway v. Country Cas. Co., 92 Ill. 2d 388 (1982), for instance, the Illinois Supreme Court ruled that “while the wrongful refusal of the insurer to conduct the defense of an action based upon a claim within the coverage of the policy makes it liable, the insurer is not exposed to a greater liability to the insured than the limit of the amount stated in the policy.” The exception to this rule was where the insurer breached the duty to defend in bad faith. Guillen v. Potomac Ins. Co., 323 Ill. App. 3d 121 (1st Dist. 2001). Also, an Illinois court recently ruled that if an insurer negligently defended an insured, and the insurer’s negligence led to an excess verdict, the insurer could be liable for the excess verdict. Delatorre v. Safeway Ins. Co., 2013 IL App (1st) 120852, 989 N.E.2d 268 (1st Dist. 2013).
Related items of interest:
In Hyland v. Liberty Mut. Fire Ins. Co., 2017 U.S.Dist. LEXIS 124374 (N.D.Ill. 8/7/2017), the court ruled that there was no need to show that the insurer acted in bad faith in breaching the duty to defend in order for the insurer to be estopped from relying on its policy limit. In Hyland, the plaintiff was injured in a one-car accident in a car owned by the insured. The insurer had a $25,000 per person policy limit. The insured owner had given her daughter permission to use the car for the evening. Later, a friend of the daughter asked if she could borrow the car. The daughter later told the insurer that she had denied permission to use the car to the friend, but had given the keys to someone else. Nevertheless, the friend was driving the car when the accident occurred, and claimed to have been given permission to use the car. The insurer concluded that the friend was not a permissive user, and therefore denied coverage.
The complaint against the driver did not mention whether the driver was a permissive user. As such it created the potential for coverage. At that point, the insurer could have filed a declaratory action, in which it could bring out evidence that the driver was not a permissive user, or it could have defended under a reservation of rights. It did neither. The plaintiff then obtained a default judgment against the driver in the amount of more than $4 million. Before obtaining the default, the plaintiff's attorney never made a policy limits demand on the insurer, but did inform the insurer that he intended to obtain a default judgment against the driver. No one appeared to defend the driver and no evidence was presented for the driver.
The insurer argued that while it was estopped from denying coverage to the extent of its policy limits because it breached the duty to defend, it should not be liable for the full amount of the judgment because it had not acted in bad faith and because its actions had not led to the default judgment. The court disagreed, stating that when an insurer breaches its duty to defend, the “insurer is estopped from asserting policy exclusions or defenses to coverage.” It went on to state that in this case, the insurer “is attempting to enforce its exclusion, although it breached one of its duties under the contract.” Therefore the insurer was estopped from asserting its policy limits as a defense to coverage.
The insurer also argued that its conduct did not proximately cause the entry of the default judgment, asserting that no defense would have made a difference. However, the plaintiff argued that she would not have pursued the default judgment if the insurer had sought a declaratory judgment on its duty to defend, so the court rejected the argument that the damages were not the proximate result of the breach.