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Should the more sophisticated get less insurance coverage?

Contra proferentem is not a South American political party. Rather, it is a fancy term for a fairly simple, well-accepted rule that ambiguities in an insurance policy are to be construed against the insurance company.

This rule was clearly articulated in Vargas v. Insurance Company of North America when a federal district court said that an "ambiguous provision in an insurance policy is construed most favorably to the insured and most strictly against the insurer. The insurer bears a heavy burden of proof, for it must establish that the words and expressions used in the insurance policy not only are susceptible of the construction sought by the insurer, but that it is the only construction which may fairly be placed on them." The court went on to say that "The insurer is obliged to show that (1) it would be unreasonable for the average man reading the policy to construe it as the insured does, and (2) its own construction was the only one that fairly could be placed on the policy."

Contrary to the suggestions of some insurance companies, this principle of construction is not the recent creation of aggressive policyholders' lawyers. As long ago as 1901, the U.S. Supreme Court, in Liverpool & London & Globe Insurance Co. v. Kearney, held: "The general rule ... is . . . that where a policy of insurance is so framed as to leave room for two constructions, the words used should be interpreted most strongly against the insurer."

More than 25 years ago, Samuel Williston in A Treatise on the Law of Contracts, citing a raft of decisions extending decades back, noted that the "well-established" and "inviolate" contra proferentem rule had been "repeated in the decided cases with almost monotonous regularity." Mr. Williston was not a secret advocate for policyholders, nor did he harbor any particular animosity for insurance companies. Nonetheless, his strong view was that the rule should be construed "strictly and most strongly against the insurer and liberally in favor of the insured so as to effect the dominant purpose of indemnity or payment to the insured, especially where a forfeiture is involved, since the forfeiture of insurance policies is not favored by the courts."

Whether or not the contra proferentem rule is applied in any particular insurance coverage dispute is critical because it may determine the outcome of the dispute. In recent years, many courts have continued to apply the rule in insurance coverage disputes. One of the most recent applications was made in December 1988 by U.S. District Judge Jack Weinstein in Uniroyal, Inc. v. The Home Insurance Co. In the decision, Judge Weinstein vigorously applied the contra proferentem rule in construing a comprehensive general liability policy to provide coverage for $12 million in liability and defense costs that had been incurred by the plaintiff, Uniroyal.

Despite the strength and widespread application of the contra proferentem rule, some courts have declined to follow it in cases in which policyholders were large companies and sophisticated in their insurance knowledge. Most recently, in April 1989, in his decision in Diamond Shamrock Chemicals Co. v. The Aetna Insurance Co., Reginald Stanton, a Superior Court judge in New Jersey, considered whether Diamond Shamrock's comprehensive general liability policies provided coverage for the many millions of dollars of environmental liabilities the policyholder had incurred. In making his determination, Judge Stanton specifically found that Diamond Shamrock "was a highly knowledgeable purchaser of insurance with a substantial amount of bargaining power in the insurance market." Substantially influenced by that factual finding, Judge Stanton also found that the policies did not provide coverage for any of the environmental liabilities. He expressed his strong disagreement with several other New jersey decisions, including a number of appellate decisions, that had construed the so-called pollution exclusion" favorably to policyholders.

In the past, other courts similarly have rejected application of the contra proferentem rule when the policyholder has been a large, sophisticated entity with perceived bargaining power or insurance expertise. However, in those cases, the critical factor for the courts in rejecting the rule's application appears to have been whether the provisions, whose interpretation was at issue, were drafted by the insurance company. For example, in McNeilab, Inc. v. North River Insurance Co., while the New Jersey federal district court appeared to endorse rejection of the contra proferentem rule "in disputes as to policies between a large corporation and a large insurance company, both of which were advised by competent counsel at the time of the agreement," the court went on to find that the policy terms and provisions were negotiated. Conversely, many courts have applied the rule even in cases in which the policyholder was "large and sophisticated."

Contra proferentem undoubtedly applies when the policyholder is an individual or small entity with virtually no expertise in insurance matters and no ability to bargain with the insurance company over the terms of a policy being purchased. However, rejection of the application of the contra proferentem rule may seem justified when policyholders are "large, sophisticated" companies, which are perceived to hold an advantageous bargaining position relative to their insurance companies. Thus, they are better able to negotiate with insurance companies. Indeed, characterizing the contra proferentem rule as a "contra insurer rule," at least two commentators, Stephen H. Cohen and Kathryn L. Quaintance, argued in a recent article in the Environmental Claims Journal that "In the business context, where the insured is a powerful corporation, the automatic application of the [contra proferentem] doctrine operates as a systematic bias against insurers which are put at a distinct disadvantage. Where the drafter does not occupy a substantially advantageous position, there is no rationale for the application of contra proferentem." However, that analysis is too superficial. In focusing on whether contra proferentem ought to be applied in construing standard form policies, thoughtful analysis of the insurance industry and knowledge of how the significant provisions of those policies are drafted are necessary. Indeed, such analysis establishes that the application of the rule should be based not on some sort of big-guy-vs.-little-guy" negotiating disparity but on the unique nature of the insurance industry and the manner in which standardized insurance provisions are created and used. When the analysis is complete, the natural conclusion is that the contra proferentem rule should be applied in construing standard form policies that have been drafted by the insurance companies selling them, regardless of the size or sophistication of the policyholder.

More Than just Contracts

The courts have long recognized that the insurance industry occupies a position of utmost trust regarding its policyholders. Moreover, the business of insurance affects the public interest. Insurance companies, therefore, are not viewed as ordinary businesses, for they are "duty bound to be cognizant of the public interest," according to the case of Abramson v. Kenwood Laboratories, Inc., which was decided by the New York Supreme Court in 1961 (and reversed in 1962).

In the frequently cited decision of Egan v. Mutual of Omaha Insurance Co., the Supreme Court of California in 1979 illuminated the inherent public nature of insurance: "The insurers' obligations are ... rooted in their status as purveyors of a vital service labeled quasi-public in nature. Suppliers of services affected with a public interest must take the public's interest seriously, where necessary placing it before their interest in maximizing gains and limiting disbursements. . . . The obligations of good faith and fair dealing encompass qualities of decency and humanity inherent in the responsibilities of a fiduciary. Insurers hold themselves out as fiduciaries, and with the public's trust must go private responsibility consonant with that trust." Accordingly, insurance policies and insurance companies' treatment of all their policyholders, regardless of their size, must be viewed in this light.

Drafting Standard Form Policies

The terms of standard comprehensive general liability policies and other standard policies are not developed on a policy-by-policy basis, or even on an insurance-company-by-insurance-company basis. Rather, members of the insurance industry are collectively permitted to develop and use standard insurance terminology pursuant to a special exemption from application of the federal antitrust laws. The exemption has a profound effect on how insurance companies conduct their business. They are permitted to communicate with each other and explicitly agree on exactly what risks they will insure and what policy forms they win all use to insure those risks on a standardized basis. (The recent antitrust complaint of 19 states and numerous private plaintiffs, grounded partly on the collective action of insurance companies agreeing on restrictive standard policy terms, was dismissed on the basis of the McCarranFerguson antitrust exemption.)

Collusion, or perhaps communication, among insurance companies is permitted because it is recognized that the business of insurance is vested with a special public interest that makes such communication, agreement and uniformity of risk desirable. If that were not the case, the risk being issued would vary in each instance and the historical loss data relied upon by the insurance industry in writing insurance would lose that meaning. In fact, special public policy concerns in the insurance area have influenced many states to adopt "standard policy" statutes requiring certain specified uniform provisions in various forms of insurance.

The language and selection of the provisions for standard form policies are not only the choice of the insurance company; they are created and used only after intense study by the legal advisers of insurance companies. The advisers study the decisions of the courts and have ample opportunity to identify the precise risk that they intend to insure.

The various states' regulatory schemes for the insurance industry also encourage the use of uniform provisions. In most states, before insurance companies may use provisions in insurance policies to be sold by them, they must submit the provisions for approval, either directly or through an industry rating organization acting as their agent, to the state's department of insurance. For instance, in Ohio, the superintendent of insurance actively regulates the insurance business. Every insurance company, either directly or through a licensed rating organization, is required to file with the superintendent "every form of a policy, endorsement, rider, manual of classifications, rules and rates, every rating plan, and every modification of any of them which it proposes to use." The superintendent must then examine the filing and determine whether it is in compliance with the provisions of the code. Similarly, in New York, policy forms must be filed with the superintendent of insurance.

When it submits the standard provisions to the various state departments of insurance for approval, the rating organization often explains the meaning and effect of a proposed new provision. For example, when the pollution endorsement was submitted to state insurance departments for approval in 1970, the insurance companies' rating organization "explained that the intent of the clause was to clarify that the definition of occurrence [in standard comprehensive general liability policies] excludes damages that can be said to be expected or intended." In reviewing the provisions submitted by insurance companies or their agents, the state departments of insurance act on behalf of the public, including all present and future policyholders.

In accordance with this attempt at creating and obtaining approval for uniform policy provisions, almost all standard form comprehensive general liability policies are not drafted by an individual insurance company but by committees of the insurance industry's rating organizations.

Once a standard policy or provision is drafted and agreed upon by the insurance industry, it is almost always used and remains unchanged regardless of the size or nature of the purchasing policyholder.

Insurance companies themselves, such as Travelers Indemnity Company and The Home Insurance Company, have recognized that negotiations between an individual policyholder and an insurance company do not determine the meaning of standard form policy provisions; the best evidence as to what they mean is the uniform definition that the original drafters intended.

In a 1981 brief, Travelers Indemnity Company stated: "Because of the way the insurance industry operates, most of the relevant policy language is found in standardized insuring forms, drafted by insurance associations or bureaus, and used industry-wide. Thus, questions of intent may be addressed on a standardized basis. Predictably, there will be precious little evidence of the negotiation of individual policies. The primary evidence on the intent of the parties drafting the contracts, and their expectations about scope of coverage, will be obtained through document productions from key industry-wide organizations and depositions of their personnel."

In a 1983 brief, The Home Insurance Company stated: "What better evidence of the intent of the insurance industry, including Home, could be proffered to the court than the intent of those who, at the behest of the industry, drafted the very language in dispute here. The only inference that can be drawn from the submission of these affidavits is that Home intended the same result as the drafters when Home adopted the standardized language for its policies."

Interpreting Standard Form Policies

Given the manner in which standard form policies are drafted and the process by which insurance companies obtain regulatory approval to use them, it seems particularly appropriate to hold an insurance company responsible for any ambiguity in its policies. Moreover, it is difficult to understand why or how a different meaning should be applied when construing an ambiguous standard form provision contained in a policy purchased by a small policyholder with no insurance expertise or bargaining power; that, as opposed to the same provision contained in a policy purchased by a policyholder that is more sophisticated and larger. As noted earlier, when a standard form policy is sold, a policyholder's sophistication and size simply has no impact upon the standard form provisions which appear in the policy.

Also, giving different meanings to the same standard provision, depending on the size and sophistication of the policyholder, would be inconsistent with the regulation of insurance companies which is based on the professed need for them to communicate with each other in order to be able to create provisions which mean the same regardless of the issuer or the policyholder. Uniformity of risk, which is at the heart of standard form provisions and policies, would be eliminated.

Indeed, the argument made by Mr. Cohen and Ms. Quaintaince, that when the insurance company drafter does not occupy a "substantially advantageous" position there is no rationale for contra proferentem, ignores the manner in which standard form insurance provisions are drafted and the fact that they are intended to mean the same from policy to policy. For all these reasons, a large and sophisticated policyholder should not get less coverage than would be afforded a smaller "Ma and Pa" purchaser of standard form insurance when the terms and provisions of the policies are the same.

To date, while some courts have declined to apply the rule of contra proferentem in construing insurance policies purchased by large, sophisticated entities, no court has done so in a case involving standard form provisions after exhaustively reviewing and considering the rationale behind the rule and the manner in which standard form insurance policies are drafted. At the very least, a reasoned, principled approach to the application of contra proferentem in construing standard form insurance policies requires such an analysis. When that analysis is properly made, it will certainly produce a more legitimate and fair construction of the coverage afforded by standard form insurance policies to policyholders of whatever size and sophistication.
COPYRIGHT 1990 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Author:Sear, Thomas H.; Scaraglino, Pietrina V.
Publication:Risk Management
Date:Feb 1, 1990
Words:2545
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