What Is A "Reservation Of Rights" Letter?

A reservation of rights (“ROR”) letter is one of the most significant documents in coverage litigation, although it may never factor into the legal analysis of whether coverage is owed for a claim under an insurance policy.  Above all, it is an announcement by the insurance company that coverage for a claim is in question, and why, in the insurer’s mind, it is in question.  Here’s an explanation of how it comes up, how it functions, and what it may portend for an insured.

Before any coverage dispute arises, there is a real-life event that gives rise to a claim against the insured, and then, in most instances, a lawsuit filed against the insured.  At some point in this process, notice of the claim or the “circumstance” (a term used in some policies to mean an event that could be reasonably expected to give rise to a claim) reaches the insurer which evaluates the claim for coverage. If a claim is required to be covered under the insurance policy, the insurer has two basic responsibilities: provide a defense for the insured (hire a lawyer to defend the suit) and, in the event of a judgment, pay all damages it is required to cover by the policy.  Issues can crop up on the fringes of these issues, but generally speaking, these are the two generally recognized duties of an insurer when a claim triggers coverage under the policy.

There are no external rules (i.e., laws) for the mechanics of an insurer’s coverage evaluation.  A coverage determination may be made by an adjuster, or an adjuster may rely on a coverage opinion from outside coverage counsel.  The outcome of the coverage evaluation can go in one of three obvious ways: (1) the insurer concludes there is coverage; (2) the insurer concludes there is not coverage; or (3) the insurer concludes coverage is uncertain.  Unless the insurer concludes there is coverage, the table is set for a potential dispute over coverage (if the insurer concludes there is no coverage, that conclusion may or may not be correct).  Suffice it to say, coverge disputes are always raised by the insurer, and thus, the insured is in a reactive position (a sophisticated insured may perform its own coverage analysis, but usually claims are not submitted to insurers with coverage arguments).

Kentucky courts have spelled out what comes next where coverage is in question to one degree or another: the insurer can defend anyway, and preserve the right to challenge coverage later by issuing an ROR, or not defend and run the risk that coverage will be found later, in which case the insurer will be liable for all damages, including defense costs. Aetna Cas. & Sur. Co. v. Com., 179 S.W.3d 830 (Ky.2005).

The function of an ROR letter is to inform the insured that the insurer is going to tentatively cover the claim, but for the various reasons spelled out in the letter, it has questions about whether it is truly obligated to cover the claim. It will inform the insured that while it is covering the claim despite these doubts, it is reserving the right to cease covering the claim at a later time if the facts more clearly point to a lack of coverage.

Insureds should read ROR’s carefully because insurers may attempt to slip new terms into them. For example, the ROR may contain a provision that by the insured accepting the defense provided by the insurer, the insured is agreeing to reimburse the insurer for all defense costs paid if the insurer is ultimately found not to owe coverage obligations for the claim. That is an example of something that cannot be ignored or go without response.

Coverage litigation does not inevitably follow the issuance of an ROR.  Sometimes, an insurer issues an ROR merely to leave itself a potential exit route should it need one.  Under Kentucky law, failing to issue an ROR letter may result in the insurer being estopped from denying coverage after it has defended the claim for a prolonged period. Kentucky Farm Bur. Mut. Ins. Co. v. Brewer, 596 S.W.3d 620 (Ky.App.2020).

But certainly, where insurers feel strongly about their coverage position, and when substantial exposure is at stake, insurers commonly follow an ROR letter with an action for declaration of rights under the federal or state declaratory judgment act.  Insureds can also take this step following receipt of an ROR letter.  Whichever party initiates the action, the outcome of the proceeding will be a judicial determination of whether there is or is not coverage, which will finally settle the matter as between the parties and will serve as guidance in future coverage cases.