Flusche 1 of 18 Insurance – Outline I. Contract Formation and Meaning A. Central Problems 1. Price-setting – money is paid in return for II’s promise of future conduct – but what to charge? 2. Adverse selection a. Prospective PH sometimes knows more about his risk than II (PH might know he’s above average) b. More high risk people purchase policies, if everyone charged average premium c. Losses will be higher than predicted, so II will have to raise premiums – only higher risk people buy d. Spirals down until no one will buy insurance, except highest risk person e. However, not quite this bad: PHs are risk-averse, II tries to get information about actual risks 3. Moral hazard a. People who don’t pay for losses won’t take care to avoid them b. Problem of imperfect information – but not solved by seeking information c. Not a problem if II was omniscient – PH would have to exercise reasonable care – II would know 4. Devices to combat AS and MH a. Screen applicants & ask questions – but questions can’t cover every aspect of the risk b. Risk-classify – but still incomplete information c. Experience-rating – raise future rates when claims are made d. Never sell unlimited coverage e. Deductibles – PH self-insures a portion of every loss f. Exclude coverage of most egregious forms of MH (intentional acts) B. Breach of Warranty 1. CL – any breach of warranty voided coverage, even if immaterial or innocent mistake a. Presumed that anything asked was relevant to risk – every increase of risk is relevant b. Intended to protect IIs, deter false answers from applicants, promote integrity, etc c. Don’t want to make II verify PH’s information – might be hard to uncover liars d. But creates a trap for unweary 2. Modern a. Certain statements are “mere” representations i. II must prove materiality ii. Only has to be “substantially” true b. Three tests for materiality i. If known by II, would it have affected this II’s decision to insure at given premium? ii. If known, would it affect reasonable II’s decision? iii. Objectively, did it actually and materially increase the risk? c. Affirmative – default rule for warranties – must only be true when you state it i. (Vlastos, p. 6 – PH stated in application that third floor has janitor’s residence, but after fire no residence existed, II denied coverage – affirmative warranty) d. Promissory – if explicitly specified, warranty can be required to continue (like condition subsequent) e. RULE i. Majority (a) Untrue or misleading (almost question of opinion, not fact – what did PH intend?) (b) Material to risk (objective or subjective II?, must II have declined policy or just raised rate?) (c) Relied upon by II ii. Minority – requires intent also 3. Contra proferentem – interpret the provisions against the drafter a. Drafter has incentive to make it clear b. PH might be lead to false conclusion through ambiguity c. Pro-coverage bias C. Misrepresentation versus Concealment Flusche 2 of 18 1. Inaccuracy at fault of agent, does not preclude coverage a. But no coverage if applicant believes agent is trying to mislead company b. (Neil, p. 15 – N’s house damaged in fire, II denied claim, found previous claims that were not disclosed – N claims that agent did wrong – court = II can’t deny coverage on this) 2. PH has duty to disclose change in conditions before policy delivered a. (MacKenzie – M applies, learns about high blood pressure, does not tell agent at delivery – no coverage) b. Combats AS (someone with condition applying, then going to doctor) c. Benefit of the doubt to PH in hard cases D. Standardized Forms 1. Process a. IIs combine statistics on losses, but data isn’t comparable (differing policy terms) b. IIs create policies with same terms c. Create cartel – rate bureaus – charges dictated prices, compiles data, prepares policies, etc d. 1950’s, only two major bureaus e. 1970, merge and form Insurance Services Organization f. No more price fixing (1945 – insurance is interstate commerce – no price fixing) g. Contracts of adhesion – take-it-or-leave-it – no one can get a different policy h. Advantages: drafting cost reduced, comparison shopping easier, IIs compete over price & service, predictability, drives price down, IIs can move into new markets i. Disadvantages: absence of product differentiation, inhibition of creativity & innovation, parallel pricing j. Customization – buy standard policy and add endorsements 2. Construing Ambiguities Against Insurer a. Courts might differ drastically about meaning of policy provision b. If ambiguous on its face, some courts allow external evidence, but others do not c. Tie-breaker of last resort – contra proferentem d. Considerations: perfectibility of the language, whether people would actually want coverage i. (Vargas, p. 28 – “within the United States” held to include flights in route to the Bahamas – II could easily exclude this, and PH desired the coverage, paid extra) e. Ambiguous terms might be sent to jury to determine meaning i. Jury must figure out what parties intended – must find a meeting of the minds somewhere ii. (World Trade Center, p. 32 – definition of occurrence as single cause of loss or series of single causes in binder – held ambiguous because NY law did not dictate result – fact finder determines the # of occurrences) 3. Role of Intermediaries a. Authority of Agent – Reasonable Expectations of Insured (minority) i. Unconscionable to deny coverage that PH reasonably expects (a) II is estopped to deny coverage, since it has let PH rely on misimpression (b) (Atwood, p. 39 – electrician denied coverage for child dying after fixing thermostat – policy did not cover completed operations, but exclusion buried among 13 others – II is almost fraudulent by its silence) ii. But might be ok to require physical damage at entry/exit point for burglary coverage (a) Judge might not be willing to extend coverage – maybe people don’t want to pay for it (b) Rationale – might be limit on liability, might simply be evidentiary (c) (Atwater, p. 42 – II denied coverage after break-in, when no evidence of forcible entry found – court upheld) iii. Agent has authority to bind II to anything that is plausible, if he has any actual authority (a) Agents need apparent authority, so people will rely on binders (b) II is bound in order to make the system function (c) (Elmer Tallant Agency, p. 49 – agent told applicant that coverage was bound & prepared binder, without getting approval from II – court = agent has actual authority) Flusche 3 of 18 b. Fraud, Waiver, Estoppel i. Estoppel can arise out of pre-contract conduct/words, but not post-contract (a) If agent represents something will be in the policy, it is treated like it is there (b) Rationale – split the baby, don’t give PHs this right (1) But under Parole Evidence, this seems to go wrong way (2) Normally, you don’t look at things prior to contract – policy is what matters (3) But if agent later tells you something, it’s a new contract – should be binding ii. Estoppel can’t expand coverage (a) It negates defenses based on conditions subsequent to loss (b) Can’t give extra coverage that would not have been present, but can give coverage that PH’s actions might have lost (c) Minority – estoppel can expand coverage iii. (Roseth, p. 58 – PH stated that his policy covered loss, adjuster did not correct – does not create coverage under estoppel) c. Group Insurance i. Why sell through group? (a) Economies of scale – less individual underwriting (b) Less risk of AS – you decide employment based on company, not insurance plan (c) Tax advantage to employment based insurance ii. Almost always, employer’s clerk signs up employees iii. To what extent is employer an “agent” of II for purposes of rights in variance with written rights? (a) Used to be matter of state law, question of fact (b) Employment Responsibility Income Security Act of 1974 (1) Applies to all employer-based insurance (2) Does not pre-empt state laws regulating insurance (3) General state law that does not solely regulate insurance is pre-empted II. Insurance Regulation A. Allocation of Powers 1. SC ruled that insurance is not commerce in Paul v. Virginia (1869) 2. SC reversed in South-Eastern Underwriters Association (1944) 3. Screams to Congress for help a. IIs were upset – seemed like they could no longer share data and standardize policies b. State regulators felt threatened 4. McCarran-Ferguson Act a. No implied federal pre-emption of state authority to regulate insurance (dormant commerce clause) b. Federal anti-trust laws are inapplicable if insurance regulated at state level (except IIs can’t boycott others for not charging set prices) B. State Regulatory Response 1. Insurance Commissioners a. State administrative official b. Functions: rate control, policy approval, deceptive practices, solvency monitoring 2. Solvency Regulation a. ICs audit IIs to make sure investments are not too risky and liabilities are not in excess of assets b. Guaranty funds – solvent IIs guarantee debts of insolvent IIs 3. Rate Regulation a. Ratemaking i. IIs predict future based mainly on the past ii. Problem – more distant past is less representative of future, but more recent past has less data iii. If market is perfectly competitive, II has every incentive to figure out right number (a) But markets aren’t perfect, people don’t comparison shop much iv. IC confronts the same problem of incomplete information Flusche 4 of 18 b. Defer to IC (rational basis review) i. (North Carolina Rate Bureau, p. 92 – Bureau did not prevail on claim that IC used wrong account principles) c. Few cases challenging IC decisions i. Deferential standard ii. All action is at agency level iii. State appellate courts don’t want these cases d. IC staffs are thin and under-funded – must determine which filings to examine i. Politically sensitive forms of coverage (automobile, homeowner’s) ii. Lines of insurance without intense competition 4. “Unfairly Discriminatory” Rates a. Few appellate decisions here i. Few IC efforts even to apply the term: most of the bases for risk-classifying are ok ii. When there is an objectionable classification variable, legislature usually controls b. IIs classify to combat AS i. You can’t be treated as individual – you must belong to groups ii. IIs discriminate (differentiate) to charge people different rates c. What is “unfair”? i. Actuarial accuracy (a) Must be a statistical difference between categories ii. Non-causal (a) Difference between two groups must be defined by something that didn’t appear to be causal (b) Should find out what is really going on, and classify based on that (c) But it might not be easy to figure out the distinguishing factor – might be costly to implement (d) Cheaper for II to use the proxy iii. Controllability (a) Might be problematic to discriminate based on people’s genes (b) But people also might have some control of what happens to them (c) Two factors: how much AS there would be, sensitivity to connotation of the term iv. Suspect (a) Look for history of discrimination associated with this variable d. Gender i. Using gender sometimes helps women ii. States have gone both ways – some outlaw, others specifically authorize iii. Federal govt. outlaws gender-based discrimination in employment insurance e. II might be precluded from using factor in deciding whether to issue policy at all i. Rates – violations are brought to attention of authorities ii. Underwriting – people won’t know actual basis for rejection iii. (Schmidt, p. 99 – II prevented from denying application based on short driving record) 5. Contingent-Commission Controversy a. Brokers help commercial PHs find coverage b. In addition to commissions paid by PHs, certain IIs were giving kickbacks to brokers c. Objections: i. Steering problem (a) Broker may place PH with II who is giving a better kickback (b) Disclosure? – would put pressure on PH to decide, but he is paying broker to decide ii. Processing (a) Broker has incentive for PH to have fewer claims than if commission wasn’t contingent on II (b) Broker has incentive to minimize claim payments to PH d. Prices end up being artificially high (bid-rigging scheme) e. Practice is prohibited now – states have authority to regulate deceptive or unfair practices Flusche 5 of 18 C. Residual Federal Regulation 1. “Business of insurance” a. Three part test i. Does it involve spreading of risk? ii. Does it involve II-PH relationship? iii. Does it have an impact on non-insurance markets? b. (Pireno, p. 112 – use of chiropractic advisory board by II to determine if charges are reasonable and services necessary – not the business of insurance) c. But there are a lot of things that are benign and useful – II would love them exempt from Sherman Act d. Does insurance industry need a blanket exemption for this kind of activity in order to operate? 2. “Regulation” by the states a. Almost no law here b. Must be a regulatory scheme within state that is more than a scam c. But IC doesn’t have to address (or be alleged to have addressed) the particular activity in question d. There may be times when activity is exempted from federal level, but no state law addresses it 3. “Boycott, coercion, or intimidation” (NOT EXEMPT from Sherman Act) a. Occurrence vs. Claims-Made i. Occurrence (a) Covers liability for injury or damage that occurs during policy period, regardless of when a suit alleging liability for that injury or damage is instituted (b) Coverage “until the end of time” ii. Claims-made (a) Covers liability arising out of suits instituted during the policy period, regardless of when the injury or damage alleged in the suit occurred (b) Coverage “from the beginning of time” (c) Retroactive date – if injury occurred before date, not covered (d) AS problem – someone knows claims are brewing, so they get better insurance, then make claim (e) Shifts less of risk of future claims to II b. Boycott – getting together to refuse to do A, in order to achieve B (np. 93) i. Boycott, intimidation, coercion – one phrase, getting at the same thing ii. Boycott must be in aid of some other transaction iii. (Barry, p. 121 – II switched to claims-made policies, then asked other IIs not to sell to their PHs – holding boycott exception extended to disputes between PHs and IIs) (a) But this seems to define “boycott” to be if all IIs charge twice the regular rates iv. (Hartford v. California, p. 126 – boycott = coercing someone to abandon his position – refusal to deal, with affect to subsequent transaction) III. Fire and Property Insurance A. Policy 1. Declarations – identifying data, limit of liability, premiums, deductible, mortgage/lien holder 2. Definitions – insured = you & residents, location = premises, occurrence = same harmful conditions 3. Property coverage – no land coverage, $1500 for jewelry theft 4. Additional coverage – debris removal, collapse (taken away, then give a little back) 5. Perils Insured Against a. “Open peril coverage” (changed from “all risk coverage”) b. Subject to limitations: vandalism (if unoccupied for 60 days), mold & fungus, wear & tear 6. Exclusions – concurrent causation (excluded loss takes priority), no earthquake coverage, must mitigate loss, no intentional loss, nuclear hazard & war excluded 7. Conditions – must report loss, settlement, mortgage (divide up payment) B. Insurable Interest Requirement 1. Cannot buy insurance in property unless you have an interest in its continued existence 2. Must make sure to have an interest beyond a legal interest Flusche 6 of 18 3. Must be able to prove you have an obligation to pay off mortgage or take an ownership interest 4. (Gossett, p. 161 – person who made offer on unfinished house & sought insurance only had insurable interest in improvements) 5. Replacement cost insurance a. Covers replacement cost of house b. MH because value of insurance is higher than house value – but you have to rebuild c. IIs rely on people being sentimental to their house and increase in premiums they demand C. Business Interruption Coverage 1. Protects against consequential damages that result from damage to your property 2. Does not protect against pure economic loss 3. Loss of market – not included to begin with – exclusion does not take anything away that was granted 4. (Duane Reade, p. 167 – pharmacy inside WTC destroyed, sought recovery for business interruption – holding policy only includes time necessary to rebuild pharmacy itself, not entire structure in which it existed) 5. Contingent business interruption – protects from damages on property other than your own D. Exclusions and Their Exceptions 1. Intrinsic Loss a. Things aren’t insured against effect of their own inherent deficiencies or tendencies, unless they are made active and destructive by a peril insured against b. Prevents MH that you will buy less quality goods c. (Chute, p. 172 – fire opal not covered by inherent crack, since they are prone to fissures) 2. Causation a. If a covered cause combines with an excluded cause to produce loss, no recovery i. (Bongen, p. 174 – home destroyed by mudslide caused by construction – no recovery because of mudslide exclusion) b. Look to reasonable expectations of the PH c. There is only one proximate cause d. (Liristis, p. 179 – policy excluded loses caused by mold, but did not exclude mold as a loss by itself – recovery for mold caused by water in putting out fire) 3. Increased Risk a. Collapse i. Problem with covering all collapse – involves too much MH – people will buy unsound buildings or not maintain properly ii. (Rosen, p. 183 – repair of deck in state of “imminent collapse” not covered under policy that excluded anything but actual collapse) iii. Decent public policy argument for coverage of cost of preventing greater loss (a) Usually found in commercial policies (b) But risk and MH problems too great for homeowners (c) PH will do maintenance and claim that it was preventing imminent harm b. No coverage of loss caused by fire if hazard was increased by any means within knowledge/control of insured i. (Dynasty, p. 187 – sprinkler system in club was locked in “off” position, preventing recovery under policy) ii. Courts read according to rule of reason iii. No requirement that risk contributes to loss, just increases risk iv. Must know about the increase of risk AND have control over it v. This is often a jury question E. Measure of Recovery 1. Two possible measures: a. Actual cash value i. Look to market value OR find replacement cost and deduct depreciation Flusche 7 of 18 ii. Usually bought by commercial owners b. Replacement cost i. Meant to compensate for subjective value ii. Usually bought by upper middle class homeowners 2. Coinsurance a. Typically must buy insurance on 80% of value of structure to get 100% coverage of loss b. If you buy < 80% of value of building, don’t have 100% coverage of even partial wall c. Whatever percentage of 80% that you insure for, that is how much coverage you get d. Remaining uncovered amount is the “coinsurance” amount e. Premiums should step up as insurance amounts go up – more likely to have lower amounts of liability 3. Subrogation a. Process by which one party who has protected another takes over the rights of another b. II steps into the shoes of the PH by paying losses – takes over PH’s rights, with respect to that loss c. Principle of indemnity – you should not be able to recover twice for the same claim d. “Active” i. II pays loss to PH ii. II is then subrogated to PH’s rights AND can recover loss from tortfeasor e. “Passive” i. II pays loss to PH ii. PH wants to sue (maybe higher loss, pain & suffering, lost wages) iii. Tortfeasor pays PH iv. PH must reimburse II for amount paid out f. PH can not extinguish II’s subrogation rights after loss – this voids coverage g. PH can extinguish subrogation rights before a loss, unless specifically disallowed i. (Great Northern Oil Company, p. 200 – pre-accident contract limiting liability did not void coverage) 4. Mortgages a. Security interest i. Lender can get judgment requiring borrower to pay money ii. Creditor can execute the judgment – get state official to covert assets of debtor iii. Creditors will not loan money unless they get first dibs on piece of property b. Bank also wants to protect security interest from damage i. Bank requires that it is listed as insured party under policy ii. II pays bank whatever is left on mortgage iii. Anything remaining gets paid to PH c. (Althauser, p. 206 – PH voided coverage for fire by material misrepresentations – II paid bank, then stepped into shoes of bank and sued PH for outstanding balance of debt) IV. Life, Health, and Disability Insurance A. Life Insurance 1. Two basic forms a. Term i. Pure life insurance ii. Provided for term of years iii. Actuarially correct premium rises with age of PH b. Whole i. Life insures plus investment feature ii. Premium is sum of actuarially correct term + amount you invest iii. Less of a good deal today iv. Universal life – allows PH to invest in differing funds – might be better deal 2. The Application a. Coverage generally begins from date of application, if application is later approved Flusche 8 of 18 b. (Gaunt, p. 246 – man found dead on railroad tracks with gunshot to head – policy interpreted to provide coverage based on reasonable expectations, even though provision required applicant be alive at time of approval) c. Pretty severe AS problem in life insurance 3. Requirement of Insurable Interest a. Must have substantial interest engendered by love and affection or substantial economic interest b. Three hats: i. Owner – has right to control incidents of ownership – designate/change beneficiary ii. Party whose life is insured (CQV) iii. Beneficiary – party to whom proceeds will be paid iv. Assignee c. Owner always has insurable interest in his own life d. If owner isn’t CQV, owner & beneficiary must have insurable interest in life of CQV e. (Ryan, p. 251) i. Partner has insurable interest in continued life of his partner ii. Except for creditors, court does not examine how valuable someone’s life was to you iii. II and estate of CQV can assert lack of insurable interest f. (Mayo, p. 256 – court requires II to pay employer, who will hold returned premiums in trust for heirs of employees that died) 4. Change of Beneficiary and Assignment a. II in doubt about who to pay, file interpleader (we have to pay, but we don’t know who – attach check) b. Change of beneficiary must be on form satisfactory to the II i. (Engelman, p. 261 – wife did not successfully change beneficiary of her life insurance policy from her husband to someone else) ii. Even most liberal courts require intention + action c. Assignee of good faith purchaser of policy does not need insurable interest i. Flip-side – if original purchase isn’t a sham, assignee does not need insurable interest ii. If assignee must have insurable interest, owner cannot capitalize on his increased value of policy iii. MH issue – if you need operation, your life insurance policy is worth a lot more iv. (Grigsby, p. 266) 5. Limitations on Recovery by Beneficiaries a. Estate of CQV has cause of action in negligence against II for issuing policy, if it should have known that it was substantially increasing risk that life of CQV would be taken i. (Null, p. 269 – Null bought policy on his life, assigned to Calvert next day, Calvert kills Null next day – holding that estate has cause of action – jury decides standard of care) b. Rule that there is no recovery for murder does not imply that you automatically get proceeds if convicted of something else (Hampton, p. 273) i. Civil court has lower burden of proof – might find 51% chance that you murdered CQV 6. Incontestability a. If misrepresented fact was discoverable by II at time of misrepresentation, it is incontestable after 2 yrs b. If relevant to potential cause of death & discoverable, no defense after 2 years c. But valid limitations on coverage valid d. Discovery does not have to be practical, just theoretically possible (Amex Life Insurance, p. 279) 7. Limitations on Risk a. If accident policy, apply rule of reason to test that accident must result exclusively from external violence and accidental means i. (Silverstein, p. 283 – PH had an ulcer, but still met the test) b. Suicide clause in policy precludes coverage if you commit suicide within certain time i. (Charney – designed to prevent AS, but none here – PH committed suicide because of medicine) c. Courts are giving people the coverage they want 8. Negligence Actions Against Insurer Flusche 9 of 18 a. (Mauroner – should be a cause of action) b. Ends up being a policy question – should there be coverage? B. Health Insurance 1. Access to Care a. Pre-Existing Condition Limitations i. Guard against AS by providing coverage, subject to pre-existing condition limitations ii. But PH seeking to buy new coverage or change jobs is less likely to be AS iii. HIPAA solves collective action problem (a) 12 month maximum limitation; accumulate “credit” for time under prior policy iv. New policy doesn’t have to cover condition, but can’t specifically exclude you v. If PH does not know about condition, coverage depends upon language of policy (a) Merely treating symptoms without them being diagnosed is not treatment “for” the condition (b) (Lawson, p. 295 – holding coverage existed for child who was treated for symptoms diagnosed as respiratory infection, got policy, then later diagnosed as leukemia) vi. No IC should approve policy with 5-year limitation on pre-existing condition limitation b. ERISA, Coverage Denials, and Changes in Coverage i. ERISA pre-empts state laws regulating employee benefits, substituting federal scheme ii. What is permitted? (a) Can bring malpractice suit against physician (b) States can have laws that give you right to appeal from denial of benefits by HMO (c) Suit against HMO seeking to impose vicarious liability for malpractice of physician working through HMO iii. What is not permitted? (a) Suits seeking extra-contractual benefits for coverage or eligibility decisions (b) Pure and mixed treatment and coverage decisions iv. Quantity = pre-empted v. Quality = not pre-empted vi. (Davila, p. 301 – plaintiffs tried to sue for extra-contract damages under Texas cause of action, but court held pre-empted by ERISA) vii. ERISA regulates provision of promised benefits, but not content of benefits viii. Employer can not discriminate in provision of benefits, but that is after deciding what to provide ix. (McGann, p. 308 – not discrimination for employer to limit AIDS benefits, after employee diagnosed) (a) Without a promise to provide continued coverage, employer has no duty to provide a benefit 2. Cost of Care a. Managed Care i. Health Management Organization – combines treatment and financing functions ii. PPO – independent physicians have agreed to abide by restrictions & accept smaller co-pay b. Medically Necessary Services i. Don’t cover cost of experimental or research treatment (a) (Fuja, p. 317 – treatment was convincing as part of research – patient knew, policy excludes) ii. A separate system for financing experimental treatment grew up – National Institutes of Health c. Coordination of Care i. Important when claim is less than sum of all policies ii. Provisions addressing coordination must be consistent iii. If one policy has no coordination provision & the others do, former pays first iv. When contract fails, other dictates kick in (statute, regulation, court) v. Medicare Secondary Payer – when Medicare available, it is secondary to employer based insurance, provided it is on the basis of current employment status vi. (Harris, p. 323 – PH covered under former employer’s plan & husband’s current plan – relation of two IIs with Medicare does not matter, since Medicare did not pay anything) Flusche 10 of 18 vii. Better to have a clear rule up front than to get to a “right” answer in the end viii. Subrogation problem in settlement – what if PH settles for less than damage amount? (a) Majority – “make whole” (b) Minority – “off the top” (Pustilnik, p. 330) (1) Appealing, since does not require inquiry into actual damages C. Disability Insurance 1. Big problem of MH: difficult to verify disability, money goes in your pocket, a lot of subjective disability 2. PH not required to lower his occupation level, but depends upon language (Mossa, p. 336) 3. Policy does not require PH to submit to surgery, just regularly visit physician (Heller, p. 342) D. Liability for Bad-Faith Breach 1. Incentive for IIs to pay claims that they should have known were valid a. Beginning – II must commit independent tort (ex: fraud) or PH suffer consequential damages b. Now – liability for bad-faith breach creates direct cause of action 2. (Silberg, p. 346) a. Bad-faith i. Reasonable people could not have disagreed that there was coverage ii. The cases usually show egregious circumstances b. Damages i. Compensatory – for emotional suffering resulting from failure to pay claims ii. Sometimes get punitive damages 3. Creates incentive for IIs to pay marginal claims – insurance against risk of not being insured 4. (Dedeaux, p. 356 – state cause of action for bad faith breach is part of broader cause of action that covers general contracts – pre-empted by ERISA) V. Liability Insurance A. Commercial General Liability Insurance 1. POLICY? 2. The Insuring Agreement a. Meaning of “Damages” and “Property Damage” i. CERCLA addresses environmental cleanup: (a) EPA can identify sites and issue orders to PRPs, directing them to cleanup (b) Govt. might undertake cleanup and seek reimbursement from PRP ii. PRP cleans up, then seeks reimbursement from CGL II iii. Principle harm = damage to groundwater – takes 30 years to pump & filter iv. Majority – cost recovery is damages (a) (A.Y. McDonald, p. 384) (b) To the extent that it is damages for govt. to cleanup & get reimbursed, it is damages to cleanup yourself v. Minority – not damages vi. What is it? (a) Govt. cleanup is much more like restitution – measure of recovery is D’s ill-gotten gain (b) Measure for damages = amount D has lost vii. Are you legally obligated before govt. requires you to pay? viii. Is there property damage when property has been diminished in value through physical incorporation of property, but no material change? (a) Majority – no, must be physical injury (1) (F & H Construction, p. 392 – pile caps were composed of wrong steel, had to be strengthened with fins – but not a physical injury) (b) Minority – yes b. Trigger and Allocation of Coverage i. Two possibilities for trigger: (a) Only initial injury triggers that year’s policy Flusche 11 of 18 (b) Initial year’s policy is triggered, as well as subsequent years while injury continues ii. Triggers: (a) Asbestos & waste – injury during period for each year from first injury through manifestation (b) Drugs – normally injured upon ingesting (look for “new” injury) (c) Exposure – ok if there is injury immediately upon exposure (true for asbestos) (d) Continuous – ok, if there is actual injury from exposure to manifestation (e) Manifestation – but you can be injured without knowing it iii. Allocation of coverage (a) Two types (1) Horizontal (2/3 of courts) – contributions are fixed for IIs (i) Pro rata by years (NSP)  Fill from bottom up, across coverage chart  Pro-rate equally by year – equal amount of damage in every year (ii) Proportion of limits in year to sum of limits in all triggered years (Owens-Illinois)  Crazy – IIs with higher limits shouldn’t pay higher proportion than other policies (2) Vertical – coverage between IIs and PHs is fixed (i) Joint and several (JH France, p. 414n.3)  If damage indivisible, treat policies as if jointly and severally liable for coverage  PH can pick whichever year it wishes to bear responsibility  PH can pick additional years, if chosen year doesn’t cover enough (ii) Pick one year only (ex: slip and fall)  If only one year triggered, just look to coverage that year  Sometimes more than one year is triggered, but court only let PH pick one year (b) PH must figure out which allocation is best, then sue in state that will apply that allocation (c) Joint and several is never worse than pro-rata (d) If an event can be identified to avoid allocation, do it (Silicone Implant, p. 407 – implant is the trigger) (e) Occurrence number is important (1) Determines number of deductibles to pay & limits on liability (2) Majority – for many claimants with different injuries, there is one occurrence per claimant (i) (Metropolitan Life, p. 416 – occurrence = each claimant’s exposure to asbestos) (3) If every claim is occurrence, II is worse off 3. Exclusions and Conditions a. Expected or Intended Harm i. (Stonewall, p. 422) (a) PH has burden of proof for insuring agreement, II has burden for exclusions (b) Subjective state of mind looked for by most courts (1) But can have objective evidence about a subjective state of mind (c) Expected = “high probability of event occurring” or “substantial uncertainty if it will occur” ii. (Unigard, p. 428 – holding damage to school caused by boy’s fire in trash can was not insurable occurrence) (a) Each individual is separate insured under policy (b) Unigard must cover parents – they did not intend to cause damage b. Owned-Property Exclusion i. Your property damaged and other harm not imminent – no coverage ii. Your property damaged and harm to neighbor’s property imminent – most courts cover iii. Your property damaged & neighbor’s property damaged – almost all courts cover iv. Groundwater – most held in trust for people by the state – owned-property exclusion inapplicable v. (Hakim, p. 432 – holding policy covered cleanup of adjacent property, but barred cost for cleanup of owner’s property) Flusche 12 of 18 c. Business Risk Exclusion i. (Weedo, p. 437 – no coverage for replacing faulty workmanship itself, but coverage for property damage or bodily injury) ii. Theories: (a) PH do not want to make payments to support other people’s bad work (b) Absence of insurance acts more like a warranty if contract has to pay for his losses (c) Claims tend to be smaller than other claims – payment of damages here is like a deductible d. Pollution Exclusion i. Pollution exclusion precludes liability for “sudden” and “accidental” discharges ii. Meaning of “sudden” (a) Half cases – coverage of liability for gradually occurring pollution is not excluded (1) Dictionary definition – abrupt, quick, unexpected – ambiguous (2) ICs had to approve exclusions (i) II told IC coverage was not being reduced (ii) PH lawyers claimed regulatory estoppel (b) Other half – “sudden” means abrupt iii. IIs were trying to create a proxy for intent (a) If something is sudden & accidental, wasn’t intended (b) If discharge is gradual, it is much more likely that someone expected it (to begin or continue) iv. “Discharge, dispersal, release, or escape” (a) If you put material in landfill with clay liner, you don’t expect migration (b) Many courts – discharge was initial deposit of material (c) Few courts – very first drip out of landfill was a sudden discharge v. Exclusion should be read to preclude liability for pollution, but not contaminants (a) (Koloms, p. 447 – pollution exclusion does not bar coverage for claims of carbon monoxide poisoning from defective furnace) e. Notice Conditions i. PH must give notice of things when they occur ii. Must give notice of occurrence as soon as practicable iii. Must give notice within reasonable period of time, whether occurrence or claim iv. (Mighty Midgets, p. 455 – question of fact for jury whether notice was within reasonable time) v. II usually must be prejudiced by the delay (a) But in NY coverage is forfeited if you do not provide notice within reasonable time vi. (West Bay, p. 459 – delay in notice by PH compromised defense of II that barrel was perforated, establishing intentional and gradual discharge) vii. Two ways II can be prejudiced: (a) More difficult to defend (b) More difficult to prove that PH is not covered viii. Juries do not like late notice defenses – seem like forfeitures B. Claims-Made Liability Insurance 1. Directors and Officers Liability Insurance a. Covers D&O for liability for economic loss they may incur in their capacity as D&O b. Three portions i. Side A – individual coverage, if not indemnified by corporation ii. Side B – coverage for corporation if indemnifies individuals iii. Side C – coverage for corporate entity, to protect against liability in its own right c. Exclusion for “adjudicated fraud” should not be held to preclude coverage for settling claim for fraud i. True fraud should be excluded, but blackmail claims must be settle-able ii. (Alstrin, p. 466 – holding that crime or deliberate fraud exclusion emasculated coverage) d. Illegal profit or advantage exclusion – must show that each D&O had this motive i. Typical remedy here is restitution – give back what you took Flusche 13 of 18 ii. Should not have coverage – potential for gain (take money, return money, but claim insurance) e. Insured v. insured exclusion i. Intended to preclude collusive suits ii. If D&O make a bad decision & corporation suffers, corporation has cause of action iii. Exception allowed for derivative action (a) Shareholders must bring claim without help of any insured (b) Insureds include past and current D&O (c) If a past D&O is involved in derivative action, current D&O aren’t covered f. Allocation of settlement when corporation itself not insured i. Larger settlement rule – every cent of settlement presumed covered, except that portion of settlement that is larger because corporate entity was a D (a) Pro-PH (b) Not easy to apply – get testimony from people involved in previous cases with corporation ii. Relative exposure rule – ask potential exposure of each party – how jury would divide up liability (a) Not as favorable to PH iii. (Owens Corning, p. 472) 2. Errors and Omissions Insurance a. Claims-made coverage insuring against liability resulting from consequential loss b. Reporting is part of the trigger of coverage c. More accurate to call these “claims-made-and-reported” policies d. (Thoracic, p. 476 – policy did not cover claim, since it was not reported during policy period & no reporting endorsement was purchased) e. Must make sure you have seamless coverage VI. Liability Insurance: Defense and Settlement A. Duty to Defend and Consequences of Breach 1. Scope of the Duty a. Scope of the pleadings rule i. II’s duty to defend extends to any claim that would be covered if allegations of complaint are true ii. Assume allegations in complaint are true b. Four courses of action II can take i. Defend unconditionally (a) Best for PH (b) If II defends unconditionally, it is estopped to deny coverage later (c) This is promising to provide coverage (d) PHs might detrimentally rely, but no need to prove it (e) (Beckwith, p. 484 – Travelers defended unconditionally for a while, then withdrew – ok, if II has confined allegations to claims that fall outside terms of coverage) ii. Defend, but reserve right to contest coverage (a) II usually sends Reservation of Rights Letter (b) II defends, but says it is not waiving anything (c) Some courts – if II does not cite an exclusion, estopped from claiming it (d) (Gray, p. 491 – no conflict of interest between II and PH, because nothing decided in underlying liability action has any impact on coverage case) iii. Refuse to defend (a) If II is right and there was no potential for coverage, II is ok (b) If II refuses to defend and there was a duty, II can’t later assert an exclusion (c) This is a penalty – encourages II to defend (d) IIs try to have it both ways – reserve right to recoup defense costs if claim isn’t covered (1) (Shoshone, p. 498 – cannot do this) iv. Get declaratory judgment about duty to defend (a) Major disadvantage – costs up front to obtain judgment Flusche 14 of 18 (b) For PH, two sets of litigation costs, instead of two – sue by its own II to not have to defend (c) PH must front cost of defending against II (not recoverable) 2. “Mixed” Claims and Conflicts of Interests a. Unsettled Matters i. Whether II can recoup defense costs (a) None, if unconditional defense (b) No cost to recoup, if no defense (c) No issue, if II gets declaratory judgment (d) Only issue – defending subject to reservation of rights (e) Majority – if complaint contains both defend and not defend allegations, II must defend all (f) Public policy – if II defends entire suit, entitled to reimbursement for portion that isn’t covered (g) Some courts allow recoupment of defense costs if there was no duty to defend (h) Duty to defend is broader than duty to indemnify (i) Against right to recoup – duty to defend is undermined – defense with reservation of rights turns into a loan to PH ii. What happens when II has doubts about whether there would be coverage if allegations are true? (a) II has duty to defend until it confines allegations to claims that fall outside terms of coverage (b) Duty to defend until allegations can be shown outside coverage, upon reasonable view of law iii. When defending subject to Reservation of Rights, no conflict of interest (a) But II might think it has 90% probability of showing that PH expected/intended harm (b) II will only invest as much as is sensible, in light of probable liability (c) It would be bad faith for II to prove less than right amount, but hard to prove in marginal cases (d) Cumis doctrine (CA and a few others) (1) If there is conflict, PH entitled to defense, but doesn’t have to be provided by II’s lawyer (2) PH can hire its own lawyer and send bills to II (3) Contradicts requirement that II can direct defense iv. Most jurisdictions – defense counsel is lawyer for II v. What information is lawyer entitled to share with II? vi. When information is shared with II, when has there been waiver of attorney-client privilege? vii. (Parsons, p. 503 – defense attorney gets info that would waive insurance coverage, but II thinks claim is worth less than P’s settlement offer – attorney has nothing good to do) B. Settlement 1. Notwithstanding policy, II has duty to accept reasonable offer of settlement within policy limits a. If II rejects reasonable offer within limits & judgment is in excess of limits, II pays all b. IIs end up accepting offers a little bit below what is reasonable c. Rule only protects against failure to accept reasonable offers d. PHs at advantage – if there was only 3% chance of P verdict, why did it happen? e. Reasonable offer = would a prudent II without policy limits have accepted the settlement? f. (Crisci, p. 510 – II should have accepted reasonable settlement within policy limits) g. If D’s only asset is insurance, P might make settlement offer within limits, hoping for rejection i. P and PH get together and sue II, saying reasonable offer was rejected C. Relations Between Primary and Excess Insurers 1. Two kinds: a. Pure excess i. Coverage above level of primary II ii. Usually no duty to defend iii. If primary exhausted, usually pays defense within limits b. Umbrella i. Combination of excess and primary 2. Two types of excess: a. Contain own terms Flusche 15 of 18 b. Incorporate (by reference) terms of underlying policy – “follows form to” lower policy 3. Duty to Settle a. Primary II owes duty to excess II to settle i. Same duty that primary II owes to PH, if PH’s money is being risked ii. Created by virtue of subrogation – excess II steps into shoes of PH iii. Duties run all the way up b. If primary II accepts settlement, excess must accept, if reasonable c. If PH self-insures, no duty to excess II to settle (but excess II could alter this rule) (Safeway, p. 517) i. By same logic, if self-insure gap in middle, PH owes no duty to settle 4. Drop-Down Liability a. Coverage depends upon language contained in policies above insolvent layers i. If policies above say that we cover when coverage underneath isn’t recoverable, drop down ii. If policies say we provide coverage when liability below isn’t “covered” – no drop down b. “Covered” = if II was able to pay, would it have to pay? c. For the most part, no drop down obligation (drop down policies are more expensive) d. (Mission, p. 522 – word use in policy did not result in drop down coverage when primary II insolvent) VII. Automobile Insurance A. Policy 1. Liability Coverage a. Pay damages…because of auto accident – not clear – maybe accidental, or any collision b. Drive other cars provision – “insured” covers you or any “family member” c. If you loan someone your vehicle, they are covered under your policy (omnibus clause) d. Intentionally – will mean expected or intended e. Doesn’t apply to person using vehicle, without reasonable belief or permission f. Other insurance – we are excess 2. Medical Payments Coverage a. Small limit – typically $2,000 b. No fault coverage for injury suffered in the car 3. Uninsured Motorist Coverage a. Covers you against risk that you will be injured by someone who can’t pay you b. Will have a cause of action, but can’t collect a judgment c. Can recover pain and suffering d. Uninsured – includes hit-and-run vehicle (but doesn’t cover “phantom headlights”) e. Limits of liability – attempts to address stacking problem 4. Coverage for Damage to Your Auto – covers against risk of dented fender 5. Duties After an Accident or Loss – must give notice and cooperate B. Liability Insurance 1. Scope of Compulsory Insurance Requirements a. Why require auto insurance? i. Want people who are held liable not to face financial ruin – paternalism ii. If people do not have insurance, victims cannot recover b. Why allow designated driver exclusions i. If invalid, anyone with really bad driver in house would have to pay a lot ii. This limits amount of insurance people can buy iii. May deter entrusting vehicle to uninsured people c. (Smith, p. 541 – named driver exclusion does not violate public policy) 2. Omnibus Clause a. Courts divided about how far permission extends i. Some courts – permission runs with keys, except to thief ii. Others – no b. Predominant rule – question of fact and degree – how much deviation from owner’s permission? Flusche 16 of 18 c. (Curtis, p. 547 – permission does not extend to third party – KA – but the daughter was insured, this guy was only a second party) 3. “Use” of the Vehicle a. Requires something like a nexus requirement, but not as strong as proximate cause i. Being in the car does not have to increase risk of harm ii. If it is a mere coincidence that this happened in the car, not covered b. Draw a line – mere coincidence that car is involved AND car is reason of accident c. (Evans, p. 553 – throwing explosive from car is too remotely related from “use” as a vehicle) 4. Notice and Cooperation Conditions a. PH has duty to notify II and cooperate – conditions precedent to coverage b. Cooperation = give testimony, give names of witnesses, etc c. II must be prejudiced by non-cooperation d. (Davies, p. 556 – PH not available at trial to testify – II must show that lack of testimony lost chance of winning, made difference between case going to jury & P getting directed verdict) e. When II takes position that it isn’t obliged to settle, policy provision requiring consent for settlement has no effect i. Good from public policy standpoint – PH should be able to protect himself ii. PH must be able to show settlement was reasonable (in light of probability and amount of verdict) iii. (Miller, p. 561 – insured did not breach duty to cooperate by settling before policy coverage decided) 5. Other Insurance Clauses a. Three types: i. Pro-rata – limits liability to proportion of total loss ii. Excess – we are second iii. Escape – we pay nothing b. When two policies contain other insurance clauses that are inconsistent, they are ignored c. Majority – pro-rate according to policy limits i. Very clear – but still requires decisions whether clauses conflict ii. But not equitable – higher limit II gets responsibility that lower II took on, for same premium d. Minority – each policy pays equal amount, up to limits of lower policy i. Totally predictable ii. More nearly equitable iii. (Carriers, p. 567 – adopts minority rule – easy to administer – shares loss better) C. Uninsured Motorist Coverage 1. Must be injured by uninsured vehicle – owner and driver not covered 2. Must have a right to recover from driver of the vehicle a. (Boynton, p. 581 – employee, driving what would otherwise be insured vehicle, drives into another employee – no way to recover in tort – not legally entitled to recover) 3. Many states have held arbitration requirement void under public policy 4. (Simpson, p. 588 – uninsured motorist statute requires coverage for phantom run losses, to protect victims) a. Minority – requires contact to prevent MH (people lying about swerving off the road) b. Majority – physical contact is an impermissible limitation 5. Stacking of coverage a. Having access to limit of liability of more than one policy b. CGL allocation cases are about the same thing c. Ability to “stack” depends upon policy language d. PH must show that, by paying higher premiums, he expected to have access to two limits of liability e. (Taft, p. 593) D. Auto No-Fault 1. “Pure” No-Fault a. Cause of action in tort for auto injuries – abolished Flusche 17 of 18 b. First-party coverage – recover from own II, regardless of cause c. Abolish pain and suffering recovery d. Spend saved money on medical expenses and lost wages e. Tort lawyers object – thought victims had right to recover & injurers should pay – like their business f. In 13 states, smaller cases are no-fault and do not go to tort 2. Desirable reform! VIII. The Secondary Market A. Residual Market Mechanisms 1. Allow high-risk PHs to obtain coverage 2. Legal form varies, but economic impact almost always the same 3. Assigned risk pool (predominant for autos) a. If licensed driver rejected from three licensed IIs within state, driver is assigned to a company b. Assignment of drivers is in proportion to market share held by II c. IIs can recapture losses: i. Surcharge next year’s policies for all PHs ii. Credit next year’s premium taxes d. High risk drivers are being subsidized e. Right answer: enforce rules to take some drivers off the road, charge high risk drivers more, subsidize enough to induce insurance purchase f. IIs do not like this – hard to recapture all costs 4. Joint Underwriting Association (JUA) a. Separate legal entity (JUA) is formed – one of IIs manages it b. JUA capitalized through assessments on all licensed IIs, in proportion to market share c. JUA writes insured for people who can’t get regular policies d. Just a different legal structure – same economic impact 5. Reinsurance facilities a. Not allowed to reject anybody b. But, II can cede a certain percentage of PHs to state reinsurance facility c. Facility is capitalized by assessments against IIs d. Percentage of policies that can be reinsured = proportional to market share B. Surplus and Excess Lines 1. Non-licensed IIs are allowed to sell insurance when PH can not get it other ways C. Reinsurance 1. II transfers to R-II some of the risk 2. Not much concern for PHs here 3. Most disputes between II and R-II – usually goes to arbitration 4. R-II can buy reinsurance – called retrocession – ceding R-II and retrocessionare 5. Two kinds of agreements: a. Treaty = general categories of coverage are reinsured b. Facultative = reinsurance of particular risk 6. Two bases for accepting risk: a. Proportional – R-II takes specified percentage of subject b. Excess of loss – R-II covers percentage of losses of subject over $X 7. Cut through clause – gives PH rights against R-II, if II goes bankrupt a. Without this, reinsurance is asset of bankrupt II’s estate 8. Two purposes: risk reduction, profit seeking 9. Duty of Utmost Good Faith a. Began at Lloyd’s Coffee House in London b. Transactions were over ships miles away – gentlemen relied on each other to tell everything c. Ceding II must tell R-II everything it would want to know, whether asked or not i. (ordinary PH – II transaction, if you’re not asked and not fraudulently concealing – you’re ok) Flusche 18 of 18 d. (Allendale, p. 611 – II knows what R-II wants to know – must convey all information, including outstanding recommendations made as part of survey report) 10. “Follow-the-Fortunes” Clause a. Usually, this clause exists – liability of R-II shall follow that of II in every case b. Few courts – even in absence of clause, R-II must follow-the-fortunes of II c. This makes sense, as long as ceding II and R-II are co-participating i. II will recover some of what was paid ii. But if R-II will give ceding II all of what was paid, II has little incentive to defend d. This is only a default rule – reinsurance agreement could specify otherwise e. (Lloyds, p. 616)