Detecting Uncertainty in the Meaning of Insurance Policy Wording
April 2001
In this article, the author explains four
reasons why courts find the meaning of contract language uncertain—ambiguity,
vagueness, absurdity, and obscurity—and the importance of detecting and clarifying
uncertainties in contract language.
by Kenneth
S. Wollner
Globe Midwest Risk Management
Few, if any, people reading this article need to be convinced of the value
of careful review of insurance policies and other coverage documents. Part of
the task is detection and clarification of uncertainties in the meaning of contract
language.
There are many reasons courts find that the meaning of contract language
is uncertain. I have grouped the main reasons into four broad categories: ambiguity,
vagueness, absurdity, and obscurity. While not complete, the list is a good
starting point.
Ambiguity
Language is ambiguous when it is susceptible to more than one interpretation.
The writing says two (or more) things. The principal types of ambiguity are:
- Semantic—the meaning of words or phrases
- Syntactic—the meaning derived from
the arrangement of words in a sentence
- Contextual—The meaning of one part
of a document differs from the meaning in another part of the document
A case involving all three types of ambiguities is Morgan Stanley Group v New England Insurance Company.
Morgan Stanley provided investment advice to customers and brokered investments
to some of the same customers. When the investments went sour, two financial
institutions sued Morgan Stanley.
Under the insurance policy, New England agreed to indemnify Morgan Stanley
for:
[l]oss . . . by reason of any actual or alleged negligent act, error or omission
committed in the scope of the Insured's duties as investment counselors.
The court found that the term "investment counselors" was ambiguous. Morgan
Stanley argued for an interpretation that covered all instances in which Morgan
Stanley provided investment advice. New England claimed that "investment counselor"
covered only those instances in which Morgan Stanley had a contract with a client
to provide investment advice for a fee.
The trial court ruled that "the hallmark of investment counseling is independent
analysis." The appeals court adopted still another interpretation, juxtaposing
a counselor and a seller. In a reductio ad
absurdum argument, the court stated:
To hold Morgan Stanley acted as an investment counselor in this case
would transform every effective salesman into an investment counselor.
Resolution of this semantic ambiguity in favor of New England did not end
the matter. The insuring agreement contained a syntactic ambiguity: did "any
actual or alleged" modify only "negligent act, error or omission" or did it
also modify "investment counselors." In the later case, Morgan Stanley was entitled
to coverage if one or both of the financial institutions alleged that Morgan
Stanley acted as "investment counselors." The court remanded the case to the
trial judge with instructions to determine whether one of the financial institutions
alleged that Morgan Stanley acted in the insured capacity.
The 1986 and the 1987 policies contained a notice of circumstance provision.
As claims-made gurus know, this provision treats a claim arising out of a notice
of circumstance given during one policy period as a claim reported (or made)
when the notice of circumstance was given. Both policies also had a traditional
claims-made coverage trigger.
Morgan Stanley gave notice of circumstance during the 1986 policy period,
and the claims were made during the 1987 policy period. Morgan Stanley argued
that this triggered coverage under both policies. Apparently, the 1987 policy
did not contain a prior notice of circumstance exclusion or other provision
explicitly precluding (or allowing) duplicate coverage limits for the same claim.
The court interpreted the 1987 policy in the context of renewal of the 1986
policy. The court noted that the word "renewal" appeared in forms submitted
by Morgan Stanley and forms attached to the 1987 policy. Morgan Stanley's risk
manager testified that the 1987 policy was a renewal of the 1986 policy. According
to the court, the renewal arrangement operated to allocate claims to particular
policy years. The case was remanded to the trial judge to determine whether
the 1986 or the 1987 policy afforded coverage.
Vagueness
Whereas an ambiguous term suggests two or more connotations, a vague term
is imprecise. A court may infer a precise meaning or it may refuse to enforce
a vague term.
Conventional owners, landlords, and tenants liability insurance policies
cover liability arising out of the ownership, maintenance, or use of the premises
described in the declarations as well as "incidental" operations. Exactly what
is "incidental" is the subject of many court decisions. A couple of these court
decisions are summarized below:
- Transmission of a disease when the policyholder had sex on the described
premises was held not incidental to ownership, maintenance, or use of the
described premises.
- Coverage was held to apply to an accident taking place at a local chapter
of a fraternity. The court found that the chapter houses were operations
incidental to the ownership, maintenance, or use of the fraternity headquarters.
Sometimes a word or phrase that appears vague is not. The courts have adequately
defined many words and phrases found in insurance policies. A vague term may
also be appropriate in situations where specificity is not desirable, such as
a requirement to report a claim to the insurer "as soon as possible" or "as
soon as practical."
Obscurity
Courts have refused to enforce provisions because the policyholder was mislead
or surprised. In one case, a requirement that the insured notify the insurer
of an unusual occurrence was contained in a section headed "PROCEDURE OF INSURED
IN CLAIM OR SUIT."
The court found that the heading was misleading because the heading omitted
mention of the insured's duty regarding an unusual occurrence. Therefore, the
court held that the insurer was not entitled to deny coverage because that the
insured did not notify the insurer of the death of a patient until after the
patient's family sued.
The reasonable expectations doctrine is mainly concerned with unfair surprise—the
insertion of a provision that conflicts with what the policyholder would suppose
based on the purpose of the insurance contract. Under the doctrine, the text
of a contract is de-emphasized and the objectively reasonable expectations of
the consumer are stressed in construing the contract.
Absurdity
Absurdity includes incongruity of a provision in relation to other provisions
of the insurance policy. In my experience, this usually happens when a provision
is "cut" from one policy and "pasted " to another policy.
In one case, a provision in an aircraft policy issued to a corporation excluded
coverage for liability arising out of personal injuries to members of the insured's
family. The court held that this provision was absurd, since the insured was
a corporation and members of its family could not possibly have personal injuries.
Therefore, the court disregarded any reference in the policy to personal injuries
of the insured's family.
Another type of absurdity is a provision that is so patently unfair that
no reasonable person would voluntarily accept the provision. In such case, a
court may reject or reform the provision.
Conclusion
The pressure on courts to be "fair" and to follow precedent sometimes results
in interpretations that appear inconsistent with the intent of the parties to
a contract. These are the ordinary hazards of contracting. However, the parties
can considerably reduce the opportunities for misunderstanding and misinterpretation
by making an effort to detect and clarify uncertainties in the meaning of contract
language.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.