Defending under a policy with a wasting limit is rife with pitfalls for both the insurer and defense counsel.  Provisions that transform a policy into a “wasting limits policy” often appear in professional liability policies, drop-down coverage situations, and excess policies. Policies with such wasting limits provisions go by many names: wasting, eroding, burning, exhausting, self-consuming, self-reducing, self-liquidating, and cannibalizing, to name a few.  When a policy contains a wasting limits provision, the limits of the policy are reduced by defense costs and when the limit is exhausted, the duty to defend and indemnify is extinguished.  Such policies are also said to provide a defense “within limits.”  A wasting limit presents unique issues for insurers and defense counsel alike and failure to navigate these potential conflicts raises the risk of bad faith litigation down the line.  The following are a few issues to consider when defending wasting limits policies.

As with any policy, before relying on a wasting limits provision, it is important to determine whether it is enforceable.  See, e.g., Ill. Union Ins. Co. v. N. County Ob-Gyn Med. Group, Inc., No. 09cv2123, 2010 U.S. Dist. LEXIS 50095 (S.D. Cal. May 18, 2010) (ambiguity as to definition of “Costs, Charges, and Expenses” defeated insurer’s claim that its policy was wasting).  In Ill. Union Ins. Co., one of the many issues with the policy was that it provided for a duty to defend, but did not contain any limit on that duty.  Id. at *7.  Cf. Amerisure Mut. Ins. Co. v. Arch Specialty Ins. Co., 784 F.3d 270 (5th Cir. 2015) (holding that wasting limits endorsement was unambiguous and insurer did not “improperly exhaust” the limits by paying defense costs).

A wasting limits policy may complicate an insurer’s duty and ability to settle claims. See, e.g., Okada v. MGIC Indem. Corp., 823 F.2d 276, 283–84 (1986) (reversal of summary judgment against insurer that it acted in bad faith by not participating in settlement discussions because its wasting limits policy had been exhausted by defense costs).  An underlying issue that complicates settlement is the relationship of defense counsel to the insured.  Because insurance policies often allocate both the authority to settle and hire defense counsel to the insurer, this can create problems in the context of wasting limits policies.

For example, under a conventional policy, the insured may have little interest in keeping defense costs and attorney fees down, while under a wasting limits policy, the insured has a vested interest in having limits sufficient to cover damages.  This unique situation somewhat alters the general duty of insurers to settle within policy limits because the limit is constantly decreasing.  In the case of an actual excess judgment scenario, an insured will almost certainly scrutinize the insurer’s decision to continue to litigate because every dollar spent in defense costs by the insurer is another dollar that the insured will have to pay in excess of whatever limits are left at the end of a case.  If such a conflict is foreseeable, one way to prevent later disputes would be to openly communicate defense cost choices with the insured or even to completely relinquish the right to control defense costs.

Ultimately, open and frequent communications are essential in good faith handling of wasting limit policy cases.  A reservation of rights letter communicating the implications of the wasting limit is essential.  In fact, in at least one case, it appears that a lack of communication by the insurer worked to the insurer’s disfavor with the court.  See Ill. Union Ins. Co., supra at *17.  Frequent communication about settlement and the available limits are especially important in the context of wasting limits policies and may help in the event claims are made against the insurer after an excess judgment.