Issuing a Reservation of Rights? You May Lose Control Over Settlement


By: Jonathan Romvary

By reserving the right to deny coverage, insurers may be relinquishing the power to force the policyholder to forego reasonable settlement opportunities for covered claims that do not align with the goals of the insurer.  In Babcock & Wilcox Co., et al. v. American Nuclear Insurers, et al., 2015 WL 4430352 (Pa. July 21, 2015), the Pennsylvania Supreme Court announced a rule similar to the rule set forth by the Arizona Supreme Court in United States Auto Ass’n. v. Morris, 741 P.2d 246 (Ariz. 1987), allowing policyholders to settle claims without their insurer’s consent when the insurer is providing a defense under a reservation of rights.  This “Pennsylvania Approach” applies only after the insurer breaches its obligation of fair dealing with the policyholder by unreasonably objecting to settlement that is in the best interest of the policyholder. 

The consent-to-settle clause in liability policies generally allows the insurer to retain control of the defense and any settlement opportunities over claims when coverage is certain.  This clause provides that a policyholder is not allowed to enter into a settlement that would otherwise bind the insurer without the insurer’s consent.  However, when an insurer is defending under a reservation of rights, coverage is uncertain, and often the goals of the insurer and policyholder are conflicting.  A strict application of the consent-to-settle clause may require policyholders to pass up reasonable settlement offers while also requiring them to pay the full judgment if the insurer ultimately determines that the claim is not covered.  The Pennsylvania Approach (1) permits policyholders to enter into a reasonable settlement rather than risk a substantial and adverse verdict at trial and (2) allows insurers to contest coverage for a settlement that is unreasonable or one that is not covered under the terms of the policy.  Determination of whether a settlement is reasonable necessarily entails consideration of the terms of the settlement, the strength of the insured’s defense against the asserted claims, and any potential fraud or collusion by the insured.

Note that this ruling does not allow policyholders full control of their litigation when a reservation of rights has been issued.  Cooperation clauses still require the insured to communicate any settlements to the insurer and seek consent.  However, now in Pennsylvania, after a reservation of rights is issued, the insurer needs to carefully consider all reasonable settlements whether or not it believes that the claim is covered.

This Pennsylvania Approach is consistent with the current draft of the Restatement of the Law of Liability Insurance being prepared by the American Law Institute.  Therefore, we can expect more states to adopt this approach in the future.