In its May 22, 2012 decision, the California Court of Appeal in Health Net, Inc. v. RLI Ins. Co., ___ Cal.Rptr. 3d ___, 2012 WL 1850929 (Cal.App. 2 Dist.), held that a professional liability policy’s exclusion for any “Claim” “arising out of” an insured’s dishonest acts did not bar coverage for the entire underlying litigation, but rather, applied only to the specific claims involving the dishonest acts, even though the policy defined “Claim” to include “any judicial proceeding,” and the insured was found to have engaged in dishonest conduct.
Health Net, a health insurer, was sued for miscalculating the sums that it reimbursed its plan participants by: (i) using systematically flawed databases; (ii) intentionally using databases containing outdated cost data to reduce reimbursements; and (iii) making other improper adjustments, such as reducing reimbursements for mental health services, emergency room services and assistant surgeons. Health Net also allegedly violated its obligations under federal law governing employer-provided health plans by failing to fairly review claims for denied benefits and failing to inform participants of their rights under the plans.
In the litigation, a federal court found Health Net engaged in egregious discovery abuses, and as a sanction, deemed certain facts established against Health Net, including that it had knowingly and willfully used outdated data. Roughly fifteen months later, the lawsuits were settled.
Health Net sued four of its insurers – one primary and three excess – for defense and indemnity. The insurers asserted that their policies barred coverage for the underlying lawsuits because the discovery sanction order constituted a finding in fact of a dishonest act and that an exclusion for any “Claim” “arising out of” any dishonest act, error or omission of any Insured applied. The insurers asserted that since the policies defined “Claim” to include “any judicial proceeding,” the exclusion barred coverage for the entire litigation. While the trial court agreed, the Court of Appeal did not.
The Court observed that the basic scope of the policies’ coverage was for damages resulting from a “Claim” for a “Wrongful Act,” involving a breach of duty, neglect, error or omission that was committed in the insured’s Professional Services as a health insurer. Importantly, the Court decided that most of the claims in the underlying action did not fall within the scope of coverage.
The Court reasoned that the claims of unpaid health benefits were not covered because those sums were owed by Health Net under its contracts with plan participants, rather than as the result of a “Wrongful Act.” The Court noted that, “[e]ven in the absence of an express exclusion, courts have held that a claim alleging breach of contract is not covered under a professional liability policy because there is no ‘wrongful act’ and no ‘loss’ since the insured is simply being required to pay an amount it agreed to pay.” The Court added that “[t]he fact that the breach of the contractual obligation may itself have been negligent also does not render it a covered wrongful act.”
The Court also rejected Health Net’s contention that the request for attorneys’ fees in the underlying litigation was itself a covered “Claim” for “Damages,” regardless of whether the “Claim” supporting an award of fees was covered. The Court stated, “[i]f the entire action alleges no covered wrongful act under the policy, coverage cannot be bootstrapped based solely on a claim for attorney’s fees. Likewise, if a complaint alleges some covered wrongful acts and some acts which are not covered, the claim for attorney’s fees is covered only to the extent it arises out of the covered wrongful acts.” In addition, the Court noted that “attorney fees are inconsistent with the meaning of the word ‘Damages’ in the ordinary and popular sense” because they do not compensate a plaintiff for the injury that brought the plaintiff into court.
The Court also determined that the claims for injunctive relief and civil penalties were not covered. However, the Court decided that the claims that Health Net improperly adjusted reimbursements fell within the basic scope of the policies’ coverage.
As such, the Court examined whether the policies’ exclusion for any “Claim” “arising out of” dishonest acts applied, specifically, whether the exclusion applied to bar coverage for only those specific acts of dishonesty or to the entire lawsuit. The policies defined “Claim” to mean “any judicial  proceeding,” “any written notice from a third party that it is the intention of such third party to hold one or more Insureds responsible for Damages . . .” or “any written notice by a third party of a circumstance involving actual and/or alleged Wrongful Acts of an Insured . . .”
The Court stated that if “Claim” were interpreted to mean an entire lawsuit (as the insurers asserted and the trial court agreed), other portions of the policies show that interpretation to be unreasonable. For instance, another exclusion barred coverage for any “Claim” “seeking non-pecuniary relief.” The Court reasoned that the insurers’ proffered interpretation would mean that the exclusion would apply to an entire lawsuit if it contained a single claim for declaratory relief. Invoking the rule of policy interpretation that the same word used in an instrument is generally given the same meaning throughout unless the policy indicates otherwise, the Court concluded that “Claim” must mean “the relevant claims within the action,” not the entire action.
As so interpreted, the Court applied that construction of “Claim” to the dishonest acts exclusion. While Health Net was deemed to have engaged in intentional, dishonest conduct by using outdated data, the Court found that the allegations in the underlying litigation that Health Net used systematically flawed databases did not “arise out of” those dishonest acts, notwithstanding California courts’ broad interpretation of the “arising out of” phrase. Therefore, the Court held that the exclusion did not preclude coverage for all claims against Health Net (or related defense fees) or the entire litigation.
This decision exemplifies that courts construe exclusions very narrowly, even where they broadly apply to all claims “arising from” certain conduct. In cases where such an exclusion is a principal coverage issue, the safest course may be to provide a defense while seeking declaratory relief concerning the scope of the insurer’s rights.
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