Claims under Professional Liability Insurance policies and Management Liability Insurance polices are often complex and notoriously expensive to defend. As a result, these policies are usually written on a “defense inside the limits” basis, meaning that the payment of defense expenses reduces the remaining limit of liability. Certain other lines of insurance, such as, for example, general commercial liability insurance, are often written on a “defense outside the limits” basis, meaning that the defense costs are paid by the insurer and do not erode the limit of liability.
In an interesting development, the Nevada legislature has passed, and the Nevada governor has approved, a Bill that prohibits insurers from issuing policies containing a provision that reduces the limit of liability by the costs of defense. I suspect that many in the liability insurance industry are unaware of this legislation prohibiting defense- inside-the-limits liability insurance. I also suspect that, for reasons discussed below, the new legislation will generate disruption in the professional liability and management liability insurance market in Nevada when it goes into effect on October 1, 2023.
Nevada Assembly Bill No. 398, the text of which can be found here, provides as follows:
Section 1. Chapter 679A of [the Nevada Revised Statutes] is hereby amended by adding thereto a new section to read as follows:
Notwithstanding any other provision of law, an insurer, including, without limitation, an insurer listed in NRS 679A.160, shall not issue or renew a policy of liability insurance that contains a provision that:
1. Reduces the limit of liability stated in the policy by the costs of defense, legal costs and fees and other expenses for claims; or
2. Otherwise limits the availability of coverage for the costs of defense, legal costs and fees and other expenses for claims.
Section 2. The provisions of this act do not apply to any contract for liability insurance existing on October 1, 2023, but apply to any renewal of such a contract.
According to the Nevada Legislatures’ website (here), the Bill passed both of the Houses of the Nevada Legislature. Nevada’s Governor approved the Bill on June 3, 2023. The Bill is effective October 1, 2023. The legislation appears to have been passed without public comment.
I am aware of only one other jurisdiction that has statutes requiring liability insurers to provide defense outside the limits. Section 2503 of the Civil Code of Quebec provides, among other things, that “Legal costs and expenses resulting from actions against the insured, including those of the defence, and interest on the proceeds of the insurance are borne by the insurer over and above the proceeds of the insurance.”
It does not appear that, in adopting its new statute, the Nevada legislature considered the experience in Quebec.
As noted in a recent WTW memo about the Quebec statutes, difficulties in application and implementation of the provincial statute caused confusion and complications. After a high-profile, complicated settlement highlighted the problems the statute caused, Quebec companies found themselves in a “hard” insurance market; Quebec-based companies found it hard to afford, or even to find, liability insurance. According to the memo, “In some situations, Quebec-domiciled companies chose to re-domicile outside of Quebec in an attempt to obtain, and afford, insurance.”
The liability insurance problems in Quebec reached the point that both Quebec-based companies and insurers lobbied the provincial legislature to amend the requirements. The legislature amended the relevant statutory provisions to provide that “The Government may, by regulation, determine categories of insurance contracts that may depart from those rules and from the rule set out in [the statute], as well as classes of insureds that may be covered by such contracts. The Government may also prescribe any standard applicable to those contracts.”
As the WTW memo details, the implementing regulations provide exceptions for a number of categories of insureds, including a “large business” as defined in the regulations, as well as a director, officer, or trustee of any of the regulatorily specified businesses. While the amended provisions and regulations are still new and the overall effect remains to be seen, at least according to the memo, “everyone can agree that this is a welcomed change for insureds and insurers with exposure in the province.”
In other words, the Quebec experiment with requiring defense outside the limits was not a success. As anyone might expect, insurers generally – and not unreasonably – were not interested in taking on what would in effect be an unlimited defense cost exposure for claims that are notoriously expensive to defend.
Of course, the Nevada statutes have only just gone into law and are not yet even effective. It remains to be seen whether Nevada’s experience will be any different from that of Quebec. My crystal ball is no better than anyone else’s; however, I don’t think I am going out on a limb here by predicting that insurers considering Nevada-based risks will be no more interested in taking on unlimited defense expense exposure than they were in Quebec.
Assuming for the sake of discussion that there will be any liability insurers willing to sell liability insurance policies to Nevada-based insureds, it seems highly likely that the amount Nevada-based insureds pay for liability insurance is about to escalate, perhaps significantly. I can also imagine insurers trying a variety of structures – such as increased retentions, coinsurance, or requiring that the insurance be written on a “duty to defend” basis – to try to minimize their risks and exposures.
That isn’t all, either. There is a particular bit of mischief smuggled into the seemingly innocuous part 2 of Section 1 of the statute; the section prohibits insurers from issuing a policy containing a provision that “otherwise limits the availability of coverage for the costs of defense, legal costs and fees and other expenses for claims.” What does this section even mean? Does it mean that insurers can’t have exclusions that preclude coverage for defense expenses for non-covered claims? Does it mean the insurers can’t rely, for example, on the late provision of notice, or the failure to cooperate, to limit their defense?
All I know is that Nevada insureds are about to experience a real-world experiment in the dynamics of the liability insurance marketplace. If what happened in Quebec is any guide, I suspect the Nevada insureds are really going to hate what comes next.
UPDATE: An alert readers has pointed out to me that in 2021, Louisiana also adopted legislation prohibiting insurers from issuing insurance policies in which the payment of defense expenses would reduce a liability insurance policy’s remaining limits of liability. See La. R.S. 22:1272(B)(3) (here). However, the Louisiana statute, by important and key contrast to the Nevada statute, expressly allows the state’s insurance commissioner to carve-out a long list of coverages from the statutory requirement, including most significantly professional liability (except for medical malpractice), D&O liability, EPL. Cyber, and E&O liability.
FURTHER UPDATE: Another loyal reader pointed to me that New Mexico has also adopted legislation prohibiting defense inside the limits, See N.M. Code R. § 184.108.40.206 (here), but the New Mexico statute is subject to a further statutory provision specifying that the statutory prohibition does not apply to a long list of coverage lines with limits of liability over $500,000 (including D&O, E&O, professional liability, and EPL), and further specifying that the prohibition does not apply to any policy over $5 million, except with respect to motor vehicle liability and medical malpractice. See N.M. Code R. § 220.127.116.11 (here).
Special thanks to a loyal reader for sending me a copy of the Nevada Bill.