Beware of "Absolute" Insurance Policy Wording
Frederick Fisher | June 14, 2019
In July 2009, a partner in a prominent law firm authored an editorial that appeared in the firm's monthly digest of recent appellate decisions. The editorial discussed "absolute exclusions." Such exclusions have been deemed "absolute" because they even exclude claims that are remotely—but not directly—related to the specific acts targeted in the exclusion. The effect of such language is to defeat coverage in situations where it could otherwise be reasonably expected that coverage would apply.
The ultimate—and troubling—theme of the attorney's article was the following concluding statement.
Nevertheless in today's market, perhaps putting aside the "hard" financial institution and financial services, D&O/E&O markets, astute brokers, and policyholder counsel will resist vigorously the 'super absolute' language. Beauty, however, is truly in the eye of the beholder and, as an insurer's coverage lawyer, I prefer super absolute beauty!!
In essence, this attorney was saying that absolute language is preferable—from the insurer's standpoint—a view that, of course, would severely restrict coverage for insureds and thereby result in claim denials in situations where an insured would presume that coverage would be available.
This article examines "absolute" policy wording and describes the dangers it presents for an insured. It begins by explaining exactly how "absolute" wording pertains to a policy's exclusions. The article then provides two case studies in which "absolute" exclusionary wording eliminates coverage where it could reasonably be expected to apply.
Next, it analyzes the manner in which "absolute" wording has worked its way into prior and pending and retroactive date provisions, offering examples of how "absolute" wording can produce adverse results for an insured. The article concludes with several takeaways that can assist a policyholder in minimizing the effect of "absolute" policy language.
"Absolute" Exclusions and How They Impair Coverage
The best way to understand the operation of "absolute" exclusions is to closely examine the exact policy wording and then analyze the effect of such exclusions in a claim situation. The figure below provides representative wording of an "absolute" exclusion.
Representative Wording of an "Absolute" Exclusion
… the Insurer shall not be liable to make any payment for Loss in connection with a Claim made against any Insured … based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving:
- damage to or destruction of any tangible property, including the loss of use thereof; or
- bodily injury, sickness, disease, death; or assault or battery of any person; or
- invasion of privacy, wrongful entry, eviction, false arrest, false imprisonment, malicious prosecution, libel, slander, mental anguish, humiliation, emotional distress, oral or written publication of defamatory or disparaging material …
Source: Berkley Insurance Company; ExecSuite; Directors, Officers and Corporate Liability Insurance Coverage Section; ML 36400 (rev. 03–18)
The critical phrases in this exclusion are "based upon," "arising out of," "directly or indirectly resulting from," "in consequence of," and "in any way involving." Such phrases indicate that coverage, even for events that are distant from the essential nature of the act depicted in an exclusion, will not be available to an insured.
The Dangers of "Absolute" Language in Exclusions: Two Case Studies
In this section, we will see how "absolute" exclusions impact the outcome of two claim situations. The first case study involves a claim under an insurance agents and brokers professional liability policy; the second pertains to an insurance company errors and omissions (E&O) liability policy.
Case One: Insurance Agents and Brokers Professional Liability Policy
Imagine you are an insurance broker who is asked to obtain an environmental engineer's professional and pollution liability insurance policy for one of your clients. Also, imagine that your own insurance agents and brokers professional liability policy contains an exclusion for pollution liability. If that exclusion is written on an "absolute" basis, it could foreseeably preclude coverage for the following claim brought against you.
Your client environmental engineer is sued in conjunction with a pollution incident caused by his alleged faulty design of a wastewater treatment plant. Coverage for the claim against your client environmental engineer is denied by the insurer who underwrote the environmental engineer's professional and pollution liability policy that you sold the client. As a result, the client sues you for providing a policy that failed to cover the single most critical exposure associated with your client's profession: a pollution incident.
In this situation, the "absolute" pollution liability exclusion within your insurance agents and brokers professional liability policy could foreseeably preclude coverage for a claim brought by your client against you, alleging that you were negligent in providing him with a defective policy. This is because the insurer could assert that the claim made against you was "based upon," "arose out of," "directly or indirectly resulted from," was "a consequence of," or "involved" pollution—however remotely! As bizarre as this conclusion may appear, coverage denials under this and similar types of circumstances are becoming increasingly common because "absolute" exclusions are now more frequently appearing in claims-made policies.
Case Two: Insurance Company E&O Liability Policy
In another example of how an "absolute" exclusion defeated coverage for a seemingly covered claim, consider the case of an insurance company that purchased E&O insurance with the intention of protecting itself against bad faith lawsuits.
The insurer issued a pollution liability policy to one of its insureds. The insured was sued by a third party for pollution, and the insurer, in turn, denied coverage. Following the denial, the insured sued the insurer, alleging bad faith. Yet, because the insurer's own insurance company E&O liability policy contained an "absolute" pollution exclusion, coverage for the bad faith lawsuit against the insurer was denied. This was despite the fact that the insurance company was not the polluter and, ironically, the insurer's premium volume received for writing pollution liability coverage was used (in part) to calculate its premium when purchasing its E&O policy! Such language—to at least one attorney's delight—is being upheld by courts with increasing frequency.
The exclusion of the bad faith claim was, of course, not the original intent of the insurance company E&O liability policy. Rather, exclusions often appear in insurance policies because other policies are more expressly designed to cover that particular type of hazard. For example, in almost every liability policy issued, there is a workers compensation exclusion (except in a workers compensation policy). Accordingly, none of these policies (i.e., automobile liability, commercial general liability, directors and officers [D&O] liability, and so forth) would be called on to pay a workers compensation claim because a workers compensation policy was available to address that hazard. Yet, when a policy contains "absolute" language, if the claim is even remotely connected to the exclusion, it is entirely possible that such an exclusion will be upheld in court; as was indeed the case when the insurance company's E&O insurer denied coverage for a bad faith claim because it was related—however tangentially—to a pollution incident.
Limit the Scope of "Absolute" Exclusions to the Insured's Activities
One key question associated with "absolute" exclusionary wording in the above two examples is whether the exclusion was limited to the activities of the "insured" insurance broker or insurance company. In other words, does the exclusion say that no coverage will apply to "any claim arising directly or indirectly from any pollution or environmental hazards …," or does it say that we don't cover "any claim arising directly or indirectly from any pollutants or environmental hazards as may be caused by acts of the Insured" (insurance broker/insurance company)? The latter wording would have afforded coverage in both claim examples, whereas the former wording would not.
The Effect of a Policy's "Claim" Definition
Recognize that the preamble to a set of exclusions often includes a reference to the term "claim" (e.g., "This policy does not afford coverage for any 'claim' based on, arising out of, involving or in any way related to …").
Therefore, the manner in which a policy defines the term "claim" can have the effect of either reinforcing, or neutralizing, the application of the "absolute" exclusions within a policy.
For example, if a policy states that a "claim means any legal action brought against an insured for a wrongful act," the insureds in both of the aforementioned case studies would probably find themselves with a coverage denial. This is because the "claim" definition does not indicate that the wrongful act be committed by the insured. Since the two coverage denials originated from acts not committed by the insured agent and insurance company, respectively, this definition of "claim" would only reinforce the policy's "absolute" pollution exclusion.
Contrast this definition of "claim" with one stating that a "claim means any legal action brought against the insured arising out of a wrongful act by the insured." This "claim" definition would (or should) neutralize a policy's "absolute" pollution definition so that unless the insured committed the actual wrongful act that gave rise to the claim, the exclusion would not apply. Therefore, since the insurance agent and insurance company, respectively, did not cause the pollution that gave rise to the claims brought against them, the "absolute" exclusion would not apply, and coverage should be available in both instances.
Limit the Scope of "Absolute" Exclusions Using "Carve-Backs"
In other instances, policies may contain so-called carve-backs for "absolute" language, which apply to certain exclusions. For instance, in one policy I have reviewed, there were 48 exclusions that used "absolute" language. However, at the end of the exclusions section there appeared blanket carve-back wording (applying to five exclusions) wherein it stated "with respect to exclusions E, F, I, M, and U, these exclusions shall not apply to a claim caused by your alleged failure or actual failure …" (emphasis added).
While such wording may be effective in limiting the extent to which the "absolute" nature of certain exclusions could restrict coverage, there is still the problem of how the "absolute" nature of the other 43 exclusions in the policy could impede coverage!
Limit the Inconsistent References to "Insured"
Similar to the problems noted above as to the selective use of carvebacks is the problem of selective use of references to the insured. In other words, it is not uncommon for policy to use absolute exclusions for all exclusions listed. However, some may refer to insurance activities, and others may not. Thus, it is imperative that all absolute exclusions refer to the insured and their activities.
Retroactive Date and Prior and Pending Litigation Provisions
In addition to appearing within exclusions, "absolute" policy language is also more frequently being found in (1) retroactive date language and (2) prior and pending litigation provisions. These are dangerous provisions given how broadly they are now being interpreted as a result of the "absolute" language they contain. Indeed, claims that one would think were otherwise covered are instead being denied because of "absolute" language.
"Absolute" Language in Retroactive Date Provisions
Prior to the inclusion of "absolute" language (exemplified below), coverage under the retroactive date provision in a claims-made policy would apply in a relatively straightforward fashion to claims that were caused by wrongful acts that took place after a specified date. Now, claims-made policies routinely use language stating the following.
Coverage will not apply based upon or arising out of, in whole or in part, directly or indirectly, from any wrongful act that took place prior to the Retroactive Date specified in item xx on the Declaration page….
The danger of such language is twofold. The phrases "arising out of" and "directly or indirectly" mean "connected with." Therefore, such language could operate in a manner that excludes coverage for a wrongful act committed by "anyone"—as opposed to just the "insured."
Consider the case of a company's assistant controller who is not an officer of the company and thus not an insured under its D&O liability policy. The company's D&O policy incepts on January 1, 2020, and also contains a retroactive date of January 1, 2020.
Beginning in 2016, the assistant controller intentionally booked all of the company's "shipments" of its products as "final sales" and did not take into account any returns of such goods. This has had the effect of inflating the company's earnings by roughly 15 percent for each fiscal year since (and including) 2016. In 2020, the assistant controller's accounting maneuver is finally discovered by an outside auditor, who requires that the company restate its earnings for 2016, 2017, 2018, and 2019. Following the public announcement of the restatement on June 1, 2020, the price of the company's shares drops significantly. A month later, on July 1, 2020, the company receives several shareholder class action lawsuits alleging accounting fraud in the company's overstatement of its earnings and naming all of the company's directors and officers in the lawsuits.
The company's D&O insurer denied coverage for these claims, pointing out that, because the assistant controller reported to the company's chief financial officer (CFO) (an officer and thus an insured), the claim "arose out of" acts with which the insured directors and officers were "directly or indirectly" "connected" and that took place prior to the policy's January 1, 2020, retroactive date. The denial was upheld despite the fact that the company's CFO played no role in the accounting fraud and had no knowledge of it until it was revealed by the audit.
"Absolute" Language in Prior and Pending Litigation Provisions
"Absolute" language is now appearing in prior and pending litigation date provisions, as follows.
[The] insurer is not obligated to pay damages or claim expenses for any claim based upon or arising out of, either directly or indirectly, any legal actions, arbitration, or other adjudicative proceeding instituted and pending prior to the effective date of policy, whether or not any Insured was named as a party to such legal action, arbitration, or other adjudicative proceeding….
The following claim scenario illustrates the way in which such language could operate to defeat coverage where it would otherwise be expected to apply. On July 1, 2018, the owner of a construction project sues Architect A who designed the building's heating, ventilation, and air conditioning system. Then, a year later, on July 1, 2019, the owner amends his original lawsuit (against Architect A) and adds Architect B, who designed the building's electrical system, to the litigation.
Assume that Architect B has an architect's and engineer's professional liability policy with a January 1, 2019–2020 term and a January 1, 2019, prior and pending litigation date. In this situation, Architect B could potentially have no coverage under her architect's and engineer's professional liability policy if that policy contained the above-noted "absolute" wording. Although the owner's first lawsuit did not assert any negligence against Architect B, the fact that the suit involved the same project on which Architect B was also participating will allow the insurer to argue that the suit against B arose "indirectly from … such legal action" and that it was filed earlier in time than the policy's prior and pending litigation date and thus barred from coverage. Despite the apparent unfairness of this result, in many states, courts have found such language to be "clear and unambiguous," thus upholding the insurer's coverage denial.
Important Takeaways
Unfortunately for insureds, the attorney's statement noted at the beginning of this article was quite prescient because in the decade since he wrote the editorial, insurers' use of "absolute" policy language has increased significantly. At the same time, courts are now serving as allies to insurers as they are more likely to interpret absolute policy language in a manner that denies coverage in situations where it was otherwise expected.
The following tips can help to protect an insured from the dangers and, ultimately, the unexpected coverage denials that can result from "absolute" policy language.
- Look for "absolute" language everywhere. Recognize that, given current trends, "absolute" language can—and will—appear in nearly every section of claims-made policy forms. Be aware of such language, not only within exclusions but in other sections of a policy, as well.
- Limit the impact of "absolute" exclusions. Limit their scope by (a) inserting language so that a particular exclusion only applies to the insured's own activities and (b) adding blanket "carve-back" language listing the exclusions to which "absolute" language does not apply to the insured's own activities. Attempt to maximize the number of exclusions that fall under this blanket.
- Analyze a policy's definition of "claim." A policy's "claim" definition requiring that the wrongful act be committed by the insured will protect the insured from a claim denial in many foreseeable situations. Seek policies using such a definition, or negotiate the "claim" definition in your current policy so that it contains such a requirement.
- Neutralize the effects of "absolute" language in retroactive date and prior and pending litigation provisions. Negotiate to remove "absolute" language from such provisions. If this is not possible, consider purchasing a policy not containing "absolute" language within these provisions.
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