It is well-settled that an insurer has an obligation to accept a good-faith settlement offer within its policy limits.  See Grand Sheet Metal Products Co. v. Protection Mut. Ins. Co., 34 Conn. Sup. 26 (Conn.Super. Feb. 24, 1977) citing, Hoyt v. Factory Mut. Liability Ins. Co. of America, 120 Conn. 156 (1935).   However, what is the insurer's duty to settle within its policy limits when it has undertaken the insured's defense under a reservation of rights and the case contains claims for punitive damages?  Unfortunately, no discernable Connecticut authority exists on this point.  Accordingly, a close examination of the facts specific to the case is necessary when faced with such a situation.

In general, an insurer is only liable for breach of contract or for bad faith if its rejection of the settlement offer was unreasonable.  See Pascale v. Great American Ins. Co., 2004  U.S. Dist. LEXIS 9187, at *1 (D.Conn. May 20, 2004); citing Bartlett v. Travelers' Ins. Co., 117 Conn 147, 155 (1933); Hoyt, 120 Conn. at 159.  This determination cannot "fairly be judged by hindsight; rather, the offer and the strength of the case against the insured must be viewed as they fairly appeared to the insurer and the attorneys retained to defend the insured at the time the offer was refused."  16 Williston on Contracts §49:105 (4th ed.). 

Although no Connecticut case law directly reflects this proposition, extra-jurisdictional case law does support the position that there is no duty to settle within policy limits where an insurer asserts a good faith coverage defense, and defends under a reservation of rights.   See Holland, Cecil, The Duty to Defend; the Duty to Settle; Selection of Counsel; the Reservation of Rights; the Effect of Conflicts of Interest: the View From New York, 380 PLI/Comm 193, 210-11 (1986) ("Holland Article"). 

In Seren Innovations, Inc. v. Transcontinental Ins. Co., 2006 Minn. App. Unpub. LEXIS 535 (Minn. App. Ct. 1986), the plaintiff alleged that the defendant-insurer breached its duty to defend or indemnify it by failing to settle the punitive damages claims.  The court held that the insurer had no such duty.  In so holding, the court stated that claims for punitive damages were not covered by the policies and that, under Minnesota law, the duty to defend was not extended such that an insurer had a duty to settle all claims within the policy limits regardless of whether the policy provides for coverage for a particular claim.  Id.  "Such an argument implies that the policy coverage amount controls a determination of good faith rather than the policy language itself."  Id.  Since the insurer properly advised the plaintiff that the underlying lawsuit sought punitive damages and advised the plaintiff that there was no coverage for such claims, the court held that the insurer did not breach its duty to defend the plaintiff by failing to settle all claims within the policy limits.  Id.

In Lira v. Shelter Ins. Co., 903 P.2d 1147 (Colo. App. Ct. 1994), the plaintiff sued his insurer after an underlying personal injury verdict against him in excess of the policy limits.  The insurer argued that it could not be held liable for bad faith failure to settle within the policy limits where the only damages claimed were the outstanding punitive damages.  The court agreed.  In so holding, the court noted that only New York Courts, the 9th Circuit and the 10th Circuit had addressed whether a bad faith claim can be based solely on an underlying verdict for punitive damages.  Those courts all held that insurance coverage for punitive damages was against public policy and that this same public policy also precludes recovery for those punitive damages through a bad faith action against an insurer.  See Soto v. State Farm Insurance Co., 83 N.Y.2d 718 (1994); Hartford Accident & Indemnity Co. v. Village of Hempstead, 48 N.Y.2d 218 (1979); Zieman Manufacturing Co. v. St. Paul Fire & Marine Insurance Co., 724 F.2d 1343 (9th Cir. 1983); Magnum Foods, Inc. v. Continental Casualty Co., 36 F.3d 1491 (10th Cir. 1994).  For the same reasons cited by these courts, the Lira court entered judgment in the insurer's favor.  See also St. Paul Fire & Marine Ins. Co. v. Convalescent Services, Inc., 193 F.3d 340 (5th Cir. 1999) (holding that the duty to settle within the policy limits is not activated unless the claim against the insured falls within the scope of coverage provided by the policy; to hold otherwise, would "extend the actual coverage of the insurance contract.").

The aforementioned cases suggest that the reasonableness of, or "motives" behind an insurer's decision to refuse settlement, are judged at the time the decision is made; not in hindsight.  Although this issue remains unsettled in Connecticut, we anticipate that Connecticut courts would adopt similar reasonable limitations on the insurer's duty to settle within its policy limits when faced with potentially uncovered claims. 

1  In California, however, an insurer's dispute as to coverage has no bearing on the duty to settle, except to the extent that a determination of whether an insurer has breached its duty to settle or not cannot be made until the coverage issue has been fully resolved.  See, Holland Article, at 210-11.