REGULATION NO.107
11NYCRR 71.0

OFFICIAL COMPILATION OF CODES, RULES AND REGULATIONS OF THE STATE OF NEW YORK

TITLE 11. INSURANCE DEPARTMENT
CHAPTER III. POLICY AND CERTIFICATE PROVISIONS
SUBCHAPTER B. PROPERTY AND CASUALTY INSURANCE
PART 71. LEGAL DEFENSE COSTS IN LIABILITY POLICIES

Section 71.0 Preamble.

(a) Prior to the original promulgation of this Part in 1983, the Insurance Department had approved a limited number of personal injury and property damage liability insurance policies in which legal defense costs were permitted to reduce the stated limits of liability when such legal defense costs were incident to a claim of legal liability covered under the policy. Further, the department had also approved certain policies that permitted legal defense costs to be applied against the deductible.
(b) Other than those limited circumstances, personal injury and property damage liability insurance policies generally provided that legal defense costs incident to a claim of legal liability and incurred in defending a claim of legal liability under the policy were covered by the policy independent of the stated limits of liability. Those policies placed no limit on defense costs and the stated limits of liability were used solely to pay the amount of damages, up to those liability limits, as ultimately determined by judgement or settlement. In such policies, any deductible was also applied only against the amount of a judgement or settlement.
(c) This Part was originally promulgated to provide rules restricting the lines of business wherein legal defense costs could be offset against the liability limits or against the deductible, and to provide for adequate disclosure to the insured in such cases. At that time, the department was advised by insurers that legal defense costs for directors and officers liability and media, publishing and advertising liability, where reputational interests are of significant concern to the insured, were relatively high compared with actual loss payments. With the legal defense costs offset, insurers can more easily estimate their maximum potential losses, provide such specialized coverages, and determine appropriate rates for such coverages.
(d) Subsequent amendments to this Part arose out of this department's concern with the proliferation of liability policies containing legal defense cost offset provisions for other types of risks. While these policies contained the required notification to insureds the department was concerned with the escalating use of these legal defense cost offset provisions, for the following reasons:
 (1) Widespread usage of legal defense cost offset provisions represents a substantial change in traditional insurance coverage, whereby the insurer generally has a duty to defend any liability suit covered under the policy in which damages are sought. This duty to defend typically has been separate and apart from the obligation to pay damages under the policy and, accordingly, an insurer must provide a proper defense regardless of cost. The duty to defend is broader than the duty to pay and extends to any action, even if groundless, false or fraudulent, in which facts are alleged within the coverage of the policy.
 (2) In the majority of the policies containing legal defense cost offset provisions filed with the department, insureds are offered neither the option of selecting the defense attorney nor the right to consent to any settlement. Insureds are unable to control how legal defense costs were spent, despite the insured's potentially large financial risk in view of the possibility that legal defense costs may have approached, or even exceeded, the stated liability limits. In such instances, the insured would become responsible for legal defense costs, as well as for damages on the liability claim itself, that exceed policy limits. As respects the deductible, depending on its size, a significant portion of initial legal defense costs could have become the insured's responsibility.
(e) The superintendent concluded that the public interest demanded that legal defense cost offsets against liability limits or deductibles be permitted only with respect to such lines, sublines, classes or subclassed where:
 (1) legal defense costs represented a significant portion for monies paid out by insurers;
 (2) the need to incorporate legal defense costs within liability limits could be demonstrated; and
 (3) such offset provisions were approved by the superintendent.
(f) In amending this Part, the superintendent considered such factors as:
 (1) industry-wide experience detailing legal defense costs expended in proportion to actual loss payments;
 (2) availability and type of coverage;
 (3) ability to establish appropriate rates for the coverage;
 (4) rate impact of the offset;
 (5) degree to which reputational interests of the insured are at stake; and
 (6) level of sophistication of the insured.
(g) These amendments set forth limitations on the type of risk or coverage for which legal defense costs would be permitted to be offset against liability limits or policy deductibles, as well as the dimensions of any such offset, and specified minimum liability limits for any policy containing these offsets.
(h) Large insureds, as evidenced by their financial size or the level of insurance coverage obtained, tend to be more knowledgeable insurance consumers than smaller, usually less sophisticated insureds and, therefore, are more typically in a better position to protect themselves or to negotiate protections for themselves from their insurers. Given their larger size and greater sophistication, these insureds should be more able to respond to claims out of their own resources if their insurance coverage is depelted by defense cost offsets. In turn, insurers warrant more flexibility in tailoring their policies to the individual needs of larger, more sophisticated insureds in order to provide coverage to them efficiently and effectively. In recognition of these factors, amendments to this Part exempt policies issued to large insureds from a number of the requirements of this Part, thus permitting defense cost offsets in liability policies in the event that the insured exceeds specified size criteria set forth in section 71.3(e) of this Part.
 (i)(1) Federal Environmental Protection Agency (EPA) financial responsibility requirements, for owners and operators of underground storage tanks (USTs), took effect in April 1991 for those with 13-to-99 USTs, and are scheduled to take effect December 31, 1993 for those with less than 13 USTs. Under these Federal UST requirements, insurance policy limits must be fully available for first-party clean-up as well as third-party liability, and cannot be reduced by defense costs. Given the potential for high defense costs, however, insurers have been unable or unwilling to provide pollution liability policies unless defense costs are somehow limited.
 (2) In order to encourage the availability of insurance within these Federal mandates, while at the same time allowing a finite limit on insurers' defense obligations, this Part authorized policies containing defense limits separate from liability limits, subject to the standards set forth in section 71.4 of this Part, for environmental impairment and pollution liability policies issued to UST owners or operators in order to meet EPA financial responsibility requirements.
(j) Marketplace developments since this Part was originally adopted have resulted in the widespread use of policies with defense costs offset against the limits of liability and the increase in knowledge and sophistication of insureds and insurance agents and brokers with respect to this type of policy. Accordingly, this Part is amended to add employment practices liability to the list of coverages that may be written on a defense within limits basis; lower the financial threshold requirements for large commercial insureds; and allow for alternative disclosure statement requirements.

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Section 71.1 Definitions.

For purposes of this Part, the following definitions shall apply:
(a) Legal defense costs means allocated attorney and all other litigation expenses that can be separately identified as arising from the defense of a specific claim.
(b) Liability insurance policy means any insurance policy covering liability, even if it also contains other types of coverage.
(c) Issue shall include issue for delivery.
(d) Commercial risk insurance means insurance as defined in section 107(a)(47) of the Insurance Law.
(e) Public entity has the meaning contained in section 107(a)(51) of the Insurance Law.
(f) Not-for-profit organization means a corporation, association, organization or trust described in section 501(c)(3) of the United States Internal Revenue Code.
(g) Large commercial insured means a commercial risk policy insured that:
 (1) has a net worth of at least $7,500,000, as determined by an independent certified public accountant, as of the insured's fiscal year end immediately preceding the policy's effective date;
 (2) has gross assets exceeding $25,000,000 and a net worth of at least $1,500,000, as determined by an independent certified public accountant, as of the insured's fiscal year end immediately preceding the policy's effective date;
 (3) is a for-profit business entity that generates annual gross revenues exceeding $25,000,000, and has a net worth of at least $1,500,000, as determined by an independent certified public accountant, as of the insured's fiscal year end immediately preceding the policy's effective date;
 (4) is a for-profit business entity that has gross assets exceeding $25,000,000 and generates annual gross revenues exceeding $25,000,000, as determined by an independent certified public accountant, as of the insured's fiscal year end immediately preceding the policy's effective date; or
 (5) is a not-for-profit organization or public entity with an annual budget exceeding $25,000,000 for each of its three fiscal years immediately preceding the policy's effective date.

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Section 71.2 General prohibition.

(a) No liability insurance policy, except as specified in this Part, shall be issued or renewed in this State containing a provision that:
 (1) reduces the limits of liability stated in the policy by legal defense costs;
 (2) permits legal defense costs to be applied against the deductible, if any; or
 (3) otherwise limits the availability of coverage for legal defense costs.
(b) Notwithstanding any other provisions of this Part, no liability insurance policy shall be issued or renewed in this State if it contains the limitations specified in subdivision (a) of this section for:
 (1) motor vehicle liability;
 (2) medical malpractice liability, except hospital medical malpractice liability as otherwise permitted by this Part; or
 (3) any liability risk or coverage subject to section 3425 of the Insurance Law.
(c) No liability insurance policy shall be issued or renewed in this State unless legal defense costs are incident to a claim of legal liability covered under the policy.

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Section 71.3 Exceptions to general prohibition.

(a) A liability insurance policy which contains a provision that reduces the limits of liability stated in the policy by the costs of legal defense, may be issued or renewed in this State only for the types of risks or coverages, and minimum limits, specified in subdivision
(d) of this section. Unless the policy provides the insured with control of the defense, as specified in subdivision (c) of this section, legal defense  costs charged against the stated limits of liability shall not exceed 50 percent of such limits and, except for the offset against the deductible authorized by subdivision (b) of this section, the insurer shall assume any legal defense costs over the amount or percentage specified in the policy.
(b) A liability insurance policy which contains a provision permitting legal defense costs to be applied against the deductible may be issued or renewed in this State only for the types of risks or coverages, and minimum limits, specified in subdivision (d) of this section. Unless the policy provides the insured with control of the defense, as specified in subdivision (c) of this section, the legal defense costs assumed by or charged to the insured shall not exceed 50 percent of such deductible and, except for the offset against the policy limits authorized by subdivision (a) of this section, the insurer shall assume any legal defense costs over the amount or percentage specified in the policy in regard to such deductible.
(c) The percentage limitation specified in subdivisions (a) and (b) of this section may be omitted if the policy provides that the insured shall have the option to:
 (1) select the defense attorney or to consent to the insurer's choice of defense attorney, which consent shall not be unreasonably withheld;
 (2) participate in, and assist in the direction of, the defense of any claim; and
 (3) consent to a settlement, which consent shall not be unreasonably withheld.
(d) A legal defense cost offset provision as specified in subdivision (a) or (b) of this section may be included in a liability policy only for the following types of risks or coverages, and only where the per occurrence liability limits for all liability risks and coverages under the policy are at least:
 (1) $100,000
  (i) employee benefit liability;
  (ii) fiduciary liability; and
  (iii) employment practices liability.
 (2) $500,000:
  (i) environmental impairment and pollution liability;
  (ii) directors and officers liability;
  (iii) media, publishing and advertising liability;
  (iv) architects and engineers liability;
  (v) errors and omissions liability; and
  (vi) professional liability, other than medical malpractice liability.
 (3) $1 million: hospital medical malpractice liability, for renewals only, if the expiring policy contained approved legal defense cost offset provisions.
(e)(1) A liability insurance policy containing a provision that reduces the limits of liability stated in the policy by the costs of legal defense, or permits offsets against the deductible by the costs of legal defense, and which meets the requirements of paragraph (2) of this subdivision, may be issued or renewed in this State if the policy:
  (i) insures a large commercial insured;
  (ii) provides primary coverage of at least $5,000,000 per occurrence;
  (iii) provides umbrella or excess coverage of at least $1,000,000 per occurrence, where the underlying limits are at least $2,000,000 per occurrence; or
  (iv) is written with a deductible, or over a self-insured retention, of at least $100,000 per occurrence.
 (2) Any policy issued or renewed pursuant to this subdivision must comply with all the provisions of this Part except:
   (i) subdivisions (a), (b), (c) and (d) of this section; and
   (ii) subdivisions (b)(1)-(3), (c) and (d) of section 71.5 of this Part.
(f) Legal services insurance that is a part of a policy of liability insurance that contains a provision reducing the limits of liability by the costs of legal defense, in accordance with the provisions of this Part, may reduce the per claim or aggregate liability limits of the liability policy if the policy limits are not reduced by greater than 25 percent.

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