We have all heard the horror stories of outrageous coverage denials by insurers
or equally wild representations of coverage by insurance sales personnel. At
any gathering of insurance or risk management professionals, new unbelievable
stories are sure to emerge. Yet, more often than not, the stories are really
the same or similar to past stories; only the names and times have changed.
Considering this and other experiences in my 2.5+ decades in insurance and
risk management, I have come to believe that there are some fundamental misunderstandings
about how insurance works. I don’t mean to suggest that there is a magic approach
that will clarify everything—some policies, like the commercial general liability
policy, are difficult to understand.
However, there are some ground rules that are helpful to understand and observe.
For example, all insurance coverage interpretation is not purely subjective
opinion. On the contrary, most jurisdictions view the interpretation of an insurance
policy as a matter of law, often with clearly articulated rulings as to the
meaning of certain policy wording. In addition, most courts follow certain rules
of "construction" in interpreting an insurance policy.
All of this is to say that the policy wording is important. Policies must
be read carefully in their entirety to be understood. Coverage is usually interpreted
not by a collective understanding (or misunderstanding) of a policy, but by
a thoughtful reading of the actual policy wording (this is what courts generally
attempt in their interpretation). To expect an insurer to "do the right thing"
and pay a claim where coverage does not exist is dicey at best—usually a losing
proposition when the stakes (or the claim) escalates.
This article addresses some areas of the Insurance Services Office, Inc.
(ISO) CGL policy (October 2001 edition) that I think are most commonly misunderstood.
While I will not claim that my illustrations will apply in all circumstances,
I suggest that my comments are worthy of consideration before determining how
the CGL applies. As there are always exceptions to every rule, I am sure there
are situations in which the general principles I am espousing do not apply.
Nonetheless, if thought is stimulated and understanding enhanced, then this
has been a worthwhile exercise.
When Does the Duty To Defend End?
When a catastrophic event occurs, invariably someone will insist that the
CGL insurer should just write a check for the limit, deposit it with the clerk
of courts, and wash their hands of the claim. In other words, they should just
get out.
The Station Nightclub fire in West Warwick, Rhode Island, that occurred in
February 2003, in which 100 people died and many others (about 200) were injured,
is a tragic and very sad case in point. The rumor is that the nightclub has
a $1 million per occurrence CGL limit. Assuming this is true, can the insurer
simply write a check for $1 million and refuse to defend? It appears the damages
resulting from the injuries and deaths will far exceed $1 million.
The wording of the ISO CGL policy will not allow the insurer to simply tender
its limit and not defend any insured. The insurer’s duty to defend does not
end until the applicable limit has been used in the payment of judgment or settlement. In other words, an insured has
a right to be defended against any "suit" alleging damages arising out of covered
bodily injury or property damage unless and until the full limit is paid via
a settlement or settlements or pursuant to a judgment for damages. And if a
standard ISO CGL policy is providing coverage, the costs of such defense are
payable in addition to the policy limit with no dollar limitation.
However, due to the magnitude of The Station disaster, it will be instructive
to see how the courts will handle the civil proceedings. Will the first person
to settle recover most or all of the insurance limit, leaving little or no insurance
available for other victims? Can the insurer seek out a family or person most
likely to settle, pay their limit, and extinguish their duty to defend? What
will the courts allow? This is, as yet, an unanswered question.
It is also worth noting that Rhode Island's attorney general brought charges
of gross criminal negligence (among other charges) against the nightclub owners.
As these charges are criminal in nature, the insurer has no duty to defend the
owners/insureds against these charges (even though "negligence" appears in the
allegation) as the duty to defend only applies to civil proceedings, not to
criminal charges.
The CGL Is Triggered by an "Occurrence"
Labeled an "occurrence"-based CGL policy since 1985, it is a common belief
that an "occurrence" triggers coverage. A closer reading of the CGL insuring
agreement reveals that the CGL only applies if the bodily injury or property
damage is caused by an "occurrence" which takes place in the "policy territory,"
but only if the bodily injury or property damage
occurs during the policy period.
While this seems simple enough, the implications are quite far ranging. Here
is a simple example that usually raises an eyebrow or two among insurance professionals.
Assume a sole proprietor has his occurrence-based CGL policy continuously with
the same insurer since 1993. The sole proprietor is a builder constructing one-family
homes, doing the carpentry work himself. In 2003 he has met his financial goals
and decides to retire, canceling his CGL policy in December of 2003.
A home he built in late 2002 has a problem: he used the wrong material to
secure the floor, which eventually weakened and collapsed in early 2004, severely
injuring the occupant at the time of the collapse. The injured party sues the
sole proprietor/builder for her injuries. Does the builder have any CGL coverage?
A common response is that the insurer writing the CGL coverage in 2002, the
time the floor was incorrectly installed, should defend the sole proprietor
and pay damages because of the bodily injury if he is legally liable. Unfortunately
for the builder, the policy does not obligate the insurer to respond in any
way because the bodily injury did not occur during the policy period.
The Infamous "Tail." The next most common response
(which I have heard from attorneys and accountants in addition to insurance
professionals), is that the builder should have bought "tail" coverage. As this
is an occurrence policy, a tail is not available to purchase. Even if the builder
had a claims-made CGL policy and purchased the tail, the policy would not respond
to bodily injuries that take place after the policy expired and during the tail or
"Supplemental Extended Reporting Period." The tail provides coverage only for
injuries and damages that occurred prior to the purchase of the tail but for
which a claim is made against the insured during the tail period.
Discontinued Completed Operations. The discontinued
operations policy is simply a standard CGL policy rated to reflect the diminishing
liability loss exposures of the person or organization. If the builder had simply
continued to purchase his CGL policy as he had for the past 10 years, the effect
would have been the same.
Would the insurer that wrote the builder’s CGL for the past 10 years be willing
to offer the discontinued completed operations policy? Even though the exposure
has not changed (it is actually reducing—there is no more operations exposure)
during the discontinued phase of the policy, they probably would not.
In the buying and selling of businesses, understanding this seemingly simple
concept is crucial. Had the same builder sold his business (its assets or possibly
the stock if he was incorporated), the builder may still have need for the discontinued
completed operations policy. Yet, it would be mildly surprising to see accountants
and lawyers recognize this and suggest such coverage to the builder.
Punitive Damages
Does the ISO CGL policy include coverage for the payment of punitive damages?
My experience is that about half of the people to whom I pose this question
answer "No, the CGL does will not pay for such damages."
There is a difference between an insurer’s obligation to pay according to
the policy terms and a legal prohibition against the payment of punitive damages.
Some jurisdictions will not allow insurers to pay punitive damages as such payments
have been found to be against public policy. Other jurisdictions have statutes
with similar prohibitions.
As the CGL insuring agreement does obligate an insurer to pay "as damages"
those sums an insured is legally obligated to pay because of bodily injury or
property damage, the simple answer to the question is, "Yes, the ISO CGL does
obligate the insurer to pay punitive damages." Legal prohibition of paying punitive
forbids the insurer from discharging an obligation otherwise included in the
CGL policy. But the obligation is clear—the insuring agreement is not restricted
to compensatory damages and thus includes all damages, including punitive damages.
Exclusionary Wording. If an insurer endorses
the CGL to exclude punitive damages (a common practice among non-admitted insurers),
then the answer becomes a very clear "No." Punitive damages are excluded, and
there is no need to look beyond the policy to issues of legality and enforceability;
there is no coverage for punitive damages.
The courts of the Commonwealth of Massachusetts apparently have not definitively
ruled on whether punitive damages can be paid by an insurer—which prompted an
insurer’s claim person to emphatically tell me punitive damages are definitely
not covered by the ISO CGL as their defense counsel advised them the issue was
unsettled. I think the person missed the distinction.
Damage to "Your Work" Exclusion
The property damage exclusion applying to "your work" is sometimes applied
more broadly than is warranted by the policy wording. The exclusion only applies
if the damage to "your work" arises out of your work and is included within
the products-completed operations hazard.
As an illustration, assume a contractor adds a downstairs bathroom to a customer’s
home. Everyone is pleased with the work, so much so that 2 years later the homeowner
decides to have the contractor remodel the upstairs family room. Just as the
work on the family room gets underway, the contractor negligently causes a small
electrical fire, which, in part, damages the downstairs bathroom.
Is the downstairs bathroom the contractor's work? Is there property damage
to the contractor’s work? The obvious answer to both questions is, "Yes." Is
the damage caused to the downstairs bathroom excluded by the "your work" exclusion?
Too frequently we see insurers automatically invoke the "your work" exclusion
and deny coverage.
The error made by the insurer in the above denial is the damage to the customer’s
bathroom did not arise out of the completed work—the
bathroom. The cause of the damage was the work being done (present tense) on
the family room, not the bathroom. The family room should not be considered
"your work" as respects the contractor as the work had not been completed (and
thus not included within the products-completed operations hazard). Therefore,
the property damage did not arise out of
"your work" or any part of it.
The contractor does have coverage for the property damage to the previously
completed bathroom, but may not have coverage for portions of the family room
(via a different property damage exclusion).
Street Sweepers Are Not Mobile Equipment
It is not uncommon for insurers to write coverage for damage to self-propelled
street sweeping equipment as inland marine coverage. This sometimes leads to
the erroneous conclusion that street sweeping equipment is mobile equipment,
and thus liability coverage is provided by the CGL for any claims arising out
of the equipment’s operation, maintenance, or use (including loading and unloading).
Self-propelled equipment designed for street sweeping and other self-propelled
road maintenance equipment is addressed in the CGL and is clearly considered
to be an auto. Any liability arising out of autos owned, operated by, rented
to, or loaned to any insured is not covered by the CGL. Coverage must be obtained
via an auto policy.
Newly Acquired or Formed Entities
This clause of the CGL has to be fully understood so as not to provide policyholders
a false sense of security. The coverage provided to new entities either formed
or acquired is actually quite limited. Consider just a couple of the following
restrictions.
Limited Liability Companies. Any joint ventures,
partnerships, or limited liability companies formed or acquired by a named insured
are not automatically included as named insureds.
Such entities must be listed on the policy as named insureds immediately to be covered. Limited liability
companies are increasing in popularity as they are easy and inexpensive to form.
The likelihood of having a newly formed entity not covered by the CGL increases
with the popularity of the limited liability company.
The Entrepreneur. The new entity must be formed
or acquired by a named insured. It is common
for an entrepreneur to own multiple corporations. If ABC, Inc., is the named
insured and is 100 percent owned by Jack Armstrong, only entities formed or
acquired by ABC, Inc., will receive any benefit from the newly acquired or formed
entity wording.
If Jack Armstrong purchases 100 percent of the shares of XYZ, Inc., there
is no automatic coverage for this newly acquired named insured as XYZ, Inc.,
was acquired by Jack Armstrong and not ABC, Inc. Determining who owns what is
often a tedious, sometimes futile task, but may make a very big difference in
how coverage applies.
Excluding Products/Completed Operations Coverage
Certain CGL classifications, such as "Buildings or Premises—Bank, Office
or Mercantile (Lessor’s Risk Only)," have a corresponding note in the Commercial Lines Manual that reads "Products/Completed
Operations Included." Such a classification, when properly described on the
CGL declarations page, will also note products/completed operations are "Subject
to the General Aggregate Limit."
The state "Loss Cost" pages will not show any separate loss costs for Subline Code 336,
products/completed operations for these classification codes. Hence, there is
no additional charge for products/completed operations coverage for this and
similar classifications. The cost of this products/completed operations exposure,
however remote, is included within Subline
Code 334, premises/operations charge.
Historically, some insurers translate "included" to mean "no coverage" and
have proceeded to exclude products and completed operations coverage and attach
the exclusionary endorsement (CG 21 04—Exclusion—Products-Completed Operations
Hazard), eliminating coverage for any bodily injury or property damage included
within the products/completed operations hazard (as defined in the policy).
Unless the insurer intends to exclude the products/completed operations hazard
for other classifications listed on the
policy, this exclusion is ineffective.
The definition in the CGL for the "products/completed operations hazard"
includes three exceptions. The third exception states that:
Products-completed operations hazard … Does not include "bodily injury"
or "property damage" arising out of: …
(3) Products or operations for which the classification, listed in
the Declarations or in a policy schedule, states that the products-completed
operations are subject to the General Aggregate Limit.
In short, any claim that would normally be considered a product or completed
operation is not considered included within the products/completed operations
hazard and thus Exclusion CG 21 04 does not apply to claims arising out of this
classification.
Illustration. Assume a janitorial service was
hired to clean the kitchen and storage area of a restaurant. Unfortunately,
the service did not adequately clean the floor of the food storage area. The
day after the cleaning was complete, an employee of the restaurant slipped and
fell on a chicken bone, and subsequently brought claim against the janitorial
service for his injuries. The CGL insurer for the janitorial service denied
all liability for the claim, citing the products/completed operations exclusion
endorsement (CG 21 04) attached to the policy.
The classification on the CGL declarations for the Janitorial Service was
listed as follows:
96816 Janitorial Services (Products-Completed
Operations Subject to the General Aggregate Limit)
As this claim arose out of operations for which the classification stated
products/completed operations were subject to the general aggregate limit, the
insurer’s claim denial was improper. The claim was not included within the products/completed
operations hazard and therefore the exclusion for products/completed operations
hazard did not eliminate coverage. Thus, the insurer is obligated to defend
and pay damages that are the legal obligations of the janitorial service.
Additional Insured’s Sole Negligence
Most policyholders will, at some point, be required to add unrelated persons
or organizations to their CGL policies as additional insureds. The extent of
coverage required to be provided is often vague at best, usually buried in a
contract that seems to be written in Old English. Nonetheless, the insurer will
usually attach one of over 35 ISO additional insured endorsements to the policyholder’s
CGL policy.
Among the many questions that arise (and often find their way into litigation)
is the extent of coverage actually provided to the additional insured by the attached endorsement.
In particular, it is often represented that the additional insured is being
provided coverage only for liability arising out of activities of the named insured.
Sole Negligence. While this may have been the
original concept behind adding an additional insured to the policy, such restrictions
are no longer followed by the majority of courts. Additional insureds do have
coverage for their sole negligence under most of the ISO additional insured
endorsements—as long as their activities arise out of operations performed for
the named insured. Of course, other restrictions found in the additional insured
endorsement would also apply (e.g., a few have exclusions for negligence of
the additional insured).
A Texas Court of Appeals case, Admiral Insurance
Co. v Trident NGL, Inc., 988 SW2d 451, 454 (1999) summarized:
The majority view of these cases is that for liability to “arise out
of operations” of a named insured it is not necessary for the named insured’s
acts to have ”caused” the accident; rather, it is sufficient that the named
insured’s employee was injured while present at the scene in connection
with performing the named insured’s business, even if the cause of injury
was the negligence of the additional insured.
The concept of coverage for the sole negligence of an additional insured
is further illustrated in a recent (November 2002) Court of Appeals case for
Montgomery, Ohio, Danis Building Construction v Employers
Fire Insurance Company. In this case, the appeals court overruled the
trial court’s decision that an Ohio anti-indemnification statute restricted
the additional insured endorsement to provide liability coverage to Danis (the
additional insured) only for the vicarious liability of the Mitre Masonry (the
named insured). The Ohio Appeals Court stated:
No provision in either policy limits coverage [for the additional insured]
to the vicarious liability for the acts of Mitre [the named insured].
In quoting from a New York Court of Appeals case, the Danis court further stated:
A distinction must be drawn between contractual provisions which seek
to exempt a party from liability to persons who have been injured or whose
property has been damaged and contractual provisions, such as those involved
in this suit, which in effect simply require one of the parties to the contract
to provide insurance for all the parties.
It is interesting to note that ISO has recently proposed additional insured
endorsement revisions that apparently will eliminate coverage for the sole negligence
of an additional insured. So far, the proposed changes have met with mixed reviews.
Conclusion
These are just some of many situations that commonly occur in interpreting
the CGL policy. There are likely many more, maybe even with greater and more
widespread misunderstanding. It is hoped that this discussion of these situations
helps shed some light on the "flood of darkness" that sometimes surrounds the
CGL insurance policy.
This article was originally published in January 2004. While the commentary regarding the 2001 additional insured endorsements no longer applies to additional insured endorsements with later ISO edition dates (i.e., 2004, 2013), all of the other commentary is as sound today as it was in 2004. For commentary on a other areas of coverage that may be a bit more complex, see "More Coverage Misconceptions of the CGL Policy" (September 2018).