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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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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
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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Chapter 27 - Insurance Law
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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