July 11, 2013 Articles

A Guide to Collusive Policyholder Settlements

When a coverage dispute arises between an insurer and its policyholder during litigation, the policyholder sometimes attempts to structure a settlement agreement with the underlying claimant(s) to reduce or eliminate potential uncovered exposure and shift that exposure to its insurer

by Joseph A. Hinkhouse and Sarah H. Dearing [1]

When a coverage dispute arises between an insurer and its policyholder during the pendency of underlying litigation, the policyholder sometimes attempts to structure a settlement agreement with the underlying claimant(s) to reduce or eliminate any potential uncovered exposure and shift that exposure to its insurer. Typically, these agreements include a stipulated judgment in which the policyholder consents to judgment in a stated sum, an agreement by the underlying claimant not to execute this stipulated judgment against the policyholder, and an assignment by the policyholder to the underlying claimant of the policyholder’s rights under the policy.

These agreements are very enticing to policyholders as they essentially represent a no-risk deal by which the policyholder may cut off all potential liability. These agreements are equally attractive to claimants as the policyholder is often willing to agree to a large-dollar stipulated judgment that does not take into consideration the policyholder’s liability defenses, because the policyholder—against whom no collection may be had—has very little incentive to negotiate a reasonable settlement.

If appropriate precautions are not taken, these types of agreements can result in an insurer having to pay for loss not contemplated by the insurance policies. For example, an insurer can become liable to pay stipulated judgment amounts that do not reflect the policyholder’s actual liability exposure and without regard to the policyholder’s liability defenses.

The circumstances under which such agreements may be entered into varies from jurisdiction to jurisdiction, although the majority of jurisdictions do permit these agreements in some circumstances. Insurers have defenses to these agreements, however, and should employ proactive claims strategies to avoid any potential liability for stipulated judgments for otherwise covered claims that are not based on the policyholder’s reasonable anticipation of liability. This article discusses these types of collusive agreements and an insurer’s rights and obligations when a policyholder enters into such an agreement. This article also sets forth recommendations for insurers faced with these potentially collusive agreements.

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