Policy Buyback Limitations

Insurance companies may negotiate with their policyholder a settlement of a coverage dispute through a coverage buyback agreement. In this situation, after a potentially non-covered loss has taken place, a settlement of the coverage dispute is negotiated whereby the insurance company offers the insured/policyholder upfront cash in exchange for an agreement to annul the policy.

As a result of the agreement, the insured becomes self-insured. The negotiations may involve a total policy buyback whereby the contractual relationship between the insurer and its insured is completely terminated. In environmental cases, the agreement may involve what is commonly called an “environmental buyout” which is similar to a total policy buyback but the buyout only terminates the relationship between the insurer and insured regarding environmental claims.

Among the panoply of potential negotiated arrangements is what has been called a “specific policy exclusion” in which all present and pending claims for a particular product or contaminant are covered but the agreement is that the policy will not cover any future claims concerning those specific products or contaminants.

In some cases, the parties will negotiate a “site buyout” which only resolves claims at a particular site in question.

The parties may also negotiate what is called a “litigation buyout” which involves the settlement of a claim that is the subject of the coverage litigation. Each of these arrangements requires clarity in the settlement terms to be enforceable. See R.T. Vanderbilt Co., Inc. v. Continental Cas. Co., 2002 WL 31125585 at *13 (Conn. Super. 8/16/02).

Policy buyback arrangements often involve either mutual cancellation of the policy or mutual rescission. See Texas Gas Utilities Co. v. Barrett, 460 S.W.2d 409, 414 (Tex. 1970) (“[P]arties may rescind their contract by mutual agreement and thereby discharge themselves from their respective duties. The mutual release of the rights of the parties is regarded as a sufficient consideration for the agreement.”).

Where the policy buyout is achieved through a mutual policy cancellation, the cancellation of the policy is prospective only. This type of buyback does not extinguish liabilities that have already accrued or rights that had already vested at the time of cancellation. See, e.g., Mann v. Charter Oak Fire Ins. Co., 196 F.Supp. 604 (E.D. Ark. 1961), aff’d Charter Oak Fire Ins. Co. v. Mann, 304 F.2d 166 (8th Cir. 1962).

The cancellation will not affect an automatic retroactive extinguishment of vested rights. See, e.g., Sid Richardson Carbon & Gasoline Co. v. Interenergy Resources, Ltd., 99 F.3d 746, 754 (5th Cir. 1996).

Where the policy buyback is activated through a policy rescission, the rescission, if valid, will operate retroactively. See, e.g., Douglass v. Nationwide Mut. Ins. Co., 913 S.W.2d 277, 279 (Ark. 1996) (“[C]ancellation is a prospective remedy and is based upon the insurer’s contract rights or rights under statute, while rescission is an equitable, common law remedy which voids the contract ab initio.”).

Many states have enacted anti-nullification statutes which operate to “freeze liability” on the part of an insurer after an injury or death occurs that triggers a liability policy. The following states have enacted such legislation: Alabama, Arizona, Connecticut, Kentucky, Massachusetts, Missouri, Ohio, Oregon and Washington.

These statutes generally provide identical or similar language to the following:

No insurance contract insuring against loss or damage through legal liability for the bodily injury or death by accident of any individual, or for damage to the property of any person, shall be retroactively annulled by any agreement between the insurer and the insured after the occurrence of any injury, death or damage for which the insured may be liable, and any attempted annulment shall be void.

In American Continental Ins. Co. v. Steen, 151 Wash.2d 512, 91 P.3d 864 (2004), the Washington Supreme Court analyzed Washington’s annulment statute which contained language nearly identical to that stated above. The Court found that the statutory language forbids and voids any agreement between the insured and the insurer to retroactively annul an insurance policy after an occurrence or event for which the insured may become liable. See RCWA 48.18.320. The Court in Steen found that the anti-annulment statute did not void agreements that were made before the occurrence of an injury, death or damage for which the insured may be liable. The Court found that the legislative intent expressed in the statute was to insure that cancellation did not adversely impact any person who was injured or damaged by an occurrence before the parties agreed to cancel the policy by agreement.

In Steen, the Court explained the overarching public policy foundation for prohibiting policy annulment for liability policies after claims had been made. “The purpose of the [anti-annulment statute] is not the protection of either the insured or the insurer. Its purpose is to protect the injured and damaged by preventing insureds and insurers from coming together and canceling or rescinding insurance contracts after a potentially covered injury … has occurred.” 151 Wash.2d at 524, 91 P.3d at 871.

To be sure, if an insurer could unilaterally rescind coverage where third-party claims are at issue, unscrupulous insurers would hold the threat over the head of third-party claimants in an attempt to bargain down their claims.

Generally, anti-annulment statutes do not preclude an insurance company and its policyholder from agreeing to a policy annulment governing future claims. However, anti-annulment statutes will void any buyback arrangement involving third-party claims that have already occurred.

Considering a buyback agreement that attempts retroactive application is problematic for the insurer.

If the insurance company relies upon the agreement and refuses to defend its insured in pending claims, and the court finds that the agreement is void, then the insurer will be responsible for the ultimate result in the undefended tort case and the consequences of its non-defense of its insured. Additionally, questions arise as to whether the insured can assert bad faith against the insurer when it refuses to defend on the basis of the agreement since the agreement is void, leaving the insurance policy in force.

Most states have enacted some variation of a motor vehicle financial responsibility act. Most of these states incorporate an anti-annulment or “frozen liability” statute within the financial responsibility act that applies to automobile liability insurance.

The following states have enacted anti-annulment statutes applying to automobile liability coverage: Alabama, Alaska, Arizona, Arkansas, Colorado, Delaware, Hawaii, Idaho, Illinois, Iowa, Louisiana, Maine, Massachusetts, Michigan, Missouri, Minnesota, Mississippi, Montana, Nebraska, Nevada, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Virginia, Washington, West Virginia, Wisconsin and Wyoming.

A typical anti-annulment statute in the automobile liability insurance context subjects every motor vehicle liability policy to the following condition:

The liability of the insurance carrier with respect to the insurance required by [the financial responsibility law] shall become absolute whenever injury or damage covered by the motor vehicle liability policy occurs. The policy may not be cancelled or annulled as to that liability by any agreement between the insurance carrier and the insured after the occurrence of the injury or damage. Any statement made by the insured or on his or her behalf and any violation of the policy shall not defeat or void the policy.

See, e.g., Ala. Code § 32-7-22(f)(1) (emphasis added).

The typical anti-annulment statute found in a state’s financial responsibility laws not only prohibits retroactive annulment of policies, but they also provide that the conduct of an insured post-accident cannot be used as a basis to void coverage. This evidences the strong public policy that injured victims have available to them specific minimum limits assigned by statute which every automobile liability policy must insure for.

Every insurance adjuster should research the involved state’s law to determine whether the state has an anti-annulment statute before considering a policy buyback. Any buyback which attempts to retroactively annul the policy should be scrutinized carefully because it is unlikely that the buyback arrangement will be legally effective.

A policy buyback for future potential claims remains a viable option provided that the language used in the agreement is specific and unambiguous regarding that intent. The buyback agreement should state that it does not apply to claims that have already occurred prior to the buyback agreement execution date.

A determination must be made as to whether there are any unnamed additional insureds under the policy. If additional insureds are involved it is unlikely that a mutual rescission of the entire policy can take place without the consent of the unnamed additional insureds. See, e.g., Lumbermens Mut. Cas. Co. v. Iowa Home Mut. Cas. Co., 405 P.2d 160 (Iowa 1965).

Additionally, one insurer’s settlement and release with its insured through a policy buyback may not affect its obligation to contribute to the costs of the insured’s defense incurred by another insurer. See, e.g., Employers Ins. Co. of Wausau v. Travelers Indem. Co., 141 Cal.App.4th 398, 46 Cal.Rptr.3d 1 (1st Dist. 2006), review denied. This is so because at the time of a loss, each insurer has a potential obligation to defend and indemnify against claims that might arise. Thus, although a policy annulment may occur, which attempts to retroactively annul the policy, if a claim has already taken place (even though unknown to the parties), the obligation of defense has attached.

Plitt is a nationally recognized expert in insurance law. He has authored numerous insurance treatises and articles. He has a national expert witness practice. Email: SP@kunzlegal.com.