The use of absolute exclusions continues unabated, creating a myriad of problems for policyholders and claimants alike. Not only are policyholders not getting the financial security they would expect, but claimants too may also not be able to collect their damages as a result. That is not what the insurance industry is about.
One might ask, "What is the phrase that triggers the problem?" Some may think it is "directly or indirectly…." The courts and commentaries say otherwise but instead focus on "arising from," meaning "connected with." From there, the broad application began, first in reviewing that language as used in an insuring agreement favoring the insured. The following was reported by the Claims Journal in 2012.
The "arising out of" clause defines the required causal link between the uninsured vehicle and the injury. Insurers have consistently argued for a narrow interpretation of the phrase while policyholders have advocated for a broader reading.1
Insurers later opted to ask for broad interrelation of such exclusions and often got what they wanted.
Well over 30 case decisions have looked at and decided on the enforceability of these exclusions since at least 2008. Several have gone against insurance companies. Certainly, there could be more that involve policies other than specialty lines (i.e., executive liability such as directors and officers (D&O) liability, employment practices liability (EPL), or fiduciary liability, as well as professional liability of all kinds and possibly even product liability).
The Three (General) Types of Phrasing Used
The following are three general wordings to keep in mind (while noting there will be variations).
"… Arising directly or indirectly, or in any way associated with <fill in the blank> … committed by any insured … (etc. and what an insured should expect and want to see).
"… Arising directly or indirectly, or in any way associated with <fill in the blank>. However, this exclusion will not apply to where the Insured [was providing a professional service ] … (a carve back example: There are many other variations. Once again, something that an insured should expect and want to see).
" … Arising directly or indirectly, or in any way associated with <fill in the blank>." (Note the lack of any carve back or reference to the insured. These can be a problem for insureds and are accelerating in use.)
The three phrasings are in and of themselves interesting. What is even more interesting, however, is how they appear in various insurance policies. Some policies have a preamble before any exclusions are listed that simply states the following: "This policy does not provide any coverage nor any defense to any claim arising directly or indirectly from:…." Thus, all of the exclusions that follow are subject to the preamble, which is absolute in nature.
Another variation is to have each exclusion start out with absolute language, while some exclusions may refer to the insured and others may not. Some exclusions may have a carve back, while others do not, and thus, there is a mix throughout the exclusionary section as to exclusions that are limited to the actions of the insured and others that are not. In such a policy, the underwriting intent as to those exclusions that do not refer to the insured can be interpreted to exclude a far greater range of acts, including those of persons unknown to the insured.
Another example is a policy that contains a carve back at the end of the exclusionary section. In other words, it may say words to the effect, "Exclusions A, G, H, M, S, T, etc., do not apply where the insured is providing a professional service as a…." Thus, once again, the underwriting intent is clear as to those exclusions not mentioned in the carve back—those exclusions could bar coverage for a far broader range of acts, again including those of persons unknown to the insured.
Early Absolute Exclusion Cases
In June 2010, Insurance Journal's MyNewMarkets published my three-part series on the evolution of the absolute exclusion and how courts were beginning to interpret them more broadly than may have been the original intent. It was suggested in that article that, originally, the language was chosen so as to make clear to the insured that there was another policy the insured could buy to insure the excluded hazard.
For instance, an insurance brokers' errors and omissions (E&O) policy should not have to cover an employment practices claim against the insured. The brokerage should instead buy an EPL insurance policy. Yet, unless the exclusion references the insured as being the perpetrator of the wrongful employment act, and in the absence of a carve back clearly stating the exclusion won't apply where the insured brokerage was selling insurance or a bond to a customer, appellate cases began, and are still now, enforcing the applicability of the exclusion to apply where a customer or any other third party is the perpetrator.
Thus, if the insurance brokerage is sued for any matter remotely "connected with" an employment wrongful act, the brokerage may not be covered. This now suggests that the intent is no longer limited to the insured's actions, and the intent is not to cover any EPL insurance matter, no matter who was involved.
One might suggest the first case to test the enforceability of the foregoing was Jackson v. Atlantic, No. A-1526-04T5F, 2005 N.J. Super. Unpub. LEXIS 262 (Super. Ct. App. Div. Oct. 26, 2005). This case ruled in favor of the insured insurance broker who allegedly didn't provide any pollution coverage to a landlord who was eventually sued by a tenant for exposure to lead. The landlord sued the broker, whose E&O insurer denied coverage due to an absolute exclusion for pollution, with no carve back nor any limitation restricting the exclusion to the activities of the insured. The court held, in finding coverage for the broker, the following.
The appellate court affirmed the trial court's decision in favor of the broker, finding that the exclusion did not preclude coverage for the professional negligence action. The court specifically noted that the policy in question covered professional negligence for wrongful acts resulting from errors and omissions of the insured from services rendered as an insurance broker.
The insurer argued that the exclusion in the policy specifically addressed the coverage question because it included language that excluded coverage for … any litigation or administrative procedure in which an Insured may be involved as a party; arising directly, indirectly, or in concurrence or in any sequence out of actual, alleged or threatened existence, discharge, dispersal, release or escape of "pollutants".…
The court dismissed the concept that the "indirect" language contained in the pollution exclusion somehow supported the potential applicability of the pollution exclusion to the allegations of professional negligence. Finding that the origin of the pollution was irrelevant, the court focused on the claim in controversy, which involved professional negligence and not pollution stemming from the broker's premises or acts. The court further noted that the broker's (as the insured) reasonable expectations of coverage would also support a finding of coverage in this circumstance. Thus, the court summarily dismissed the insurer's arguments.
Similarly, in 2009, the US District Court for the Northern District of California, in deciding California law, ruled in S.J. Amoroso Constr. Co. v. Executive Risk Indem., Inc., No. C 06-2572 SBA, 2009 U.S. Dist. LEXIS 116080 (N.D. Cal. Dec. 11, 2009). This case involved a D&O liability policy containing an absolute exclusion for contractual liability, with the court holding the following.
[A]n exclusion within a D&O policy which precluded coverage for claims "arising from" liability "under any written or oral contract or agreement" did not bar coverage where the insured was not a party to the contract at issue and thus had no liability under it.
However, few favorable decisions for insureds have been seen since, including the aforementioned New Jersey and California courts, where rulings have since gone the other way.
In 2008, the case of James River Ins. Co. v. Ground Down Eng'g, Inc., 540 F.3d 1270 (11th Cir. 2008), was decided. This case involved a Florida-based engineering firm that, although not mentioned in the opinion, does 100 percent environmental testing of land (also known as Site 1 Surveys). After failing to find any pollution at a particular site, they were sued when it was determined they were wrong.
James River denied coverage based on an absolute exclusion that was not limited to the acts of the insured and did not have any carve back for professional services. Florida is a strict adherent to the four-corners rule, a doctrine that states that, in the event of ambiguous terms, the court should rely solely on the relevant written instrument. In part due to this adherence, the trial court found the exclusion was clear and unambiguous and ruled in favor of James River.
Subsequently, an appellate court reversed the decision due to the fact the engineering firm hadn't created the pollution and was only providing a professional service. In other words, Ground Down was not the cause nor the source of the pollution. That decision was reversed by a higher court based on the four-corners rule. The court held causation was not relevant (a theory that has been followed by many states since).
In addition, the court briefly addressed the issue of illusory coverage. The court stated that other engineering services giving rise to claims would be covered, and thus, the policy was not illusory. This argument is questionable given the fact that the insured only did environmental-related services. Other cases have resulted in rulings that coverage is not illusory if only one type of claim is covered—despite premium costs that are more in line with more complete and less limited coverage.
Many cases have since followed the concept that causation isn't a factor, leaving large potential gaps in one's policy and, thus, one's financial security.
Lines of Business Particularly Impacted by Absolute Exclusions
The usage of absolute exclusions that are not limited to the actions of the insured exists in most types of specialty lines insurance policies. What is interesting is to what extent.
Those insuring hazards that seemed to have the most exclusions that go beyond the activities of the insured are found in the following.
Miscellaneous professional liability policies
D&O liability policies
Insurance agent and broker E&O policies (especially)
When one looks at the vast number of exclusions not limited to the actions of the insured that exist in insurance agent and broker professional liability policies, it is rather extraordinary considering the industry's reliance on agents and brokers. Many other hazard groups have a mix where some policies have a few absolute exclusions, and some policies have a few more.
What is interesting is the hazard group that has the fewest absolute exclusions for acts that arise from someone other than the insured. That group is lawyers, with accountants a close second. Some lawyers professional liability policies have no absolute exclusions involving a third party, as every exclusion refers to the "insureds" (a favorable approach for those insureds). In other words, attorneys need not worry about working on a wrongful termination or discrimination case or an environmental case—but an insurance broker may not have any coverage for selling an EPL insurance or pollution policy due to an absolute exclusion with no carve back for simply selling or placing the coverage.
Public Policy Issues/Insurance Maxims and Absolute Exclusions
The Duty To Read the Policy
There are many US court decisions that look at the duty of an insured to read the policy. Even in the event that they do closely read their policies, would any "civilian" policyholder realize how a court would interpret the intent of the policy? Only the court can determine the intent. Policyholders, other than coverage lawyers, will have difficulty knowing how the courts may interpret an absolute exclusion. Thus, the only time an insured learns that there is a problem is after it has submitted the claim—when it is expecting assistance. This is not a time anyone wants surprises.
That also begs the question as to whether or not every policyholder will now have to seek the advice of counsel to review the policies they are thinking of buying or have purchased to determine whether or not they are properly covered. That would be cost-prohibitive for most and anticonsumer to some extent. The industry would benefit from regulators examining this problem.
Insurance Policies as Contracts of Adhesion
It has long been held that insurance contracts are considered contracts of adhesion. According to the IRMI Glossary definition of contract of adhesion, it is a contract between two parties where the terms and conditions are drafted by the party with superior bargaining power (typically a business) and the other party (typically a consumer) has little or no ability to negotiate more favorable terms. As a result, the consumer is placed in a take it or leave it position. Courts scrutinize adhesion contracts and will sometimes void certain provisions on the basis that the provisions are unconscionable and are the product of unequal bargaining power. One has to ponder why that argument has not been raised regarding absolute exclusions.
One argument related to the "adhesion" theory is whether such absolute language is "unconscionable." What makes a contract unconscionable?2 A contract may be found to be unconscionable based on five different factors.
Undue influence. This is where one party exercises unreasonable pressure to get the other party to sign the contract (especially where one party takes advantage of the other in some way).
Duress. This is where one party uses threats to get the other to agree to the contract terms. This can take the form of physical or other types of threats (such as not releasing goods in the proper way until the other party signs).
Unequal bargaining power. This occurs where one party has an unreasonable advantage over the other. This is usually proved if one party is aware that the other obviously did not understand the contract terms.
Unfair surprise. When the party who creates the contract includes a term in the contract without the other parties' knowledge and is not within the other party's expectations.
Limiting warranty. A contract would be unconscionable if one party tries to limit their liability to a breach of contract or to any damages that he may incur on other party.
Unlike contracts of adhesion, courts generally will not enforce unconscionable contracts. Courts will not enforce the contracts because they are considered too unfair. Unconscionability is a defense to contract formation. If one party is sued for breaching a contract, he might argue that the contract itself was unconscionable, therefore, the contract was not a legal contract and he cannot be forced to comply with its terms. To determine whether a contract is unconscionable, the courts will usually require that the contract be both procedurally and substantively unconscionable.
Of course, "the courts" are something one hopes to avoid when one submits a claim to one's insurer. These arguments seem to be lacking in proinsurer decisions regarding absolute exclusions. Should the four-corner rule supersede?
The Reasonable Expectation of the Insured To Be Covered
The following is described by US Legal.
The reasonable expectation doctrine is a principle applied in insurance law which states whenever there is an ambiguity in an insurance policy, it is resolved in favor of the insured's reasonable expectations. Usually, an ambiguity arises when there are plausible, competing interpretations of a policy term. Ambiguity is an essential prerequisite to application of the reasonable expectation doctrine.
The "expectation" of the insured is a tough sell to the courts when predicated on whether the language is ambiguous or not. Most decisions find the exclusions to be (patently or on their face) unambiguous. But what about latent (i.e., hidden) ambiguities? Can we expect insureds to know their claim could be denied not because of the insured's actions but due to the acts of others over whom they have no relationship nor control?
Fair Claim Practice Regulations
The National Association of Insurance Commissioners has long championed consumer protections with respect to insurance company operations. In the late 1980s, they drafted fair claim practice regulations that were adopted by most states in some form. Often, the states implemented the fair claim practice regulations exactly as written. The same is true of unfair trade practices of insurance companies. Unfair claim practices were, in fact, defined.
The one pertinent definition states that unfair claim practices involve "knowingly misrepresenting to claimants and insureds relevant facts or policy provisions relating to coverage." Section 4 of the Unfair Trade Practices defined an unfair trade practice as being "a misrepresentation of the benefits, advantages, conditions or terms of any policy." Section B also considered an unfair trade practice as the following.
[T]o give out false information and advertising by making, publishing, disseminating, circulating, or placing before the public any assertion or a representation or statement with respect to the business of insurance or with respect to any insurer in the conduct of its insurance business which is untrue, deceptive, or misleading.
One could argue, for example, that an absolute bodily injury exclusion in an EPL insurance policy that effectively eliminates emotional distress damages from coverage could fit the definition of an unfair trade practice. This is enhanced by the fact that insurers often advertise that they are providing a broad definition of "wrongful act," yet they are silent on advising that many of the losses that thereafter arise from a wrongful act are excluded.
These issues continue to evolve and not favorably for insureds or their brokers. For more on this and a review of 30 appellate cases, please refer to the IRMI reference service Professional Liability Insurance for a more in-depth review.
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