In the face of rising litigation costs, the most valuable benefit of a company’s insurance policy may be its insurer’s duty to defend claims. Often, claims asserted in litigation may include a mixture of covered and uncovered claims with some claims potentially excluded from the coverage provided by an insurance policy. Alternatively, the claims asserted may potentially exceed the coverage afforded under the policy. In these circumstances (and others), an insurer’s first move in response to a claim under an insurance policy is likely to be a lengthy “reservation of rights” letter. The insurer’s response will track the language of your policy identifying the reasons the insurer contends that there may not be coverage for your claim or portions of the claim. But confess: the language used in the policy was so mind-numbing that you may not have read it when you purchased it or were uncertain as to what was actually covered by the policy. So what does a reservation of rights letter mean to you as an insured?

While identifying exclusions to coverage, the insurer’s reservation of rights letter will often offer to provide a defense. Many policyholders draw a deep sigh of relief that the insurer has agreed to provide a defense without grasping the implications of the various exclusions to coverage identified by the insurer in the letter. Do not be fooled because what the insurer “giveth” through the reservation letter, it may later seek to take away through the counsel that the insurance company assigns to “protect” you. But do not despair because in these circumstances, an insured may be entitled to select its own counsel at the insurer’s expense.

In Perma-Pipe, Inc. v. Liberty Surplus Insurance Corp., a recent decision by an Illinois appellate court, the insurer’s initial reservation of rights letter accepted its duty to defend its insured, and at the same time the insurer reserved its right to contest its obligation to defend its insured citing a number of potential exclusions to coverage. The exposure presented by the claim potentially exceeded the coverage afforded by the insurance policy. The policyholder responded to the reservation of rights letter by telling its insurer that in light of the conflicts articulated in the reservation of rights letter, the policyholder would defend itself through its own counsel but at the insurer’s expense. The insurer apparently had second thoughts, and in order to avoid the rates charged by the policyholder’s counsel and to have the opportunity to exert control over the defense, the insurer withdrew its reservations now agreeing to defend without the reservations. The exposure presented by the claim still potentially exceeded the available coverage, and the policyholder wanted to maintain control of its own defense. The insured insisted that it was entitled to engage its own counsel at its insurer’s expense, and the court agreed.

The policyholder correctly recognized that the insurer’s control of the defense posed two risks to the policyholder. First, it presented a conflict between the loyalties owed by the attorney assigned by the insurance carrier to defend the insured and to the loyalties owed to the attorney’s client, the policyholder. The policyholder correctly recognized that it was entitled to a defense by counsel loyal only to its own interests at the insurer’s expense. The other risk presented was that the duty to defend would terminate at the exhaustion of the policy. In such a circumstance, cost of the defense may exceed the coverage, and the insurer may be incentivized to look for ways around providing that defense. When presented with litigation that presented “nontrivial” risk of exposure in excess of the coverage, the court held that the policyholder had a right to independent counsel at the carrier’s expense.

Clearly, there is substantial value in being able to select your own counsel. Frequently, the defense coverage afforded by an insurance policy may be worth much more than the amount sought in the litigation. It is imperative to give close scrutiny to the insurer’s reservation of rights both to understand the insurer’s view of the limits of your insurance coverage, as applied to the claim. And the reservation of rights may give you the invaluable opportunity to select your own counsel at your insurer’s expense so that you can maintain better control of the defense of the claim against you.