This article originally published on Bill Wilson’s awesome Insurance Commentary, republished here with the author’s permission. This particular article is an excerpt from his upcoming book When Words Collide, published by Insurance Nerds.

The first rule in the claim resolution process is to never accept an oral declination of coverage. It’s not only a bad idea, it’s usually the law. Not only may Unfair Claims Settlement Practices laws mandate written denials, courts have often found this to be relevant in evaluating the enforceability of denial and reservation of rights letters, and most legal experts advise detailed denial letters that cite policy language and its relevance to the claim in question.

In one claim, a written denial was sent in the form of a letter that stated “You have no coverage for this loss.” That is no more acceptable than an oral declination. All claim declinations should meet at least three criteria:

1. Be in writing;
2. Cite the specific policy language (and only that language) that is applicable to the present denial; and
3. Explain why and how that policy language works to exclude coverage.

If a reservation of rights is included (and it almost certainly will be), additional policy language that could apply may be cited. However, as discussed below, the insurer should not include a laundry list of policy language excerpts that come close to copying and pasting the entire insurance contract into the letter.

Insurers seek to eliminate claims based on waiver and estoppel by issuing nonwaiver agreements or reservation of rights letters. These documents advise the insured of the existence of coverage questions. If the insurer undertakes an unconditional defense, it may be estopped from later denying coverage by effectively having waived the coverage issue. A reservation of rights establishes the basis for a conditional defense when it appears that there is coverage but that could change as the investigation proceeds. It also may establish additional contractual premises for potentially denying a claim beyond those cited in a declination letter.

A typical reservation of rights letter might include a statement such as:

“We will continue to handle this claim even though a coverage question exists. However, no act of any company representative while investigating or negotiating the settlement of this claim or defending a lawsuit shall be construed as waiving any of our rights. We reserve the right, under the policy, to deny coverage to you or anyone claiming coverage under the policy. There may also be other reasons why coverage does not apply and we do not waive our right to deny coverage for any other valid reason which may arise.”

Expanding on Criterion #2 above, the policy language citations in a reservation of rights letter should NOT:

1. Generalize or paraphrase policy language;
2. Include policy language excerpts that misrepresent the intent of the language; or
3. Essentially consist of copying and pasting most of the policy exclusions, especially those that realistically have nothing to do with the claim.

To illustrate these points, below are five illustrations, four of which are claim denials and one a coverage inquiry.

Example 1:

An insured under a cyber crime policy had a bank wired transfer intercepted and monies stolen. According to the declination letter, the adjuster advised that the fraud itself must physically take place from within the insured’s premises or the bank’s location, citing (with quotation marks) policy language which said the fraud must be:

“…related to the use of a computer inside the insured’s premises or the premises of the bank.”

The policy language actually said [emphasis added]:

“…related to the use of any computer to fraudulently cause a transfer of that property from inside your premises or from a banking institution or similar safe depository, to a person (other than a ‘messenger’) outside those premises or to a place outside those premises.”

The computer used for the fraudulent transfer did not have to be located inside the insured’s or bank’s premises.

Example 2:

To illustrate a ‘selective’ language denial, a condo owner rented the clubhouse for his child’s birthday party. The property management company required at least $300,000 of liability insurance. Fortunately, this was a coverage inquiry and not a claim denial, though the agent likely made the mistake of posing the question to the underwriting, not claims, department. An underwriter responded that, while his limits were adequate, there would be no coverage under his homeowners policy and that the agent should procure a special events policy for the insured. In the email response, the underwriter cited this liability exclusion:

Arising out of a premises:

(2) Rented to an “insured”

The problem with this policy language citation is that it did not include the exception to the exclusion:

Arising out of a premises:

(2) Rented to an “insured”;

that is not an “insured location”;

The definition of “insured location” includes “Any part of a premises occasionally rented to an ‘insured’ for other than ‘business’ use.” In other words, the clubhouse is an “insured location,” so the exclusion does not apply. It is unknown whether this was an oversight or a deliberate attempt to conceal relevant policy language. The moral for EVERYONE involved is “RTFP!”

Example 3:

An insured left home for work at 7:30 a.m. and, when she returned home at 4:00 p.m., water was running from underneath the front door. The first floor of the house had flooded due to a burst pipe fitting in the kitchen. There had allegedly never been a water leak known to the insured prior to this occurrence.

In his denial letter, the adjuster cited over a dozen exclusions, from wear and tear to pollution to birds, vermin, rodents, or insects to “water damage” to neglect to faulty construction, and on and on. Much of the citations were simply blocks of exclusions copied and pasted into the letter. Certainly, the loss had nothing to do with birds and pollution, just to name two.

In addition, while citing exclusionary provisions completely unrelated to the claim, critical parts of the policy language were omitted. For example, in one listing of eight exclusions, from wear and tear to agricultural smudging smoke to the ‘animals’ exclusion, the adjuster neglected to reference the paragraph at the end of listing:

“If any of these cause water damage not otherwise excluded, from a plumbing, heating, air conditioning or automatic fire protective sprinkler system or household appliance, we cover loss caused by the water….”

The cited exclusion for faulty, inadequate or defective construction also had an exception similar to that above:

“However, any ensuing loss to property described in Coverages A and B not excluded or excepted in this policy is covered.”

The adjuster also cited an exclusion for “Constant or repeated seepage or leakage of water…over a period of weeks, months, or years….” There was no evidence of any water damage beyond that which occurred that day. Also cited was the “Neglect” exclusion even though the claim was reported the day it occurred and within two hours of discovery.

What might have contributed to this is the following sequence of events:

August 19            Water damage loss occurred

August 27            Adjuster was licensed by the state as an adjuster

September 22    Date of the claim denial letter

Needless to say, the claim was ultimately paid when the agent took it to the supervisory level of the insurer’s claims department.

My experience has been that claim denials that cite exclusions while ignoring exceptions to the exclusions, as in the last two examples, are very common. Often the exception is placed at the end of a series of exclusions, so one reason for the frequency of these types of improper denials could be simply overlooking them, not that this is a valid excuse.

Example 4:

A dentist’s office computer system was hit by ransomware that encrypted all of his customer files (personal information, x-rays, insurance information, accounting records, etc.), including backups. The dentist experienced a significant business income and extra expense loss and accounts receivable loss.

In the adjuster’s voluminous denial letter, exclusions are cited for everything from “wear and tear” and “mechanical breakdown” to “faulty workmanship.” None of the cited exclusions were relevant to the claim. What was not cited and was relevant was the fact that there was no “direct physical loss,” as required by the policy form’s insuring agreement to trigger coverage. So, the loss wasn’t covered but not for any reason cited in the denial letter. My experience over the years is that claims are often correctly denied but for the wrong reason.

Example 5:

A crane inspector overloaded a crane during a test, causing it to collapse. The claim was denied by his CGL insurer. The denial never really says why the loss isn’t covered and the reservation of rights paragraph is so broad as to presumably allow denial by some sort of divine intervention at a later date. The 10-page letter cites, word for word, the Coverage A Insuring Agreement, Exclusions j.(1)-(6), k., l., m., n., and t. For the record, Exclusion n. is for product recall which is not even remotely applicable to the claim. The letter goes on to cite, verbatim, every definition referenced from the insuring agreement and exclusions but, again, never says which exclusions apply and why.

Is Example 5 above a legitimate denial and reservation of rights letter? In his excellent Coverage Opinionsnewsletter (Vol. 6, Iss. 9), attorney Randy Maniloff discusses Harleysville Group Insurance v. Heritage Communities, 803 S.E.2d 288 (S.C. 2017) where the state Supreme Court opined:

“[I]t is axiomatic that an insured must be provided sufficient information to understand the reasons the insurer believes the policy may not provide coverage. We agree with the Special Referee that generic denials of coverage coupled with furnishing the insured with a copy of all or most of the policy provisions (through a cut-and-paste method) is not sufficient.”

Mr. Maniloff has written and spoke about reservation of rights issues for years. More information on the “adequately inform” standard required by many courts can be found on his web site at www.coverageopinions.info.