Most liability policies contain two key provisions, the duty to indemnify and the duty to defend. Both provisions are critical, but the “duty to defend” concept is often overlooked or misunderstood. However, it is a key factor in the decision to purchase nonprofit insurance of various types and has a significant impact on risk management.
Indemnify versus Defend
The duty to indemnify is the most common and known aspect of an insurance policy. This duty requires the insurer to pay for any judgment awarded to the third party against its insured or any settlement that the parties may reach instead of a judgment.
The duty to defend is a term that describes an insurer’s obligation to provide an insured with a defense to claims made under an insurance policy. The duty to indemnify describes an insurer’s obligation to pay a claim for loss or damage against an insured. The mere possibility that a claim covered under the insurance policy may succeed is sufficient to impose the duty to defend. As such, the duty to defend is quite broad and arises even if the claim is eventually dismissed. It is important to note that the duty to defend is triggered much more frequently than the duty to indemnify.
What you don’t know
Most insureds believe their insurance policy provides financial protection for damages and may not know that many claims are settled without any damages being paid. However, all claims result in expenses, primarily defense expenses. The cost to defend any claim usually results in thousands of dollars of defense costs. In many cases, the “defense” coverage in your liability policy is far more valuable to your nonprofit organization than the “indemnity” coverage.
How Does it Work
Insurance policies are drafted in a way that clearly sets out the scope of the duty to defend. The duty to defend can take different forms, and it is essential to read and understand the portion of your liability policy that defines the insurance companies’ obligations.
Some Key Differences – Inside or Outside the Limit of Liability
Policies may offer defense “inside” the limit of liability or “outside” the limit of liability. When the limit is “inside,” that means the liability limit is the total available for both defense and indemnity. When the limit is “outside,” the defense is paid without regard to the policy limit. Depending on the insurance policy, when the defense is “outside” the limits of liability, it can be unlimited or have an expressly stated limit for defense. Defense costs can be astronomical, so it is crucial to understand how your liability policy responds to these costs.
Defense Cost and Claim Settlement
In almost every situation, the insurance company retains the right to settle a claim without the advice and consent of the insured. Mounting or anticipated defense costs alone may compel a company to settle a claim. In some Professional Liability policies, the insured has the right to approve or disapprove of the proposed settlement. However, a refusal to approve a claim settlement proposed by the insurer often triggers a “hammer clause.” The hammer clause limits the ultimate dollar value of a settlement to the amount initially proposed by the insurance company, regardless of the policy limits. The insured would be responsible for anything over the initially proposed claim settlement. Hammer clauses can retake many forms-so it is imperative to read and understand the defense and claims provisions in your policy.
Generally, insurance companies provide legal representation while defending a claim. In some cases, insureds may want to use their own attorney to defend a claim rather than the insurance company’s legal team. If allowed, this approach must always be approved by the insurance company and a budget negotiated.
As with so many things associated with your insurance program, it can be difficult or impossible to read and understand the provisions of your insurance policies. After reviewing your policies, the best approach is to consult a Nonprofit Insurance Specialist to discuss and define the components of your policies