Nevada burning limits: The end of defense within policy limits

As of October 1, 2023, liability insurers admitted in Nevada may no longer issue or renew any liability policy where policy limits are eroded by defense costs, legal costs and fees and other expenses for claims. Professional and management liability insurers in Nevada should take notice.

On June 3, 2023, Nevada adopted law Assembly Bill 398 (the “Act”). It modifies the Nevada insurance code by prohibiting insurers from issuing or renewing a liability policy that erodes the policy limits of liability by the costs of defense and that otherwise limits the availability of coverage for the costs of defense.

Overall, the types of policies expected to be impacted include Directors’ and Officers’ liability insurance, Errors and Omissions and other professional liability policies, cyber liability, employment practices liability, pollution and environmental impairment, fiduciary, products and clinical trial liability, excess and umbrella liability policies. Traditional defense outside of policy limits products like commercial general liability or auto policies remain untouched by the Act.

In light of market players’ concerns due to the potential of runaway carriers and increased premiums, Nevada issued on July 21, 2023 an emergency regulation attempting to clarify the scope of the Act (“Emergency Regulation”). The Emergency Regulation however expires on November 21, 2023. The Nevada Insurance Department has indicated that it will be working to develop permanent regulations. In a nutshell, it states that the Act applies to liability policies issued by “authorized insurers” as well as non-risk retention group captive insurers. This implies that the Act does not apply to: (i) non-admitted insurers (excess and surplus); (ii) risk-retention groups; (iii) captives that do not cover liability and (iv) surety and fidelity bonds unless the bond includes defense in the surety contract. The Emergency Regulation also cryptically indicates that policies subject to the Act, must make defense coverage available “at the defense coverage limit selected by the insured, if any” and which can be $0.

In separate Act Guidance, the Nevada Division of Insurance explained that “the law does not require unlimited defense costs” but a “separate” limit for defense costs may be selected by the insured. In practice, this means that insurers may provide for a separate limit of defense costs, including a limit of $0, provided that limits dedicated to indemnity shall not be eroded by defense costs. The Guidance also clarified that insurers may include self-insured retentions or deductibles before defense costs coverage is triggered. 

The Guidance also explained that when underwriting liability excess layers, first excess insurers may issue follow form excess policies up to a secondary defense costs limit, third excess insurers may also include a third defense costs limit and so on, provided that none of those defense costs limits have any impact on the limits available for indemnity coverage.

One solution for carriers willing to continue insuring risks in Nevada without having to be constrained to cover defense within limits is to underwrite new business on surplus lines paper. Others may choose to leave Nevada as the prohibition of defense within limits coverage increases less predictable costs exposure. Others may opt to increase premiums, increase retentions, use coinsurance and/or sell independent low defense costs limits to keep affordability and control risks and exposures.

The Act will also likely affect litigation strategies, settlement negotiations, and judgment recoveries. Only time will tell if the Act encourages or discourages prompt claims settlements. If insurers in Nevada opt to offer lower defense limits, time will be ticking fast for claimants to settle as insured-funded defense money is eroded (while preserving limits for settlement and judgments) but once the defense limit is exhausted, and if there is no excess coverage, it will be the insured which will have to bear the burden of defense from such point onwards until the claim is fully resolved. On the other hand, defense counsel may have more room to put forward more aggressive defense strategies and prolong claim resolution and eventually reduce indemnity exposure.

Only two other states in the country have enacted similar legislation, but none had been as bold. In 2021, Louisiana prohibited 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). However, Louisiana carved out a long list of policies from the requirement, such as professional liability, D&O, EPL, Cyber and E&O. New Mexico also has legislation prohibiting defense inside the limits, see N.M. Code R. § 13.11.2.8, but such prohibition does not apply either to a long list of coverage lines with limits of liability over $500,000 (including D&O, E&O, professional liability, and EPL) and does not apply to any policy over $5 million, except for motor vehicle liability and medical malpractice. See N.M. Code R. § 13.11.2.9.

It remains to be seen whether insurers with interests in Nevada have any appetite for unlimited defense expense exposure, particularly in the already litigious professional and management liability insurance field.