Insurers and insureds often disagree about whether a claim or lawsuit against an insured should be settled and if so, for how much. What should not be subject to disagreement is an insurer's duty to pay reasonable settlements.
The California Supreme Court stated the governing rule nearly 60 years ago: "There is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement. This principle is applicable to policies of insurance." Comunale v. Traders & Gen. Ins. Co., 50 Cal. 2d 654, 658 (1958) (citation omitted). As the court explained: "It is common knowledge that a large percentage of the claims covered by insurance are settled without litigation and that this is one of the usual methods by which the insured receives protection. Under these circumstances, the applied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty" (citation omitted).
This duty to settle "is implied in law to protect the insured from exposure to liability in excess of coverage as a result of the insurer's gamble — on which only the insured might lose." Murphy v. Allstate Ins. Co., 17 Cal. 3d 937, 941 (1976). It is "included within the implied covenant of good faith and fair dealing." Archdale v. Am. Int'l Specialty Lines Ins. Co., 154 Cal. App. 4th 449, 466 (2007).
Therefore, as the Murphy court stated, "When the carrier does breach its duty to settle, the insured has been allowed to recover excess award over policy limits, economic loss, physical impairment, emotional distress, and punitive damages." Id. at 941-42. This "[l]iability is imposed not for a bad faith breach of the contract but for the failure to meet the duty to accept reasonable settlements." Crisci v. Sec. Ins. Co., 66 Cal. 2d 425, 430 (1967).
"Moreover, the insurer may not consider the issue of coverage in determining whether the settlement is reasonable." Blue Ridge Ins. Co. v. Jacobsen, 25 Cal. 4th 489, 502 (2001). The "only permissible consideration in evaluating the reasonableness of the settlement offer ... [is] whether, in light of the victim's injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the amount of the settlement offer." See also Howard v. Am. Nat'l Fire Ins. Co., 187 Cal. App. 4th 498, 530-31 (2010) ("[I]t has never been held that an insurer in a third party case may rely on a genuine dispute over coverage to refuse settlement. ... '[A] belief that the policy does not provide coverage ... should not affect a decision as to whether the settlement offer in question is a reasonable one.'"). Therefore, an insurer must "evaluate settlement proposals as though it alone carried the entire risk of loss." Diamond Heights Homeowners Ass'n v. Nat'l Am. Ins. Co., 227 Cal. App. 3d 563, 578 (1991).
"[W]henever it is likely that the judgment against the insured will exceed policy limits 'so that the most reasonable manner of disposing of the claim is a settlement which can be made within those limits, a consideration of good faith of the insured's interests requires the insurer to settle the claim.'" Johansen v. California State Auto. Ass'n Inter-Ins. Bureau, 15 Cal. 3d 9, 16 (1975).
As a consequence, when an insurer fails to effect a reasonable settlement of a claim against its insured, it cannot hide behind the policy limits. "There is an important difference between the liability of an insurer who performs its obligations and that of an insurer who breaches its contract. The policy limits restrict only the amount the insurer may have to pay in the performance of the contract as compensation to a third person for personal injuries caused by the insured; they do not restrict the damages recoverable by the insured for a breach of contract by the insurer." Comunale, 50 Cal. 2d at 659. Therefore, an insurer that "refuses to accept a reasonable settlement within the policy limits in violation of its duty to consider in good faith the interest of the insured in the settlement, is liable for the entire judgment against the insured even if it exceeds the policy limits." Id. at 661.
An insurer's obligation to contribute to a settlement is not excused simply because a reasonable settlement opportunity is not solely within its limit, at least if it is within the limits of its policy when combined with other available insurance. "When multiple insurance policies provide coverage, each insurer's obligation is to cover the full extent of the insured's liability up to policy limits." Howard, 187 Cal. App. 4th at 525 (2010). Therefore, an insurer may be liable for amounts in excess of its limits when, if it and the other insurers properly had responded to a settlement demand, it could have settled the lawsuit against its insured.
As the Howard court emphasized, "the law 'cannot excuse one insurer for refusing the tender of its policy limits simply because other insurers likewise acted in bad faith. If this were not the case, insurers on the risk could simply all act in bad faith, thus immunizing themselves from bad faith liability.'" See also Lance Camper Mfg. Corp. v. Republic Indem. Co. of Am., 90 Cal. App. 4th 1151, 1156 (2001) ("Simply put, as a mother might say to her child, just because other insurers do it, does not necessarily make it right.").
One question that remains is: What must be shown before an insurer is obligated to pay for the amount in excess of a reasonable settlement that it did not fund? As the cases discussed above long have held, the insurer's excess liability can be shown when there is a judgment against the insured for a larger amount. But there has been some question as to whether it can be established by a subsequent settlement, rather than judgment.
That question was answered in Ace American Insurance Co. v. Fireman's Fund Insurance Co., 2 Cal. App. 5th 159 (2016). There, an excess insurer and primary insurer funded a settlement of a lawsuit against their insured. The excess insurer contended that the suit should have been settled earlier for less. The primary insurer disagreed, arguing that because the lawsuit against the insured had been settled rather than gone to judgment, the excess could not sue. The Court of Appeal rejected this argument. It held that "a bad faith action may be brought by the insured, or ... the insured's assignee, 'despite the absence of a litigated excess judgment'" (quoting Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718, 731 (2002)).
As the court concluded, "An excess judgment is not a required element of a cause of action for ... breach of the duty of good faith and fair dealing; where the insured ... has actually contributed to an excess settlement, the plaintiff may allege that the primary insurer's breach of the duty to accept reasonable settlement offers resulted in damages in the form of the excess settlement."