Liability insurance (also called third-party insurance) is a part of the general insurance system of risk financing to protect the purchaser (the “insured”) from the risks of liabilities imposed by lawsuits and similar claims and protects the insured if the purchaser is sued for claims that come within the coverage of the insurance policy.
Originally, individual companies that faced a common peril formed a group and created a self-help fund out of which to pay compensation should any member incur loss (in other words, a mutual insurance arrangement). The modern system relies on dedicated carriers, usually for-profit, to offer protection against specified perils in consideration of a premium.
Liability insurance is designed to offer specific protection against third-party insurance claims, i.e., payment is not typically made to the insured, but rather to someone suffering loss who is not a party to the insurance contract. In general, intentional damage and contractual liability are not covered under liability insurance policies. When a claim is made, the insurance carrier has the duty (and right) to defend the insured.
The legal costs of a defence normally do not affect policy limits unless the policy expressly states otherwise; this default rule is useful because defense costs tend to soar when cases go to trial. Often, the defense portion of the policy is more valuable than the insurance, as in complicated cases, the cost of defending the case might be more than the amount being claimed, particularly in “nuisance” cases, where the insured must be defended even though no liability is ever brought to trial.
Market
Commercial liability is an important segment for the insurance industry. With premium income of US$160 billion in 2013, it accounted for 10% of global non-life premiums of US$1,550 billion, or 23% of the global commercial premiums. Liability insurance is far more prevalent in advanced than in emerging markets. The advanced markets accounted for 93% of global liability premiums in 2013, while their share of global non-life premiums was 79%.Liability claims trends: emerging risks and rebounding economic drivers, Swiss Re sigma, Sept 2014 "http://media.swissre.com/documents/sigma4_2014_en.pdf "
The US is by far the largest market, with 51% of the global liability premiums written in 2013. This is due to the size of the US economy and the high penetration of liability insurance (0.5% of GDP). In 2013, US businesses spent US$84 billion on commercial liability covers, of which US$50 billion was on general liability, including US$12 billion for Errors and Omissions (E&O) and US$5.4 billion for Directors and Officers (D&O). US businesses spent another US$13 billion on the liability portion of commercial multi-peril policies, US$9.5 billion for medical malpractice, and US$3 billion for product liability covers.
The UK is the world's second largest market for liability insurance, with US$9.9 billion of liability premiums in 2013. The largest sub-line of business is public and product liability. This is followed by professional indemnity and employers’ liability (cover for employment-related accidents and illnesses). There has been a significant shift in the sub-segments of UK liability insurance. In the last decade, the share of professional indemnity has increased from about 14% to 32%, highlighting the shift towards a more services-driven economy. Manufacturing, meanwhile, comprises a lower share of liability claims as accidents related to injuries and property damages have declined.
In continental Europe, the largest liability insurance markets are Germany, France, Italy, and Spain. Together they made up almost US$22 billion of global liability premiums in 2013. Typically governed by civil law systems, these markets rely on local conditions and historical experience to determine which liability policies and covers are available. Penetration ranges from 0.16% to 0.25%, which is low compared to the common law countries such as the US, the UK and Australia.
Japan and Australia are the largest markets in the Asia Pacific region, with commercial liability premiums of US$6.0 billion and US$4.8 billion, respectively, in 2013. At 0.12% of GDP, liability insurance penetration in Japan is much lower than in other advanced economies. In Australia, penetration is much higher at 0.32% of GDP. This is due to the country's English law-derived legal framework, which has increased demand for employers’ liability insurance. Australia has mandatory covers for aviation, maritime oil pollution, and residential construction and, in certain states, for medical practitioners, property brokers, and stock brokers. Liability insurance premiums have grown at an average annual rate of 11% since 2000.
China is the ninth largest commercial liability market globally, with premiums of US$3.5 billion in 2013 and strong annual average growth of 22% since 2000. However, penetration remains low at 0.04% of GDP. Growth has been driven by increasing risk awareness and regulatory changes.
Insurer duties
Liability insurers have one, two, or three major duties, depending upon the jurisdiction: the duty to defend, the duty to indemnify, and the duty to settle a reasonably clear claim.
To defend
The duty to defend is prevalent in the United States and Canada, where most liability insurance policies provide that the insurer “has the right and duty” to defend the insured against all “suits” to which the policies apply. It is usually triggered when the insured is sued (or in some instances, given pre-suit notice that they are about to be sued) and subsequently “tenders” defense of the claim to its liability insurer. Usually this is done by sending a copy of the complaint along with a cover letter referencing the relevant insurance policy or policies and demanding an immediate defense.
In most U.S. states and Canada, the insurer generally has four main options at this point, to: defend the insured unconditionally; defend the insured under a reservation of rights; seek a declaratory judgment that it has no duty to defend the claim; or decline to defend or to seek a declaratory judgment.
The duty to defend is generally broader than the duty to indemnify, because most (but not all) policies that provide for such a duty also specifically promise to defend against claims that are groundless, false, or fraudulent. Therefore, the duty to defend is normally triggered by a potential for coverage. The test for a potential for coverage is whether the complaint adequately pleads at least one claim or cause of action which would be covered under the terms of the policy if the plaintiff were to prevail on that claim at trial, and also does not plead any allegations which would entirely vitiate an essential element of coverage or trigger a complete exclusion to coverage. It is irrelevant whether the plaintiff will prevail or actually prevails on the claim; rather, the test is whether the claim if proven would be covered. Vague or ambiguous allegations broad enough to encompass a range of possibilities both within and without coverage are usually construed in favor of a potential for coverage, but speculation about unpled allegations (that is, matters on which the complaint is totally silent) is insufficient to create a potential for coverage. Some jurisdictions allow extrinsic evidence to be considered, either because it is expressly described in the complaint or it is relevant to the facts expressly alleged in the complaint.
If there is a duty to defend, it means the insurer must defend the insured against the entire lawsuit even if most of the claims or causes of action in the complaint are clearly not covered. An insurer can choose to defend unconditionally without reserving any rights, but by doing so, it waives (or is later estopped from asserting) the absence of coverage as a defense to the duty to defend and impliedly commits to defending the insured to a final judgment or a settlement regardless of how long it takes (unless the policy expressly provides that defense costs reduce policy limits). In the alternative, the insurer may defend under a reservation of rights: it sends a letter to the insured reserving its rights to immediately withdraw from the insured's defense if it becomes clear there is no coverage or no potential for coverage for the entire complaint and to recover from the insured any funds expended to that point on defending against any particular claims or causes of action that were never covered or even potentially covered to begin with.
If the insurer chooses to defend, it may either defend the claim with its own in-house lawyers (where allowed) or give the claim to an outside law firm on a “panel” of preferred firms that have negotiated a standard fee schedule with the insurer in exchange for a regular flow of work. The decision to defend under a reservation of rights must be undertaken with extreme caution in jurisdictions where the insured has a right to independent counsel, also known as Cumis counsel.
The insurer can also seek a declaratory judgment against the insured that there is no coverage for the claim, or at least no potential for coverage. This option generally allows the insurer to insulate itself from a bad faith claim, in the sense that an insurer acts in good faith when it promptly brings coverage disputes to the attention of a court, even though it also places the insured in the awkward position of defending itself against two lawsuits: the plaintiff's original complaint and the insurer's complaint for declaratory judgment. Indeed, in some jurisdictions, an insurer acting in good faith must seek declaratory relief from a court before declining to defend its insured (e.g., Illinois) or withdrawing from its defense pursuant to an earlier reservation of rights (e.g., Georgia).
Finally, the insurer can decline to defend and also refrain from seeking declaratory judgment. If the insurer is absolutely certain that there is no coverage or no potential for coverage, then in most jurisdictions the insurer adequately preserves its defenses to coverage by sending a letter to the insured explaining its position and declining to provide a defense. But this option can be very risky, because if a court later determines that there was a duty to defend all along, then it will hold that the insurer necessarily breached that duty and may also hold that the insurer is subject to tort liability for bad faith. So insurers will often defend under a reservation of rights rather than decline coverage altogether.
Outside the United States and Canada, liability insurers generally do not assume a duty to defend, in the sense of assuming a direct responsibility for hiring and paying a lawyer to defend the insured. Many write policies that promise to reimburse the insured for reasonable defense costs incurred with the insurer's consent, but this is essentially a form of indemnification (covered in the next section below), under which the insured remains primarily responsible for hiring a lawyer to defend themselves. Such insurers often expressly reserve a right to defend the insured, presumably so they can intervene to protect their interests if the insured's counsel of choice is not providing an adequate defense against the underlying claim.
To indemnify
An indemnity case arises when an individual is obliged to pay for the loss or damage incurred by another person in the event of an accident, collision, etc. The duty of indemnity generally originates from the agreement between the insurer and insured, which protects the insured against any liability, damage, or loss.