The Third Circuit’s decision in Wolfe v. Allstate Property & Casualty Company, No. 12-4450 (3d Cir. June 12, 2015) addresses a very interesting and important coverage issue and one where the existing law, nationally, is sparse. This confluence of factors leads me to conclude that the decision will find a place in my annual end of year Insurance-Palooza.

The decision in Wolfe addresses two important issues associated with a bad faith failure to settle claim. First, some background.

Karl Zierle rear-ended Jared Wolfe. Zierle’s blood alcohol level tested at 0.25%. Zierle had three prior DUIs. Wolfe required treatment at the emergency room. Zierle was insured by Allstate and his policy had a $50,000 limit. The policy expressly excluded coverage for punitive damages.

For ease (mine that is), I’ll provide the remaining background facts verbatim from the opinion:

“Wolfe made an initial settlement demand to Allstate of $25,000, based on medical records provided to Allstate’s adjuster. Allstate valued Wolfe's claim at $1,200 to $1,400, and Allstate responded with a counteroffer of $1,200. Wolfe rejected this offer, and neither party moved from those numbers. Wolfe then filed suit against Zierle. . . . During discovery, Wolfe learned of the extent of Zierle’s intoxication and amended the complaint to add a claim for punitive damages. Allstate wrote to Zierle about the potential for punitive damages and reminded him that those damages were not covered under his policy. Allstate advised Zierle that if a verdict was rendered against him on the punitive damages claim, Allstate would not pay that portion of the verdict, and he would be held responsible for it.

Prior to trial, Wolfe reiterated the $25,000 demand and emphasized that Allstate’s $1,200 offer was too low. Allstate stated that it would not increase its $1,200 offer (despite having authority to offer $1,400) unless Wolfe reduced his $25,000 demand. No further efforts at settlement were made by either party. The case went to trial, and the jury awarded Wolfe $15,000 in compensatory damages and $50,000 in punitive damages. Allstate paid the $15,000 compensatory damages award, but not the $50,000 punitive damages award. Following the trial, in return for Wolfe’s agreement not to enforce the punitive damages judgment against him personally, Zierle assigned his rights against Allstate to Wolfe.”

Wolfe, in Zierle’s clothing, sued Allstate in the Pennsylvania Court of Common Pleas, alleging, among other things, breach of contract and bad faith conduct under Pennsylvania’s bad faith statute.

So far this is nothing more than the general description of a typical bad faith failure to settle case. But here’s where it gets interesting. Under the breach of contract claim, Wolfe sought to recover the $50,000 in punitive damages awarded against Zierle. This gave rise to two issues before the Third Circuit Court of Appeals: (1) Could Wolfe introduce the punitive damages award from the underlying suit as evidence of his damages?; and (2) Did Allstate have a duty to factor in the potential for punitive damages when considering its obligation to settle within limits?

On the first question, the court held that Wolfe could not recover the punitive damages as part of his damages in a bad faith failure to settle case. The issue is not a pure form of the question whether punitive damages are insurable, but the answer was tied to that. The court noted “Pennsylvania’s longstanding rule that a claim for punitive damages against a tortfeasor who is personally guilty of outrageous and wanton misconduct is excluded from insurance coverage as a matter of law.” Thus, “[b]ecause Pennsylvania law prohibits insurers from providing coverage for punitive damages in order to ensure that tortfeasors are directly punished, we hold that Allstate cannot be responsible for punitive damages incurred in the underlying lawsuit. To hold otherwise would shift the burden of the punitive damages to the insurer, in clear contradiction of Pennsylvania public policy.”

The court also noted that California, Colorado and New York have similar prohibitions on the indemnification of punitive damages. “[T]hose states highest courts have similarly held that an insured cannot shift to the insurance company its responsibility for the punitive damages in a later case alleging a bad faith failure to settle by the insurer.”

In essence, the court is saying that if an insurer is not liable for punitive damages directly to its insured, then it is also not liable for them in an indirect manner.

While the court’s discussion of the second issue was very brief, it is, in my view, the more important of the two. Here’s the whole kit and kaboodle: “It follows from our reasoning that an insurer has no duty to consider the potential for the jury to return a verdict for punitive damages when it is negotiating a settlement of the case. To impose that duty would be tantamount to making the insurer responsible for those damages, which, as we have discussed, is against public policy. See Zieman Mfg. Co. v. St. Paul Fire & Marine Ins. Co., 724 F.2d 1343, 1346 (9th Cir.1983) (affirming the conclusion by the district court that ‘[t]he proposition that an insurer must settle, at any figure demanded within the policy limits, an action in which punitive damages are sought is nothing short of absurd. The practical effect of such a rule would be to pass on to the insurer the burden of punitive damages in clear violation of California statutes and public policy’); see also Wardrip v. Hart, 28 F.Supp.2d 1213, 1215–16 (D.Kan.1998) (same).”

Punitive damages are alleged much more frequently than they are actually awarded. That being so, the fact that punitive damages – in a state where they are fundamentally uninsurable -- are not an appropriate form of damages, in a bad faith failure to settle claim, is not likely to have a lot of applicability. Certainly some, yes, but not as much as the second issue.

When considering whether an insurer is obligated to settle a case, based on the possibility of a verdict in excess of limits, it may be the potential for the punitive damages that has a lot to do with pushing the case into that category – especially one that is relatively small or has fixed damages that do not exceed the policy limit. By taking away insurers’ obligation to consider punitive damages, when assessing whether a verdict can potentially exceed policy limits, the Wolfe court has given insurers justification for taking cases to trial, and then avoiding liability for a verdict in excess of limits, if that’s how it turns out.