The United States Court of Appeals for the Fifth Circuit, applying Mississippi law, has held that policies providing that defense costs erode policy limits are enforceable as written and do not offend public policy.  Federal Ins. Co. v. Singing River Health Sys., 2017 WL 816235 (5th Cir. Mar. 1, 2017).  The court further held that the policy’s Employee Benefits Law Exclusion barred coverage for a broad set of claims including those based on the federal and state constitutions and statutes.

The insured health system purchased a health care portfolio policy containing both an executive and employee liability coverage part and a fiduciary liability coverage part.  The policy provided that “loss will be reduced, and may be exhausted by defense costs unless otherwise specified.”  The policy’s employment practices liability coverage part also contained an Employee Benefits Law Exclusion barring coverage for any claim “for any actual or alleged violation of the responsibilities, obligations or duties imposed by any federal, state, or local statutory law or common law . . . that governs any employee benefit arrangement program.”

A number of underlying lawsuits were brought against the insured alleging that it underfunded its retirement plan and trust.  The suits alleged beaches of contract and fiduciary duty, as well as violations of the Mississippi and United States constitutions and 42 U.S.C. § 1983.  The insurer defended the insured under a reservation of rights.  The insurer then filed an action seeking a declaration that defense costs were included in the limit of liability and that no coverage existed under the EPL coverage part due to the Employee Benefits Law Exclusion.  The insured counterclaimed and sought continued payment of defense costs without regard to policy limits.  The parties cross-moved for summary judgment, and the trial judge granted the insurer’s motion in part and denied the insured’s motion in full.  Both parties appealed.

On appeal, the Fifth Circuit recognized that defense costs erode the limit of liability under the plain language of the policy.  The court noted that the policy stated in multiple places that defense costs erode policy limits.  The insured argued that the term “defense costs” was defined in reference to “loss,” which only included amounts the insured became “legally obligated to pay.”  Accordingly, the insured argued, amounts advanced by the insurer cannot be defense costs because the insurer rather than the insured is obligated to pay them.  The Court rejected this argument, opining that the only reasonable interpretation of this language is that it encompasses defense costs that, but for the insurance policy, would be the insured’s legal obligation.

The court further held that the Employee Benefit Law Exclusion barred coverage for claims not only under ERISA and related laws but also based on federal and state constitutions and statutes, including § 1983 claims.  The court noted that the language of the exclusion is “broad.”  The panel found that the term “govern” means laws that create obligations with which employee benefits plans must comply.  The exclusion could not be limited to laws solely governing employee benefit plans because the provision stated it includes but is not limited to laws like ERISA and COBRA.  Because the federal and state constitutions and the federal civil rights statute create obligations with which every employee benefit plan must comply, claims alleging that the plan violated those obligations fell within the scope of the exclusion.