OPINION
BOOCHEVER, Justice.
This case arises out of a medical malpractice suit brought by Melba Guin, appellant, against Young H. Ha, M.D., appellee. The principal issue raised on appeal requires us to determine if an insurer is liable for prejudgment interest which, when added to liability damages, exceeds the limitation on liability under the applicable insurance contract. This narrow issue is one of first impression in Alaska. A subsidiary question involves the determination of the proper rate of interest under Alaska's general interest statute. We have concluded that the insurer is not liable for prejudgment interest in excess of policy limits, and we do not reach the subsidiary issue.
Dr. Young H. Ha performed surgery upon Melba Guin on or about July 8, 1974. In the course of the surgery, Dr. Ha accidentally severed the radial nerve in Guin's right arm, partially paralyzing her right hand. In June of 1975, Guin brought suit against Ha to recover damages for the injuries she sustained as a result of the operation. Dr. Ha's answer denied liability. After partial discovery and pretrial skirmishing, the parties entered into settlement negotiations and reached a tentative settlement
Dr. Ha carried three insurance policies protecting him against malpractice liability. The first layer of protection, issued by Manufacturers and Wholesalers Indemnity Exchange, provided $25,000.00 coverage. The second layer provided coverage between $25,000.00 and $100,000.00 and the third layer provided coverage above $100,000.00. The present appeal involves only the first layer of coverage. Manufacturers and Wholesalers Indemnity Exchange is represented by Alaska Guaranty Association (hereinafter "Alaska Guaranty" or "insurer").
Complications involving the second and third layer insurance carriers delayed final settlement, but an acceptable settlement agreement was ultimately concluded between Guin and Ha on July 13, 1977, some three years after the date of the operation. Under the terms of the agreement, Alaska Guaranty agreed to pay to Guin a total sum of $28,519.54, representing the limits of liability ($25,000.00), costs ($919.54), and attorney's fees ($2,600.00). In consideration of this sum, Guin released Ha and Alaska Guaranty of further liability for injuries arising out of the operation, expressly reserving, however, the issue as to the insurer's liability for prejudgment interest in excess of policy limits. The parties agreed to submit that issue to the superior court for declaratory judgment on stipulated facts.
On July 26, 1977, the parties filed with the superior court a stipulation of facts and request for declaratory relief. The stipulation recited the terms of the settlement and requested the court to resolve two points of contention between the parties, to wit: the insurer's liability for prejudgment interest and the rate of such interest, if the insurer was found liable.
Based upon the stipulated facts, memoranda submitted by the parties, and oral argument before Judge Gerald Van Hoomissen, the superior court denied Guin's motion for declaratory judgment and granted declaratory judgment in favor of Alaska Guaranty. Finding that prejudgment interest is an element of damages under Alaska law, the court concluded that the insurer was not obligated to pay such interest in excess of the policy's damage limits.
From this order denying her motion for declaratory judgment, appellant Guin appeals.
In this appeal, the central issue is whether the obligation to pay prejudgment interest exceeding policy limits should be shifted from an insured defendant, who is concededly liable for such interest, to an insurer with whom the defendant holds a policy.
Guin argues that since a tort defendant is liable for prejudgment interest, public policy requires that the defendant's insurance carrier should be liable for such interest, regardless of policy language, because the insurance company has the use and benefit of the money between the date of injury and the date of judgment.
On the other hand, Alaska Guaranty argues that the obligations owed by the insurance carrier to its insured are defined exclusively by the insurance contract. Relying on prior decisions of this court which have characterized prejudgment interest as damages, the insurer argues that it is not liable for such interest to the extent that it exceeds the limitation on damages contained in the policy.
We shall first examine the insurance contract to determine if it imposes upon the insurer an obligation to pay prejudgment interest in excess of policy limits. We shall then turn to an analysis of the public policy arguments advanced by Guin to determine if they require insurers to assume liability for prejudgment interest exceeding policy limits regardless of the terms of the insurance contract.
THE INSURANCE CONTRACT
Judicial tribunals are particularly sensitive to the rights of both the insured and third parties when disputes arise concerning the coverage afforded by insurance contracts. In the past, we have carefully avoided strict adherence to traditional contractual principles in insurance cases, preferring to adopt a more flexible approach when insurance policies are involved:
Stordahl v. Government Employees Insurance Co., 564 P.2d 63, 65-66 (Alaska 1977) (footnotes omitted). This approach, however, is not to be used as an instrument for ignoring or rewriting insurance contracts. An insurance policy is essentially contractual in nature. Thus, "the liability of an insurer and the extent of the loss under a policy of liability or indemnity insurance must be determined, measured, and limited by the terms of the contract." 15 G. Couch, Cyclopedia of Insurance Law § 56:1 (2d ed. 1966). Against the background of these principles, we turn to an examination of the insurance contract in this case.
The provisions of the insurance policy, insofar as they are relevant to the issue of prejudgment interest, provide:
Under paragraph 2, the insurer has agreed to pay "all sums which the Assured shall by law be held liable to pay for damages." Pursuant to paragraph 4, the damage liability clause is subject to an amount limitation of $25,000.00. Under paragraph 3, the insurer has agreed to defend the insured and to pay the "costs and expenses incurred in such defence." This supplemental payment clause is not subject to any amount limitation. Furthermore, under paragraph 4, costs and expenses are made payable by the insurer in addition to the otherwise applicable limit on damage liability. Finally, interest is nowhere mentioned in the contract of insurance.
Nothing in the supplemental payment clause can be construed as imposing upon the insurer the obligation to pay prejudgment interest. Alaska Guaranty's promise to pay all "expenses" incurred in the defense of the suit would extend to the expense of investigation, of hiring attorneys to defend the action, and the like. Prejudgment interest cannot reasonably be viewed as an expense of defense.
Alaska Guaranty's promise to pay all "costs" incurred in the defense of the suit would not, in common understanding, include prejudgment interest.
The heart of the present controversy involves the damage liability clause in which Alaska Guaranty has agreed to pay "all sums which the Assured shall by law be held liable to pay for damages" (emphasis added). Alaska Guaranty's liability under this clause is limited to $25,000.00. Guin demands interest on this amount for the three-year period prior to settlement. Alaska Guaranty argues that
The issue, therefore, is whether prejudgment interest is an item of "damages" within the damage liability clause. We believe that our prior decisions establish, in accordance with the great weight of authority, that prejudgment interest is an item of compensatory damages.
In State v. Phillips, 470 P.2d 266 (Alaska 1970), we construed Alaska's general interest statute, AS 45.45.010(a),
In Davis v. Chism, 513 P.2d 475, 481 (Alaska 1973), we clarified the reasoning in Phillips. In Davis, the defendant made an offer of judgment, pursuant to Alaska Civil Rule 68, which was refused by the plaintiff. The jury returned a verdict for $18,000.00, a sum less than the amount of the offer, to which the trial court added prejudgment interest in excess of $3,000.00. Id. at 480. The addition of prejudgment interest increased the plaintiff's recovery to an amount in excess of the offer of judgment. Alaska Civil Rule 68 imposed certain costs on the offeree "[i]f the judgment finally obtained by the offeree is not more favorable than the offer... ." Defendant argued that, in order to make the comparison, prejudgment interest should have been added to his offer of judgment. We rejected this argument, reasoning that prejudgment interest is in the nature of compensatory damages and, therefore, should be included in the amount offered for settlement in comparing the offer with the "judgment finally obtained." Specifically, we stated:
513 P.2d at 481. We concluded:
Id. at 482.
Appellant Guin asks this court to limit Davis's characterization of prejudgment interest to the specific context in which the case was decided, that is, Alaska Civil Rule 68 offers of judgment. This we decline to do. First, there is a complete lack of language in Davis indicating that it was intended to be so limited. More important, however, is Davis's reliance on Phillips and its explicit clarification of the reasoning in Phillips. Davis's classification of prejudgment interest rested in part upon the theory that such interest is necessary in order to make the plaintiff whole, for he has lost the use value of the damages eventually awarded. This economic maxim applies with as much force to the case at bar as it does to Civil Rule 68 offers of judgment. We adhere to our reasoning in Davis and reaffirm the principle that prejudgment interest is an item of compensatory damage. So classified, prejudgment interest falls within the liability damage clause in the insurance contract and is subject to the amount limitation contained therein. Thus, when an insurer pays on behalf of its insured the limits of liability coverage to an injured third party, it discharges its obligation under the insurance policy.
Classification of prejudgment interest as an item of damages clarifies, in other respects, the obligations the insurer owes to the insured. While the insurer will not be liable for prejudgment interest in excess of the applicable damage limitation, the insurer will be liable for any prejudgment interest which, when added to damages rendered against the insured, does not exceed the limitation on liability. Thus, the insurer may be obligated to pay prejudgment interest assessed against its insured despite the absence of a clause specifically addressed to prejudgment interest in the insurance contract.
Unlike many liability insurance contracts, the agreement between Alaska Guaranty and Dr. Ha does not obligate the insurer to pay interest accruing after entry of judgment.
While we believe that prior Alaska cases make clear the proper disposition of this case, our reasoning and conclusions are reinforced by decisions from other jurisdictions. Most other jurisdictions have classified prejudgment interest as an item of damages.
The leading case in the area is probably Factory Mutual Liability Insurance Co. of America v. Cooper, 106 R.I. 632, 262 A.2d 370 (1970). Factory Mutual's insured was held liable for damages to third parties injured in an automobile accident covered by the insurance policy. The policy limit for liability was $20,000.00; the judgment exceeded this amount. A Rhode Island statute directed that interest be added to the amount of damages recovered in personal injury actions, computed from the date of the commencement of the action.
106 R.I. 632, 262 A.2d at 372. The court held that the insurer is not liable for prejudgment interest in excess of policy limits.
In arriving at this conclusion, the court looked to the language of the insurance policy, which it held governed the result. Id. at 372. The court first examined the extent of the insureds' liability and found that they were "legally obligated to pay as damages" the entire judgment rendered against them, including prejudgment interest added to the verdict pursuant to statute.
Id. at 373. Finally, the court concluded that prejudgment interest did not fall within any of the categories of supplementary payment obligations assumed by the insurer.
It would not be useful to detail the facts and reasoning of other cases which have adopted the rule of Factory Mutual. Although the relevant state statutes and insurance policy language have varied more or less from that involved here and in Factory Mutual, courts have resolved the legal issue in the same way: the insurance company is not liable under the insurance policy for prejudgment interest in excess of policy limits.
PUBLIC POLICY
Appellant Guin does not attempt to bring her claim for prejudgment interest within any express provision of the insurance policy. Rather, Guin relies on public policy, AS 45.45.010(a), and this court's decision in State v. Phillips, 470 P.2d 266 (Alaska 1970), to support her argument that Alaska Guaranty is obligated to pay prejudgment interest in excess of policy limits.
Upon close analysis of the rule announced in State v. Phillips, we believe plaintiff's reliance upon the case to be misplaced. In Phillips, we were faced with the task of construing Alaska's general interest statute, AS 45.45.010(a),
In Phillips, we dealt with the economic relationship between an injured tort plaintiff and a culpable tort defendant. Phillips did not involve rights and obligations arising under liability insurance agreements, which are executed between tort defendants and insurance carriers. Thus, the case does not purport to delineate the obligation of the insurer to pay prejudgment interest, even if the insured's obligation to pay such interest is clear.
Guin also attempts to find on behalf of the insurer an obligation to pay prejudgment interest based squarely on the language of AS 45.45.010(a), which provides that the rate of interest in Alaska is eight per cent on money after it is due. Guin argues that the policy limits were "due" from the insurer on the date of injury rather than the date of settlement. This contention we find untenable. Under this liability insurance policy, the insurer agreed to pay on behalf of the insured all sums which the "Assured shall by law be held liable to pay for damages." Until a valid judgment is rendered against the insured or a settlement agreement is entered into, the insured is not by law liable to pay damages to the injured party. Thus, the sum that the insurance company may eventually pay on behalf of the insured is not "Due" at the time of the injury, but rather at the time of settlement or judgment.
Finally, appellant Guin argues that general public policy considerations should persuade this court to impose upon the insurer the obligation to pay prejudgment interest in excess of policy limits. While policy considerations mentioned in some of our decisions may lend support to the rule advocated by Guin, we are not convinced that such factors should override the allocation of obligations contained in the insurance contract before us.
We recognize that under this insurance policy, like most liability insurance policies, the insured has relinquished to the insurer his right to settle claims and his right to control the litigation during the post-injury/prejudgment period.
Similarly, we are not persuaded by the policy encouraging early settlement of claims that the insurer should bear the burden of prejudgment interest in excess of policy limits. This policy factor was given some weight in our decision in State v. Phillips, 470 P.2d 266 (Alaska 1970), where we stated:
Id. at 274. Encouraging early settlement where liability is clear is a salutary goal, but it does not require the insurer to bear the burden of a risk it has not assumed. Countervailing policy considerations favoring the insurer were expressed in Dittus v. Geyman, 68 Mich.App. 433, 242 N.W.2d 800, 805 (1976):
Further, the insured has undertaken to bear the costs of defending the litigation which presumably will increase substantially in the advanced stages of trial preparation if settlement is delayed.
Finally, the insured defendant will not be at the mercy of the dilatory or uncooperative insurance company. In every contract, including policies of insurance, there is an implied covenant of good faith and fair dealing that neither party will do anything which will injure the right of the other to receive the benefits of the agreement.
Furthermore, the insured defendant need not be caught in the bind of prejudgment interest liability. The insured may protect himself by obtaining additional insurance coverage in an amount sufficient to include prejudgment interest which otherwise would exceed applicable policy limits.
We do not believe the result we reach to be unjust. Strong policy arguments exist on either side of the issue; in such a case, we find no compelling reason to override the provisions of the contract which the parties have entered into.
We affirm the judgment of the trial court.
FootNotes
One court has squarely held that prejudgment interest is not an item of damages within the policy language. Dittus v. Geyman, 68 Mich.App. 433, 242 N.W.2d 800, 803 (1976). The court nevertheless imposed upon the insurer liability for prejudgment interest based on public policy. It then held that the insurance company was liable for prejudgment interest only up to the limits of the policy. The court's reasoning, as the dissent points out, is inconsistent.
See 1966 R.I. Pub. Laws, ch. 1, § 10. The wording of Rhode Island's interest statute differs from the wording of Alaska's general interest statute, AS 45.45.010(a), in two respects, but neither difference leads us to depart from the reasoning in Factory Mutual. First, the Rhode Island statute explicitly provides that the clerk of the court add interest to the verdict rendered for pecuniary damages. Davis v. Chism, 513 P.2d 475 (Alaska 1973), makes clear, however, that this is the procedure used in Alaska — prejudgment interest is added to the verdict returned by the jury. Furthermore, Rhode Island's characterization of prejudgment interest as an item of damages parallels this court's reasoning, as enunciated in Davis. Second, the Rhode Island statute provides for the addition of interest from the date of the commencement of the action, while Alaska's statute has been interpreted to provide for addition of interest from the date the cause of action accrues. State v. Phillips, 470 P.2d 266, 274 (Alaska 1970). This difference changes only the date at which interest begins to accrue on an amount later made certain. The essential character of the statutory sums — prejudgment interest — and the purpose in providing for the addition of such sums — compensation of the plaintiff for loss of use value — are the same.
It is interesting to note that Rhode Island subsequently amended its general interest statute to provide for interest from the date the cause of action accrues. See R.I. Gen. Laws § 9-21-10 (Supp. 1977).
Of the many cases cited by Guin, only one, Fruge v. American Serv. Mut. Ins. Co., 227 So.2d 646 (La. App. 1969), arguably supports the conclusion that insurance carriers are liable for prejudgment interest in excess of policy limits. In Fruge, plaintiff recovered judgment in the amount of $5,293.66 against the insurer whose liability was limited to $5,000.00 under the applicable policy. A Louisiana statute provided for an award of prejudgment interest accruing from the date of judicial demand. The court limited the liability of the insurer to "the principal sum of $5,000, plus legal interest from the date of judicial demand until paid." Id. at 649. Although the court imposed liability for prejudgment interest in excess of policy limits, we find the case unpersuasive: the opinion contains no reasoning on the issue of prejudgment interest and cites no authority.
§ 25-1-1 ACLA 1949.
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