Market Advisory: Nevada AB 398/Defense Outside the Limit

August 2023 

On June 3, 2023, Nevada Assembly Bill (AB) 398 was signed into law and will be effective as of October 1, 2023. The law prohibits an insurer from issuing or renewing a liability policy that erodes the policy limits of liability by the costs of defense.

Uncertainty among Insurers, Insureds and brokers as to the application of Nevada AB 398 has led to the Nevada Commissioner of Insurance issuing Guidance. Highlights from the Guidance is as follows:

• The law applies to liability insurance issued by authorized (admitted) insurers and non-risk retention group captive insurers (RRGs) providing third-party liability insurance. (Thus, the law would not appear to include E&S policies.)
• AB 398 does not apply to RRGs and captive insurance that does not cover third-party liability.
• “Liability insurance” within the meaning of the statute is “insurance against legal liability for the death, injury, or disability of any human being or for damage to property, including liability resulting from negligence in rendering expert, fiduciary or professional services.”
• Defense outside the limit and defense coverage must be made available but are not unlimited. For liability policies, other than liability policies which do not limit defense cost coverage, a separate limit for defense costs may be selected by the insured, including a limit of $0.
• Any defense coverage limit selected, including $0, must be included on the declaration page.
• Liability coverage and or defense costs may be subject to self-insured retentions or a deductible.
• Towers of insurance must contain a separate limit for defense coverage for each policy on the tower. Each policy will have its own limit of defense coverage, which must be negotiated between the parties. Individual indemnity policies must have their own limit of liability that cannot be eroded by defense costs.
• Endorsements are part of the contract and must fully comply with AB 398.
• Cyber policies that include first- and third-party indemnity coverage may share the same limit of coverage. However, defense coverage may not erode the per occurrence coverage or annual aggregate limit of liability coverage, and legal defense coverage for third-party claims must be offered as a separate limit of liability.

Historical and Comparative Analysis

The bill was proposed as a committee bill [no identified individual sponsor(s)] on March 24, 2023, out of the Labor and Commerce Committee of the 82nd Nevada Legislature. It passed the Assembly by a vote of 29 to 11 with two abstentions and the Senate on May 26, 2023, by a 19 to 1 vote with one abstention.

The bill was presented by Justin Watkins, a former State Assemblyman who served one term from 2016-2018. Understanding there to be “grave concerns” with the new law, the Nevada Commissioner of Insurance acted quickly in submitting emergency regulations to clarify certain aspects of AB398. These emergency regulations expire November 21, 2023 and cannot be renewed or extended.*

Quebec Laws (Article 2500 and 2503)

• Original Article effective 1991; revised in April 2022, went into effect
• May 6, 2022.
• Article 2500 originally provided that “the proceeds of the insurance are applied exclusively to the payment of injured third persons.”
• Article 2503 legally bound insurers to assume the insured’s legal costs and expenses. The insurer must cover these costs “over and above the proceeds of the insurance.”
• The Quebec laws led to soaring premiums for insurance companies who decided to continue to do business in Quebec; a number of insurers withdrew from doing business in Quebec.
• The 2022 amendment to Article 2500 and 2503 changed the law so that it would apply to certain categories and classes of insureds who may subscribe to policies that depart from the dictates of Articles 2500 and 2503.
  • Among those classes and categories are “large businesses,” defined as businesses that have total taxable sales in a given fiscal year in excess of $10 million, i.e., large businesses and sophisticated insureds who have sufficient financial resources to pay for significant litigation.
  • Individuals and small- and medium-sized businesses are still subject to Articles 2500 and 2503.
• Directors and officers of certain businesses may also be exempted from Articles 2500 and 2503, except as members of a pension committee. Total coverage for those that may qualify for defense within limits policies must be at least $5 million.
• The government may by regulation determine categories of insurance contracts that may be covered by a “civil liability insurance contract.”
• Contracts containing defense outside the limit provisions can be for no more than one year and must qualify for a continuing allowance at the time of renewal.
• No other province in Canada imposes a similar burden on the insurance industry.

Louisiana

In 2021, Louisiana enacted La. R.S. 22:1272 providing defense within limits policies. In 2022, the statute was amended by 675 JBE 2022, making defense outside the limits less restrictive.

Under the original legislation, the prohibition applied without exception to four types of insurance: personal lines, medical malpractice, commercial vehicle, and commercial general liability. It excepted nine types of insurance from the prohibition:

1. All Professional Liability other than malpractice
2. Directors’ and Officers’ Liability
3. Errors and Omissions Liability
4. Pollution Liability
5. Employment Practices
6. Cyber Risk Liability
7. Information Security and Privacy Liability
8. Patent Defense or other intellectual property infringement liability
9. Commercial liability coverages “sold in combination”

The amended legislation maintains a general prohibition against defense cost-eroding policy limits, but with expanded exceptions and less authority for the Commissioner to restrict the defense cost-erosion of limits. Personal lines and medical malpractice coverage are the only liability insurance not entitled to a waiver under any circumstance. The statute applies only to “authorized” insurers, not to non-admitted or surplus lines carriers.

The permissive waiver provision requires the Commissioner to consider the customs of the industry and the interests of the insured. If there is a waiver of the eroding-limits prohibition, the insurer is no longer prohibited from exhausting policy limits by payment of defense expenses.

The law restricts defense expense erosion to “reasonable attorney fees and expenses directly connected to the insurer’s defense of a specific liability claim on behalf of an insured and any other litigation expenses directly arising from the defense of a specific liability claim.” It prohibits an insurer from  reducing policy limits with overhead costs and unallocated loss expenses incurred by the insurer in the ordinary course of business. An eroding-limits policy must include a separate notice or inclusion on the declarations page that defense expenses erode policy limits.

New Mexico

N.M. Code R 13.11.2.8 prohibits a liability policy issuing within the state if it:

A. reduce(s) the limits of liability in the policy by the amount of legal defense costs; or

B. permit(s) legal defense costs to be applied against the deductible, if any.

N.M. Code R. 13.11.2.9 provides that the prohibition shall not apply to aircraft liability policies, fidelity and surety policies, nuclear liability policies, marine protection and indemnity policies, or prepaid legal service plans, reinsurance policies, or self-insured retentions.

A legal defense offset provision otherwise prohibited in 13.11.2.8 NMAC may be included in a liability insurance policy only for the following types of risks or coverages, and only where liability limits for all liability risks and coverages under the policy are at least:

1. $500,000:

    a) pollution and environmental impairment liability

    b) directors and officers liability

    c) governmental entity liability

    d) employee benefit liability

    e) fiduciary liability

    f) media, publishing and advertising liability

    g) errors and omissions liability

    h) professional liability, other than medical malpractice liability

2. $5 million – any kind of commercial liability risk or coverage except:

    a) motor vehicle liability

    b) medical malpractice liability

Consequences

Uniformly, the carriers understand the Nevada Insurance Commissioner has confirmed the following three key conditions:

1. The regulatory change applies to liability casualty coverage, including financial lines.
2. The regulatory change does not apply to non-admitted issuance and E&S.
3. Placements may be canceled or rewritten subject to all other applicable statutes, for example, notice of cancellation (See NRS 687B.310, 687B.320, 687B.350), or extended, but the policies must be effective before October 1, 2023.

The Commissioner is in the process of responding to many more questions. A second Workshop will be hosted by the Commissioner of Insurance on August 31 with a Hearing scheduled for September 12.

Carrier responses vary, including:

1. We are providing a conditional renewal notice as a courtesy notice of prospective changes.
2. We are likely to accommodate requests for extension or cancel/ rewrite, but the action needs to be completed before October 1. We are taking each request on a case-by-case basis.
3. Given the notice requirements for cancellation, existing policies will be extended for up to 12 months and re-evaluated thereafter.
4. New business will be written on surplus lines paper.
5. Accommodation of an 18–24 month cancel rewrite is being considered on a case-by-case basis.
6. Renewals, re-writes, and new policies will be written on a non- admitted basis.
7. Undecided and under discussion.

 * The Nevada Independent. https://the nevadaindependent.com/article/Nevada-officials-rush-emergency-rule-change-amid-grave-concerns-with-new-insurance-law.