Natl Sur Corp v. Hartford Cslty Ins ( 2007 )

RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206
File Name: 07a0287p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
_________________
X
Plaintiff-Appellant. -
NATIONAL SURETY CORPORATION,
-
-
-
No. 06-6168
v.
,
>
HARTFORD CASUALTY INSURANCE COMPANY, -
Defendant-Appellee. N
Appeal from the United States District Court
for the Western District of Kentucky at Louisville.
No. 05-00119—Charles R. Simpson III, District Judge.
Argued: May 31, 2007
Decided and Filed: July 30, 2007
Before: RYAN, DAUGHTREY, and ROGERS, Circuit Judges.
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COUNSEL
ARGUED: Barry M. Miller, FOWLER, MEASLE & BELL, Lexington, Kentucky, for Appellant.
Douglas L. Hoots, LANDRUM & SHOUSE, Lexington, Kentucky, for Appellee. ON BRIEF:
Barry M. Miller, FOWLER, MEASLE & BELL, Lexington, Kentucky, for Appellant. Douglas L.
Hoots, LANDRUM & SHOUSE, Lexington, Kentucky, for Appellee.
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OPINION
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ROGERS, Circuit Judge. When a primary insurer against tort liability refuses to settle and
then loses at trial for amounts greater than its coverage limits, what recourse does an excess insurer
have against the primary insurer? This case involves the issue of whether, under Kentucky law, an
excess insurer can recover against a primary insurer pursuant to the doctrine of equitable
subrogation, either for the primary insurer’s failure in good faith to settle a claim or for the primary
insurer’s failure to investigate whether an insured has other insurance.
The excess insurer in this case, National Surety Corporation, argues that the primary insurer,
Hartford Casualty Insurance Company, acted in bad faith by failing to settle a tort claim against their
1
No. 06-6168 Nat’l Sur. Corp. v. Hartford Cas. Ins. Co. Page 2
mutual insured, Sufix U.S.A., and thereby exposed Sufix to excess liability.1 National Surety seeks
to step into Sufix’s shoes, pursuant to the doctrine of equitable subrogation, to assert this bad-faith
claim. National Surety also seeks to assert a claim against Hartford for Hartford’s failure to discover
that Sufix was insured by National Surety. The district court held that National Surety did not have
a cause of action under Kentucky law, and accordingly granted Hartford’s motion to dismiss.
We reverse the district court’s order because the Supreme Court of Kentucky would likely
recognize a cause of action in this case. Kentucky law already permits an insured to sue a primary
insurer for bad faith failure to settle a claim. Kentucky law also recognizes the doctrine of equitable
subrogation, which permits an insurance company to “step into the shoes” of the insured and recover
what the insured would have been able to recover against a tortfeasor. Combining these two
principles to allow an excess insurer to recover from a primary insurer is a logical extension of these
principles and furthers Kentucky’s policy goals of encouraging fair and reasonable settlements and
preventing third parties from profiting from an insured’s insurance coverage. However, the district
court’s order properly dismissed National Surety’s failure-to-investigate claim because an insured
does not have a cause of action under Kentucky law against its insurer for failing to discover an
insured’s other sources of insurance.
National Surety’s complaint alleges the following facts, which this court must accept as true,
Evans v. Pearson Enters., Inc., 434 F.3d 839, 847 (6th Cir. 2006). Hartford and National Surety
both issued insurance policies to Sufix U.S.A. Hartford’s policy provided $1 million in primary
liability coverage and National Surety’s policy provided $10 million in excess liability coverage.
On or about May 19, 1998, a weed trimmer manufactured by Sufix injured Tommy Cook when the
trimmer broke apart while Cook was using it.
In May of 1999, Cook filed suit against Sufix in Jefferson Circuit Court, alleging that the
weed trimmer was defectively designed and that Sufix was grossly negligent in failing to discover
the defect. Hartford assumed the defense of Sufix pursuant to its insurance contract. Hartford,
through its attorneys, engaged in settlement negotiations with Cook, and ultimately rejected Cook’s
offer to settle for the limits of Hartford’s policy (i.e., $1 million).
National Surety did not receive notice of Cook’s action against Sufix from Sufix or Hartford
until approximately two weeks before trial. National Surety alleges that because of the lack of
timely notice, it was (1) unable to evaluate effectively its exposure to Cook under the excess policy,
(2) unable to evaluate Cook’s settlement demand, (3) not given the opportunity to participate in or
direct the preparations for the trial, and (4) unable to engage in informed settlement negotiations
with Cook.
On May 21, 2002, a jury found Sufix liable to Cook and awarded Cook $6,486,588.44. After
the trial, National Surety assumed the defense of Sufix and brought an unsuccessful appeal to the
Court of Appeals of Kentucky.
On February 24, 2005, National Surety filed suit against Hartford in the United States
District Court for the Western District of Kentucky. National Surety sued Hartford for breach of
contract and for violation of the common-law duty of good faith. National Surety asserted in its
complaint that Hartford failed “[t]o perform an adequate investigation of the allegations that form
the basis of the Civil Action,” failed “[t]o provide Sufix with an adequate and competent defense
of the allegations contained in the Civil Action,” and failed “[t]o settle claims against Sufix within
1
A primary insurer insures against liability risk from $0 up to the policy limits. An excess insurer insures
against liability above the limits of primary insurance. For example, here, the insured had a primary insurance policy
with Hartford that covered liability up to $1 million and an excess insurance policy with National Surety that covered
any liability above $1 million, up to $10 million.
No. 06-6168 Nat’l Sur. Corp. v. Hartford Cas. Ins. Co. Page 3
its policy limits so as not to expose Sufix and its assets to an excess judgment.” National Surety
claimed that it is subrogated to Sufix pursuant to the terms of the excess policy and the doctrine of
equitable subrogation. Hartford filed a motion to dismiss, pursuant to Federal Rule of Civil
Procedure 12(b)(6), on the grounds that Kentucky does not recognize the right of excess insurers to
sue primary insurers in a situation like this one.
The district court granted Hartford’s motion to dismiss. Nat’l Sur. Corp. v. Hartford Cas.
Ins. Co., 445 F. Supp. 2d 779 (W.D. Ky. 2006). The district court predicted that the Kentucky
Supreme Court would not recognize a cause of action by an excess insurer against a primary insurer
pursuant to the doctrine of equitable subrogation, even though such a rule had been adopted by the
overwhelming majority of jurisdictions to have considered the issue. Id. at 781-85. First, the district
court observed that “the Kentucky Court of Appeals refused to recognize the theory of equitable
subrogation in a similar situation,” where an excess insurer sought to sue an insured’s defense
counsel for malpractice. Id. at 781 (referring to Am. Cont’l Ins. Co. v. Weber & Rose, P.S.C., 997
S.W.2d 12 (Ky. Ct. App. 1998)). The court noted that Weber & Rose “is the strongest indicator of
how the Kentucky courts would rule in the case at bar.” Id. The court reasoned that, as in Weber
& Rose, allowing recovery against the primary insurer would “threaten the integrity of the settlement
process by allowing the excess carriers, who were not involved in those underlying negotiations, to
second-guess the judgment of the primary insurer’s representatives.” Id. at 782.
Second, the district court concluded that Kentucky would not follow the jurisdictions that
have adopted the rule advocated by National Surety because excess insurers do not suffer an injury
when a primary insurer, in bad faith, fails to settle a claim within its policy limits. Id. at 782-83.
The district court reasoned that the excess insurer, National Surety, has received a premium in
exchange for assuming the risk of an excess judgment and therefore suffered no wrong, while the
insured, Sufix, who has been fully indemnified, has suffered no loss. Id. at 783. The district court
supported this reasoning with several hypotheticals. Id. at 783-85. Finally, the district court refuted
the argument that failing to adopt the majority rule would raise excess insurance premium costs by
raising the countervailing likelihood that adopting the majority rule would raise primary insurance
premiums, thereby ultimately distributing costs unfairly. Id. at 785.
In resolving an issue of state law in a diversity case, this court must “‘make [the] best
prediction, even in the absence of direct state court precedent, of what the Kentucky Supreme Court
would do if it were confronted with’” the same question of law. Managed Health Care Assocs., Inc.
v. Kethan, 209 F.3d 923, 927 (6th Cir. 2000) (quoting Welsh v. United States, 844 F.2d 1239, 1245
(6th Cir. 1988)). Because Kentucky law and policy support the majority rule that an excess insurer
may recover against a primary insurer under the doctrine of equitable subrogation, and arguments
to the contrary are not persuasive, the Kentucky Supreme Court would likely recognize the rule
asserted by National Surety in this case.
The Kentucky Supreme Court would likely adopt the majority rule because that rule naturally
follows from two other Kentucky insurance rules: (1) that an insured may sue an insurer who, in
bad faith, fails to settle a claim within policy limits, and (2) that an insurer may step into the shoes
of the insured, pursuant to the doctrine of equitable subrogation. In addition, the majority rule
furthers Kentucky policies of encouraging fair and reasonable settlements and preventing
wrongdoers from piggybacking on an insured’s insurance.
Kentucky law permits an insured to sue a primary insurer that, in bad faith, fails to settle a
claim. Under Kentucky law, the insurance contract between an insured and insurer contains an
implied covenant of good faith and fair dealing. Manchester Ins. & Indem. Co. v. Grundy, 531
S.W.2d 493, 498 (Ky. 1975). The insured has a cause of action against the insurer if the insurer, in
bad faith, fails to settle a claim within the policy limits. Id. at 497-98. Kentucky follows the general
rule that “damages recoverable for a wrong are not diminished by the fact that the injured party has
No. 06-6168 Nat’l Sur. Corp. v. Hartford Cas. Ins. Co. Page 4
been wholly or partly indemnified for his loss by insurance (to whose procurement the wrongdoer
did not contribute).” Taylor v. Jennison, 335 S.W.2d 902, 903 (Ky. 1960). In the instant case, even
though Sufix had excess insurance, and thus was compensated for the entire verdict against it, Sufix
still had a cause of action against Hartford.
Kentucky also recognizes the doctrine of equitable subrogation. Although Kentucky courts
note that equitable subrogation “should be strictly limited in its application,” United Pac. Ins. Co.
v. First Nat’l Bank of Prestonsburg, 457 S.W.2d 833, 835 (Ky. 1970), the courts recognize that
equitable subrogation “has a long and rich tradition of benevolence and fairness, . . . and is
irrevocably anchored in principles of natural justice.” Wine v. Globe Am. Cas. Co., 917 S.W.2d 558,
561 (Ky. 1996) (citations omitted). Equitable subrogation is “designed to prevent unjust enrichment
by requiring those who benefitted from another paying their debt to ultimately pay it themselves.”
Id. The rule, as applied in the insurance context, allows an insurer to sue a third party for injuries
that the third party caused to the insured, when the insurer compensated the insured for those
injuries. See, e.g., Employers Mut. Liability Ins. Co. v. Griffin Constr. Co., 280 S.W.2d 179, 182
(Ky. 1955); Ohio Cas. Ins. Co. v. Vermeer Mfg. Co., 298 F. Supp. 2d 575, 579-80 (W.D. Ky. 2004).
For example, if A negligently runs over B with his car, B’s insurer can sue A if B’s insurer
compensated B for her injuries.
Considering these two principles together leads to the conclusion that an excess insurer is
permitted to step into the shoes of the insured and sue a primary insurer pursuant to the doctrine of
equitable subrogation to enforce the primary insurer’s duty to avoid excessive judgments against an
insured. The overwhelming majority of jurisdictions that have considered the issue in this case have
adopted such a rule.2 Only Alabama and Idaho adhere to the minority position. See Fed. Ins. Co.
v. Travelers Cas. & Sur. Co., 843 So. 2d 140, 145-46 (Ala. 2002); Stonewall Surplus Lines Ins. Co.
v. Farmers Ins. Co. of Idaho, 971 P.2d 1142, 1148-49 (Idaho 1998).
The majority rule encourages the fair and reasonable settlement of lawsuits. See, e.g., Am.
Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480, 482-83 (Tex. 1992). Absent a rule
permitting excess insurers to recover against primary insurers, primary insurers could, in bad faith,
fail to accept settlement offers at or near policy limits with impunity. The Supreme Court of
2
See Hartford Accident & Indem. Co. v. Aetna Cas. & Sur. Co., 792 P.2d 749, 754 (Ariz. 1990); Commercial
Union Assurance Cos. v. Safeway Stores, Inc., 610 P.2d 1038, 1041 (Cal. 1980); Ranger Ins. Co. v. Travelers Indem.
Co., 389 So. 2d 272, 273 (Fla. Dist. Ct. App. 1980); Home Ins. Co. v. N. River Ins. Co., 385 S.E.2d 736, 740 (Ga. Ct.
App. 1989); Certain Underwriters of Lloyd’s v. Gen. Accident Ins. Co. of Am., 909 F.2d 228, 233 (7th Cir. 1990)
(applying Indiana law); Ins. Co. of N. Am. v. Med. Protective Co., 768 F.2d 315, 320-21 (10th Cir. 1985) (applying
Kansas law); Great Sw. Fire Ins. Co. v. CNA Ins. Cos., 557 So. 2d 966, 967 (La. 1990); Fireman’s Fund Ins. Co. v. Cont’l
Ins. Co., 519 A.2d 202, 205 (Md. 1987); Hartford Cas. Ins. Co. v. N.H. Ins. Co., 628 N.E.2d 14, 15 (Mass. 1994);
Commercial Union Ins. Co. v. Medical Protective Co., 393 N.W.2d 479, 483 (Mich. 1986); Cont’l Cas. Co. v. Reserve
Ins. Co., 238 N.W.2d 862, 864 (Minn. 1976); Estate of Penn v. Amalgamated Gen. Agencies, 372 A.2d 1124, 1126-27
(N.J. Super. Ct. App. Div. 1977); Hartford Accident & Indem. Co. v. Mich. Mut. Ins. Co., 463 N.E.2d 608, 610 (N.Y.
1984); Centennial Ins. Co. v. Liberty Mut. Ins. Co., 404 N.E.2d 759, 762 (Ohio 1980); Am. Fidelity & Cas. Co. v. All
Am. Bus Lines, 190 F.2d 234, 238 (10th Cir. 1951) (applying Oklahoma law); Me. Bonding & Cas. Co. v. Centennial
Ins. Co., 693 P.2d 1296, 1300 (Or. 1985); Greater N.Y. Mut. Ins. Co. v. N. River Ins. Co., 85 F.3d 1088, 1094 (3d Cir.
1996) (applying Pennsylvania law); N. River Ins. Co. v. St. Paul Fire & Marine Ins. Co., 600 F.2d 721, 723-24 nn.3&4
(8th Cir. 1979) (applying South Dakota law); Am. Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480, 482-83 (Tex.
1992); Prime Hospitality Corp. v. Gen. Star Indem. Co., No. CIV.1997-91, 1999 WL 293865, at *4 n.10 (D. V.I. Apr.
29, 1999) (unpublished); Truck Ins. Exch. of the Farmers Ins. Group v. Century Indem. Co., 887 P.2d 455, 459-60
(Wash. Ct. App. 1995); Vencill v. Cont’l Cas. Co., 433 F. Supp. 1371, 1376 (S.D. W. Va. 1977) (applying West Virginia
law); see also Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23 F.3d 1175, 1178-79 (7th Cir. 1994) (applying Illinois
law and endorsing majority rule) Allstate Ins. Co. v. Reserve Ins. Co., 373 A.2d 339, 340 (N.H. 1977) (permitting excess
insurer to sue primary insurer under assignment theory); Elec. Ins. Co. v. Nationwide Mut. Ins. Co., 384 F. Supp. 2d
1190, 1193 (W.D. Tenn. 2005) (applying Tennessee law; denying motion to dismiss); Horace Mann Ins. Co. v. Gov’t
Employees Ins. Co., 344 S.E.2d 906, 908 (Va. 1986) (assuming without deciding); Hocker v. N.H. Ins. Co., 922 F.2d
1476, 1485 (10th Cir. 1991) (applying Wyoming law; assuming in dicta).
No. 06-6168 Nat’l Sur. Corp. v. Hartford Cas. Ins. Co. Page 5
Michigan, for instance, reasoned that the majority rule “discourag[es] primary carriers from
‘gambling’ with the excess carrier’s money when potential judgments approach the primary
insurer’s policy limits.” Commercial Union Ins. Co. v. Medical Protective Co., 393 N.W.2d 479,
483 (Mich. 1986). For example, suppose in this case that Hartford estimated that, if Cook’s case
against Sufix went to trial, there was a 50% chance that Cook would lose, and a 50% chance that
Cook would win a jury verdict of $5.5 million. The weighted expectation of liability for going to
trial would have been $2.25 million (50% x $5.5 million + 50% x $0) and Cook’s settlement offer
of $1 million would have been a great bargain. However, Hartford would have had to pay only $1
million if Cook won and $0 if Cook lost, for a weighted expectation of liability on Hartford’s part
of $500,000 (50% x $1 million + 50% x $0). Thus, it would have been in Hartford’s best interest3
to go to trial because the economic risk of going to trial did not fall completely on Hartford.
Therefore, in the absence of the majority rule, there is a potential that a primary insurer will forgo
fair and reasonable settlements and roll the dice with, what is in essence, the excess insurer’s money.
Such hypotheticals cannot be disposed of with the observation that they fail to take into
account the litigation costs incurred by the insurer when the case goes to trial. Although the
presence of litigation costs diminishes the incentive an insurer has to go to trial, the underlying
problem still remains. For example, in the above hypothetical, suppose that if the case went to trial,
Hartford would have incurred $100,000 in litigation costs. Then the total weighted expected cost
of going to trial would have been $2.35 million. But Hartford would have had to pay $1.1 million
if Cook won and $100,000 if Cook lost, for a weighted expected cost of $600,000. Thus, it still
would have been in Hartford’s interest to go to trial.
Similarly, Kentucky law values the fair and reasonable settlement of lawsuits. The Kentucky
courts have repeatedly stated that “[t]he law always looks with favor upon an agreement between
two or more persons who, to avoid a lawsuit, amicably settle their differences on such terms as to
them seem fair and reasonable.” Dexter v. Duncan, 265 S.W. 832, 832 (Ky. 1924); accord Childs
v. Hamilton, 214 S.W.2d 106, 108 (Ky. 1948). This principle also applies in the insurance context.
For example, Kentucky’s Unfair Claims Settlement Practices Act prohibits persons in the business
of entering into insurance contracts from “[n]ot attempting in good faith to effectuate prompt, fair
and equitable settlements of claims in which liability has become reasonable clear.” Ky. Rev. Stat.
Ann. § 304.12-230(6) (LexisNexis 2006).
In addition, the majority rule’s goal of preventing a primary insurer from, in bad faith, failing
to settle a claim comports with Kentucky’s insurance policy goals. As discussed above, a primary
insurer has an incentive to fail to settle a claim within its policy limits even though the settlement
offer is objectively fair and reasonable. Although the insured has a cause of action against a primary
insurer who fails to settle in good faith, when the insured has excess insurance, the insured has little
incentive to sue because the harm of the primary insurer’s refusal to settle falls completely on the
3
Judge Posner used a similar hypothetical in explaining the Seventh Circuit’s anticipation of Illinois law on the
subject:
Suppose the claim was for $2 million, the policy limit was $1 million, the plaintiff was willing to settle
for this amount, but the defendant’s insurer believed that if the case was tried the plaintiff would have
a 50 percent chance of winning $2 million and a 50 percent chance of losing. The insurer’s incentive
would be to refuse to settle, since if it lost the trial it would be no worse off than if it settled-in either
case it would have to pay $1 million—but if it won it would have saved itself $1 million. It is in order
to quench this kind of temptation that the liability insurer’s duty to settle in good faith was read into
liability insurance contracts. When by virtue of an excess insurance policy the victim of the behavior
that we have described is the excess insurer rather than the insured, the former is permitted to step into
the shoes of the latter and assert the latter’s implied contractual right against the misbehaving insurer.
Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23 F.3d 1175, 1179 (7th Cir. 1994).
No. 06-6168 Nat’l Sur. Corp. v. Hartford Cas. Ins. Co. Page 6
excess insurer. See, e.g., Twin City Fire Ins. Co., 23 F.3d at 1179. The reason why Kentucky law
permits an insured to sue a wrongdoer despite the fact that the insured is indemnified for his loss is
because “there is no logical or legal reason why a wrongdoer should receive the benefit of insurance
obtained by the injured party for his own protection.” Taylor, 335 S.W.2d at 903. This policy
applies as strongly when an insured has excess insurance and favors adoption of the majority rule
because otherwise a wrongdoer (the primary insurer who fails to settle in good faith) would receive
the benefit of the insured’s excess insurance.
Adopting the rule that excess insurers can sue primary insurers in cases like this does not,
as argued, conflict with the Kentucky Court of Appeals’ decision in American Continental Insurance
Co. v. Weber & Rose, P.S.C., 997 S.W.2d 12 (Ky. Ct. App. 1998). In Weber & Rose, the Kentucky
Court of Appeals held that an excess insurer cannot sue an insured’s defense counsel for malpractice
under the theory of equitable subordination, relying on the Kentucky courts’ “clearly-defined duty
to protect, encourage, and preserve the traditional attorney-client relationship.” 997 S.W.2d at 14.
Permitting such suits “would be inimical to the preservation of traditional and longstanding concepts
associated with attorney-client relationship, as recognized by Kentucky law.” Id. at 13. Assuming
that the Kentucky Supreme Court would agree with the Court of Appeals, that holding does not
foreclose the possibility that the Kentucky Supreme Court would permit excess insurers to sue
primary insurers for breach of their good faith obligation to insureds. The latter obligation is one
that is outside of the attorney-client relationship, which was the central basis for the Court of
Appeals holding in Weber & Rose. Also, other jurisdictions have permitted these two rules to
coexist. See St. Paul Ins. Co. v. AFIA Worldwide Ins. Co., 937 F.2d 274, 279, 281 (5th Cir. 1991)
(holding that although Louisiana law permitted an excess insurer to sue a primary insurer under a
subrogation theory, Louisiana law did not permit the excess insurer to sue the insured’s counsel);
Am. Employers’ Ins. Co. v. Med. Protective Co., 419 N.W.2d 447, 448 (Mich. Ct. App. 1988)
(holding that an excess insurer could not sue an insured’s defense attorney for legal malpractice
under the doctrine of equitable subrogation, notwithstanding the fact that Michigan permitted excess
insurers to bring bad-faith-failure-to-defend-or-settle claims against primary insurers), abrogated
by Atlanta Int’l Ins. Co. v. Bell, 475 N.W.2d 294, 298-99 (Mich. 1991) (permitting excess insurer
to sue defense attorney). There is no reason why the Kentucky Supreme Court would fail to impose
a duty upon primary insurers in this case in light of the Kentucky policy reasons in favor of such a
duty.
Other concerns with adoption of the majority rule do not, in the end, provide persuasive
reasons for Kentucky to reject it. It is not enough to say, for instance, that an excess insurer’s
premiums reflect the possibility that a primary insurer would, in bad faith, fail to settle a claim.
Such an argument proves too much: it would do away with equitable subrogation altogether in the
insurance context. For example, a health insurance company will pay for hospital bills covering
injuries that an insured suffers by reason of a third party’s negligence. The health insurance
company may sue the third-party tortfeasor, under the doctrine of equitable subrogation, to recover
the damages owed to the insured that the insurer covered, and only circular reasoning would
preclude such subrogation on the theory that the insurance company’s premiums reflect the
possibility of tortiously inflicted injuries. Like any business, an insurer will factor many risks of loss
into the cost of its goods (i.e., insurance premiums), but that does not mean that the insurer must
absorb the costs when those risks come to fruition if a third party’s negligence or bad faith caused
the insurer to suffer those costs. Moreover, from the perspective of the primary insurer, the primary
insurer’s premiums reflect its duty to settle in good faith, and failing to impose the duty on primary
insurers provides them a windfall. See Centennial Ins. Co., 404 N.E.2d at 762.
Nor can it be persuasively argued that the excess insurer does not really “step into the shoes”
of the insured because the insured’s cause of action against a primary insurer presupposes the lack
of excess insurance. As noted above, the insured still has a cause of action under Kentucky law even
when the insured’s loss is indemnified by insurance. Taylor, 335 S.W.2d at 903. Contrast Fed. Ins.
No. 06-6168 Nat’l Sur. Corp. v. Hartford Cas. Ins. Co. Page 7
Co., 843 So. 2d at 144 (noting that in Alabama, the insured does not have a cause of action if the
insured suffered no personal loss). In addition, the situation where an insured does not have excess
insurance is, in effect, no different from when the insured has excess insurance. When an insured
does not have excess insurance, he or she self-insures against the risk of loss above primary
insurance limits. The insured, in that case, “pays” for the risk of loss exceeding the primary
insurance, but still has a cause of action against the primary insurer for bad faith failure to settle
within policy limits.
It could be argued that the interests of the excess insurer and the insured are not truly the
same, but we are persuaded by the Seventh Circuit’s rejection of the argument:
It is true that the harm to the insured (when there is no excess insurer) is apt to be
even greater than the harm to the excess insurer (when there is one in the picture),
because the insured, at least if an individual, will be risk averse—that is why he buys
insurance—while the insurance company eliminates risk by pooling the risks of
many insureds. But the excess insurer is hurt, nonetheless, if the primary insurer
takes steps that increase the probability that the excess insurer will be liable, as in
our hypothetical example [see n.3, supra], where the conduct of the primary insurer
converts a zero probability of liability to the excess insurer into a 50 percent
probability that the latter will lose $1 million. No court has ever suggested that the
difference in attitudes toward risk between an insured and an insurance company
should alter the measure of recovery when an excess insurer is subrogated to an
insured’s claim of bad faith.
Twin City Fire Ins. Co., 23 F.3d at 1179.
Finally, the Kentucky courts are unlikely to reject the majority rule because it might raise
premiums for primary insurers. The risk of liability for an insurance company’s own bad faith is
doubtless included in the cost of primary coverage premiums, just as the cost of committing torts
is built into the price of doing business generally. The cost of bad faith refusal to settle is
presumably built into the primary insurance premiums where an insured has no excess insurance,
and there is no good reason not to have the cost of bad faith refusal to settle included in the
premiums for insureds who do have excess insurance. Bad faith costs, in other words, are a cost of
doing business. There is no clear economic efficiency derived from shifting them to other insurers
who have not acted in bad faith.
National Surety, however, may not assert a claim against Hartford for Hartford’s purported
failure to investigate whether Sufix had other insurance. Such a claim does not sound in subrogation
because Sufix, who presumably knows from whom it has obtained insurance, would have had no
such claim against Hartford. Instead, such a claim would presume a direct obligation of the primary
insurer to the excess insurer, a concept rejected by most of those jurisdictions accepting subrogation
of the primary insurer’s obligation to its insured. As the Seventh Circuit said in Twin City Fire
Insurance Co., supra, “the arguments in favor of the direct duty are not so compelling that we could
responsibly predict that the Supreme Court of Illinois would buck the national trend and declare that
under the common law of Illinois a primary insurer has a direct duty, actionable in tort, against the
excess insurer.” 23 F.3d at 1180-81. National Surety concedes that no Kentucky court has
recognized a duty of an insurance company to investigate whether an insured has other insurance,
but instead points out that two other states do recognize such a duty. See Cas. Indem. Exch. Ins. Co.
v. Liberty Nat’l Fire Ins. Co., 902 F. Supp. 1235, 1240 (D. Mont. 1995); Am. Star Ins. Co. v. Allstate
Ins. Co., 508 P.2d 244, 249 (Or. 1973). However, neither decision from these states is particularly
persuasive and National Surety does not offer any reason why the Kentucky Supreme Court would
impose a duty on an insurance company to investigate whether its insured has other insurance
No. 06-6168 Nat’l Sur. Corp. v. Hartford Cas. Ins. Co. Page 8
coverage. Therefore, the district court properly granted Hartford’s motion to dismiss with respect
to this aspect of its claim.
For the foregoing reasons, we affirm the dismissal of the claim against Hartford to the extent
it relied on the failure to investigate whether its insured had other insurance coverage, but otherwise
reverse the district court’s order granting Hartford’s motion to dismiss, and remand for further
proceedings consistent with this opinion.