978-0077733711 Chapter 27 Lecture Note

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Chapter 27 – Insurance Law

CHAPTER 27

INSURANCE LAW

I. OBJECTIVES:

This chapter is designed to acquaint students with important components of insurance law and to

familiarize them with specialized concepts and issues that relate to specific types of insurance.

After reading the chapter and attending class, a student should:

A. Understand the nature of an insurance relationship and the benefits each party to such a

relationship receives.

B. Understand how major concepts of contract law apply to insurance contracts.

C. Understand the nature of property insurance and fundamental concepts associated with this

type of insurance.

D. Understand the nature of liability insurance and fundamental concepts associated with this

type of insurance.

E. Understand issues that arise when an insurer is sued for bad faith breach of an insurance

contract.

In addition, see the Learning Objectives that appear near the beginning of the chapter.

II. ANSWERS TO INTRODUCTORY PROBLEM:

A. Even though wind is a typical covered peril in property insurance policies, floods are

typically an excluded peril. Whether losses stemming from Hurricane Katrina are covered

under the typical policy would depend on whether they are losses caused by wind or losses

caused by flood.

B. The typical exclusion for floods. See above.

C. The former losses would be more clearly wind-caused, whereas the latter losses would be

potentially subject to an argument by the insurer that they resulted from an excluded peril:

flood.

D. Some of each. The relationship resembles that of contracting parties in the sense that the

insurer and insured are on opposite sides of a contract. Yet the relationship differs from the

usual relationship of contracting parties because of the “we’ll take care of you” assurances

that insurers furnish to insureds. In this relationship, the insurer clearly has the dominant

bargaining power in the sense of establishing the policy’s terms. Moreover, the insurer is the

drafter of the policy. These aspects of the insurer-insured relationship are taken into account

in the judicial approaches to insurance policy interpretation (discussed later). In addition, the

special nature of the insurer-insured relationship (recall the “we’ll take care of you”

provisions) serves as a reason why the bad-faith breach doctrine (discussed later) has been

recognized in the insurance setting.

E. The various legal obligations are detailed throughout the chapter. As for ethical obligations,

engage the student in discussion of the possibilities. Possibilities include duties to act in good

faith, disclose material information, avoid overreaching, and the like. Note the extent to

which such ethical obligations may translate into legal duties.

F. Presumably not, because the focus in insurance policy interpretation is on the terms of the

parties’ agreement rather than on what the “public interest” supposedly requires. However,

the parties and perhaps even courts may find it difficult to “tune out” the magnitude of a

disaster such as Hurricane Katrina.

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Chapter 27 – Insurance Law

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Chapter 27 – Insurance Law

G. Courts play a key role in interpreting insurance policy provisions, as numerous examples in

the chapter indicate.

H. Much of the content of insurance policies left to the market, but legislatures and government

agencies sometimes mandate certain provisions. When certain provisions are required by the

government, a consumer protection rationale is normally present.

III. SUGGESTIONS FOR LECTURE PREPARATION:

A. Introduce the topic by noting the function of insurance: to allow parties to shift, to someone

else, a risk of loss they would otherwise have to bear. Describe the nature of the insurance

relationship and note the benefits each party to such a relationship presumably obtains.

B. As a transition from the introductory discussion to the discussion of insurance policies as

contracts, clarify basic insurance terminology (insurer, insured, premium, peril, etc.).

C. Note that because insurance policies are contracts, important aspects of contract law apply to

insurance policies.

1. Explain how the offer, acceptance, and consideration elements of a contract relate to the

insurance setting. Note the issues that may arise when the insurer delays in responding to

an application for insurance. Explain the effect of an insurance binder.

Stuart v. Pittman (p. 746). The plaintiff entered into oral agreement with the defendant’s

agent, Pittman, regarding construction insurance for plaintiff’s new home. The defendant

agreed to create a new policy for the construction of the new home, which was to be

effective as of September 1, 2003. The plaintiff never received a written policy and in

January of 2004, an ice storm caused severe, irreparable damage to the home. The

plaintiff contacted the defendant, and in March of 2004, the defendant stated that the

additional coverage was added to the plaintiff’s initial policy so that the plaintiffs would

be covered. On the contrary, the policy that the defendant issued contained explicit

language that barred recovery for faulty workmanship, mold, and damage caused by

water backup. The plaintiff stated that the defendant was under an oral binder and even if

the defendant was not, that the defendant never delivered a written agreement. The trial

court awarded the plaintiff $268,417. The appellate court reversed, stating that there was

insufficient evidence to create an oral binder and that the plaintiff could not have been

harmed due to the fact that he never received a written agreement. The Supreme Court of

Oregon reversed the appellate court and affirmed the judgment of the trial court.

Points for Discussion: An oral binder can be created if the terms are clear and express, in

which case the terms of the initial agreement will be superseded. The terms “safety net”

and “catch basin” used in the context of “in all instances something goes wrong during

construction” were deemed clear and express by the Supreme Court. Attorneys fees were

awarded as well.

2. Note, in general, the potential effect of an insured’s misrepresentation in connection with

an application for insurance.

a. Highlight the distinction between warranties and representations and the respective

legal treatments they have traditionally received.

3. Mention that capacity of parties is seldom an issue with regard to insurance contracts.

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Chapter 27 – Insurance Law

4. Note the distinction between lawful insurance contracts and unlawful wagering

agreements: insurance contracts transfer existing risks, whereas wagering agreements

create new risks that did not previously exist. Note that the insurable interest requirement

(to be discussed later) is a major device for separating insurance contracts from wagering

agreements.

Examples: Problem Cases #2 and #10.

5. At the risk of being overly obvious, note that insurance policies are almost always

reduced to written form–on the insurer’s standard form, of course–regardless of whether

applicable state law requires a writing. What if, in the judgment of at least one of the

parties, the written policy does not set forth the parties’ actual agreement? The question

then becomes whether there should be reformation of the written policy, so as to make it

conform to the parties’ true agreement.

a. Note that one who seeks reformation–usually the insured–is generally in for an

uphill fight. Courts start off presuming that the written policy accurately sets forth the

parties’ agreement, thanks to the usual contract law approach of not making it easy

for parties to undermine the stability of the written instrument. Most courts refuse to

grant reformation to an insured unless the insured proves either mutual mistake

regarding a supposedly covered event other supposed contract term, or fraud or other

inequitable conduct on the part of the insurer. This will normally be a tall order for

the insured. Example: Problem Case #7 (Ridenour v. Farm Bureau, formerly a text

case).

6. Discuss major principles of insurance contract interpretation.

a. Note that courts generally interpret insurance policy provisions as they would be

understood by an average person. This is especially true of technical language in

insurance policies.

1) Although courts take this approach because they recognize that many purchasers

of insurance do not have the background necessary to enable them to understand

technical terms, it does not mean that insureds are relieved of the previously

discussed obligation to at least make reasonable efforts to read and understand

their policies. Neither does this approach lessen the practical importance of an

insured’s seeking competent advice (as set forth above) when he or she does not

understand a policy provision.

b. If ambiguities are present in the policy, extrinsic evidence of the parties’ intent may

be relevant. See Problem Case #1.

c. Discuss the typical approach of construing ambiguities against the insurer (the

drafter of the contract).

1) Note why this approach would not have aided the insured in Problem Case #7

(Ridenour v. Farm Bureau): the coverage language used in the written policy was

unambiguous.

Examples: Problem Cases #3 and #4.

d. Mention the reasonable expectations of the insured approach. Note that whether this

approach adds anything to what has already been discussed depends upon what

formulation of the reasonable expectations doctrine has been adopted by a given

state.

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Chapter 27 – Insurance Law

7. Discuss, in a general sense, the fact that states frequently require certain policy

provisions, policy formats, and policy language (including the use of nontechnical

language where possible, etc.).

a. As noted in the text, the business of insurance is heavily regulated by the states. The

Global Business Environment box at p. 754 discusses a constitutional challenge to a

California statute, the Holocaust Victim Insurance Relief Act (HVIRA). This statute

required the reporting of Holocaust-era insurance policy-related information by

insurers that do business in California and are affiliated with companies that sold

Holocaust-era policies. The necessary information contemplated by HVIRA

frequently would be in the hands of companies located in Europe rather than in the

United States. The U.S. Court of Appeals for the Ninth Circuit rejected arguments

that HVIRA violated the U.S. Constitution’s Commerce Clause and its guarantees of

due process and equal protection. As explained in the Global Business Environment

Box, however, the U.S. Supreme Court held in American Insurance Association v

Garamendi, 539 U.S. 396 (2003), that HVIRA was unconstitutional because it

interfered too greatly with the federal executive branch’s power to conduct foreign

policy.

8. Note the typical importance of the insured’s furnishing the insurer suitable notice and

proof of a loss-causing event, and of the insured’s doing so within the time limits

established by the insurance policy.

9. Briefly discuss cancellation and lapse of policies.

10. Discuss the fundamental concepts of performance and breach by the insurer.

a. Note the compensatory damages recoverable by the insured in the event of the

insurer’s breach. Explain why the amount of these breach of contract damages may

exceed the dollar limits set forth in the policy, and why these damages may include

recovery for consequential losses even when the policy contained a provision stating

that the insurer was not obligated to pay for consequential harms. The explanation is

simple: the insurer gets the benefit of policy provisions that limit its payment

obligation (e.g., clause setting forth policy limits, clause saying no coverage for

consequential harms, etc.) only if the insurer complies with its obligations under the

policy. If the insurer commits a breach of contract by not living up to its obligations

under the policy, the insurer cannot hide behind policy provisions in an attempt to

limit the damages recoverable by the insured.

Example: Problem Case #8 (an especially good vehicle for class discussion of the

above).

1) Note that the damages recoverable by the insured in the event of the insurer’s

breach are limited to compensatory damages if the insurer’s breach consisted of a

good faith (though erroneous) denial of the insured’s claim. If the insurer’s

breach sank to the level of bad faith breach (a subject to be addressed at the end

of the chapter), punitive damages are also recoverable.

D. Discuss property insurance.

1. Introduce the topic by briefly noting the nature of property insurance and why it is

important from an insured’s standpoint.

2. Explain the insurable interest concept. Note why such an interest is required and when it

must exist in order to support a recovery under the policy. Give some typical examples of

what would constitute an insurable interest. Emphasize that the extent of a person’s

insurable interest controls the extent of her recovery under the policy.

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Examples: Problem Cases #2 and #10.

3. Discuss the difference between covered and excluded perils and note the ways in which

property insurance policies attempt to define the causes of loss that are and are not

covered.

a. Provide examples of typical covered perils such as fire, lightning, hail, wind, and

others set forth in the text.

b. Engage in particular discussion of fire as a covered peril. (Note the text’s discussion

of the historical use of the term “fire insurance” even when perils other than fire are

covered by a policy.)

1) Note that policies make the commonsense coverage distinction between

accidental fires and fires set deliberately by the insured for the purpose of

damaging the property.

2) Explain the frequently used coverage distinction between hostile fires and

friendly fires.

c. Provide examples of typical excluded perils, such as floods, earthquakes, and others

listed in the text. Refer again to the chapter’s introductory problem concerning

Hurricane Katrina-related losses. Note the possibility of purchasing additional

coverages or a specialized policy, if the insured wishes to have coverage for a

particular peril that is normally an excluded peril.

1) Stress that in any dispute over whether something is a covered, or instead an

excluded, peril, the language of the particular policy at issue must always be

consulted.

Stor/Gard, Inc. v. Strathmore Insurance Company (p. 755). Store/Gard, the insured party,

was suing for coverage on a claim that Strathmore denied. The claim emanated from

excessive rain, which “caused” a landslide and serious property damage to the adjacent

buildings. The circuit court awarded summary judgment for Strathmore, as Stor/Gard

could not satisfy the “predominant cause” or “train of events” test. This test stated that for

events that involve concurrent causes [i.e., both included and excluded causes], the

insured party must prove that the predominant cause of the damage was the covered

event. In the case at bar, Stor/Gard, whose property was inspected by a professional,

attempted to argue that a broke water pipe caused the majority of the damage. The

expert’s report, however, indicated that only 2% of the damage was caused by the water

pipe bursting [a covered event]. The other 98% was caused by a landslide [an uncovered

event]. Therefore, Stor/Gard could not prove that the covered event was the predominant

cause of the damages and summary judgment was affirmed.

4. Note that although the discussion so far has been largely in terms of insurance on real

property, personal property is, of course, insurable too.

a. Generally note how homeowners’ policies provide coverage for personal as well as

real property.

b. Point out the extent to which automobile insurance policies furnish property

insurance coverage.

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Chapter 27 – Insurance Law

c. Mention the importance, to lessees of residential or commercial real estate, of

obtaining insurance coverage on their personal property.

5. Discuss the nature and extent of the property insurer’s payment obligation. Explain the

operation of the typical policy provisions that help define the extent of the insurer’s

payment obligation: usually cost of repair, in the event of property damage but not total

destruction; and either actual cash value or cost of replacement, in the event of

destruction of the insured property.

a. Explain the distinction between valued policies and open policies, noting that most

property insurance policies are of the latter variety.

b. Discuss two other specialized provisions, coinsurance clauses and pro rata clauses,

noting how each may further define and limit the property insurer’s payment

obligation. Illustrate how such clauses are applied by using hypotheticals similar to

those set forth in the text.

6. Explain the right of subrogation that operates in favor of a property insurer when it pays

its insured’s claim for property damage.

7. Discuss general concepts connected with the duration and cancellation of property

insurance policies. Note the typical limited bases on which a property insurer may be

allowed, upon proper notice, to cancel a policy.

a. Discuss increase of hazard clauses and note how they may furnish the insurer with

both a defense to liability under the policy and a basis for cancellation of the policy.

Example: Problem Case #5.

E. Discuss health insurance.

1. Although health insurance is not an extensively treated topic in the chapter, Figure 1

discusses major aspects of the Patient Protection and Affordable Care Act, which

Congress enacted in 2010. Figure 1 appears at p. 761 of the text. Note the major features

of this wide-ranging statute, as summarized in Figure 1. Also note the constitutional

challenges, which the Supreme Court will (has) resolve(d).

2. The Ethics in Action box at p. 770 mentions selected health insurance-related legal issues

and outlines ethical issues that attend the debate over the public’s access to health

insurance. The issues identified in the Ethics in Action box should lead to lively

classroom discussion.

F. Discuss liability insurance.

1. Explain the nature and purposes of liability insurance.

2. Note the major types of liability insurance policies mentioned in the text (personal

liability, business liability, professional liability, and workers’ compensation liability).

Note that some insurance policies (e.g., automobile policies and homeowners’ policies)

combine features of property insurance and liability insurance.

3. Provide an overview of the sorts of liabilities typically insured against under each major

type of policy. Note, for instance, the personal liability policy’s frequent focus on bodily

injury or property damage stemming from an “occurrence,” which is usually defined in

terms of an accidental happening. Also note that under business liability policies, whether

a given liability is covered generally depends upon whether it stems from the “conduct of

business” by the insured or the insured’s employees. The insured’s intentional behavior of

a wrongful nature usually will not be covered, regardless of the type of liability policy

(though some business liability policies may provide coverage for defamation, which is

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Chapter 27 – Insurance Law

classified as an intentional tort). Determining whether a given liability is covered by a

policy requires close examination of relevant policy language and frequently necessitates

application of contract interpretation techniques discussed earlier in the chapter.

Francis v. Allstate Insurance Company (p. 763). Francis and her minor

made defamatory comments about Mr. Towers, an instructor at Francis’

minor’s school. Mr. Towers was adversely a!ected by the comments

and pursued litigation as a legal recourse. At the time, Francis was

insured through Allstate [∆ in the case at bar] for liabilities and other

accidents. Here, however, Allstate refused to cover Francises because

their statements were not an accident. The Francises rebut Allstate’s

assertion by stating that their comments were meant to protect

themselves and prevent any harm from coming to them. Allstate

countered with the fact that just because the insured’s claim did not

intend to cause harm does not mean that they are accidental. The

term “accident” applies to the insured’s act itself, not the

consequences of the actions. The court a,rmed the judgment of the

district court.

Other Examples: Problem Cases #1 and #4.

4. Discuss the insurer’s major obligations under a liability insurance policy.

a. Explain the duty to defend and what it entails. Note the declaratory judgment and

reservation of rights options frequently pursued by insurers when it is not clear

whether the duty to defend applies or does not apply.

Examples: Medmarc (text case discussed below); Problem Case #9; AOL case

(thoroughly discussed in Cyberlaw in Action box at p. 769 of text).

Medmarc Casualty Insurance Co. v. Avent America, Inc. (p. 766): The Seventh

Circuit holds that Medmarc had no duty to defend a class action lawsuit filed against

its insured, Avent, where the policy terms referred to claims for “bodily injury” and

there were no allegations of bodily injury in the complaint. Rather, the complaint

alleged only economic loss resulting from the purchase of a product that the

purchasers ended up not using because of safety concerns.

Points for Discussion: Have a student summarize the basic allegations in the

underlying class action lawsuit. Then ask what the critical policy language was.

(The “because of bodily injury” language.) According to the court, what is the

standard for whether a liability insurer has a duty to defend? (Whether the claim

against the insured is even potentially within the terms of the policy). Here, why was

the class action claim not even potentially within the terms of the policy? (It lacked

allegations of bodily injury from use of the cups. In addition, the complaint

suggested that the concerned parents did not even have their children use the

purchased cups, because they had concerns about potential adverse health effects for

their children.) In the end, this was a claim for economic loss not tied to any bodily

injury, and thus was not a claim as to which Medmarc needed to provide its insured a

defense.

b. Explain the duty to pay sums owed by the insured. As part of this explanation, discuss

the liability insurer’s role in negotiating settlements of claims. Note the strategic

concerns that affect the insurer’s decision on whether to settle a claim.

5. Discuss the major arguments on each side in the debate over whether there is a liability

insurance crisis and, if so, what to do about it.

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Chapter 27 – Insurance Law

G. Discuss the cause of action for bad faith breach of insurance contract and note courts’

increased inclination to recognize this claim in recent years.

1. Explain that this cause of action is a tort claim, not merely an ordinary breach of contract

claim. Note that the bad faith claim cannot be made out when the insurer possessed a

plausible (though erroneous) reason for not performing its policy obligations. The bad

faith claim arises when the insurer’s policy obligations were clearly triggered but the

insurer, with no reasonable justification, nonetheless refuses to perform–or unreasonably

delays in performing–its duties. Examples: Problem Cases # 6 (illustrating difference

between ordinary breach of contract case and bad faith case) and #8.

2. Note the significance of this claim’s being a tort (intentional tort, to be more specific)

action: punitive damages become available in addition to compensatory damages. This

obviously increases the potential for a large award if the plaintiff is successful.

3. Provide other examples of the types of situations in which bad faith liability has been

recognized. Publications such as the Wall Street Journal and the National Law Journal

are good sources of current examples.

IV. RECOMMENDED REFERENCES:

A. LEE R. RUSS, COUCH ON INSURANCE.

B. ERIC M. HOLMES, HOLMES‘S APPLEMAN ON INSURANCE.

C. BUIST M. ANDERSON, ANDERSON ON LIFE INSURANCE.

D. ROBERT E. KEETON & ALAN I. WIDISS, INSURANCE LAW: A GUIDE TO FUNDAMENTAL

PRINCIPLES, LEGAL DOCTRINES, AND COMMERCIAL PRACTICES.

E. JOHN F. DOBBYN, INSURANCE LAW IN A NUTSHELL.

F. ROBERT H. JERRY, UNDERSTANDING INSURANCE LAW.

G. BARRY R. OSTRAGER, HANDBOOK ON INSURANCE COVERAGE DISPUTES.

H. Ellen S. Pryor, The Tort Liability Regime and the Duty to Defend, 58 MD. L. REV. 1 (1999).

I. Kent D. Syverud, The Duty to Settle, 76 VA. L. REV. 1113 (1990).

J. Roger C. Henderson, The Doctrine of Reasonable Expectations in Insurance Law After Two

Decades, 51 OHIO ST. L.J. 823 (1990).

K. Jeffrey W. Stempel, Unmet Expectations: Undue Restriction of the Reasonable Expectations

Approach and the Misleading Mythology of Judicial Role, 5 CONN. INS. L.J. 181 (1998).

L. Frona M. Powell, Insuring Environmental Cleanup: Triggering Coverage for Environmental

Property Damage Under the Terms of a Comprehensive General Liability Insurance Policy,

71 NEB. L. REV. 1194 (1992).

M. Jeffrey W. Stempel, Unreason in Action: A Case Study of the Wrong Approach to Construing

the Liability Insurance Pollution Exclusion, 50 FLA. L. REV. 463 (1998).

N. Rebecca M. Bratspies, Splitting the Baby: Apportioning Environmental Liability Among

Triggered Insurance Policies, 1999 BYU L. REV. 1215.

O. William T. Barker, Evidentiary Sufficiency in Insurance Bad Faith Suits, 6 CONN. INS. L.J. 81

(1999).

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