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May 22, 2007

On Suits and Prophylactics: Recurring Environmental Coverage Issues

Commercial general liability policies provide coverage for the insured’s liability for “damages” on account of bodily injury and property damage and require the insurer to provide a defense to “suits” seeking such damages. Since the beginning of the environmental liability coverage wars some twenty-five years ago, insurers have disputed whether their insureds’ environmental liabilities seek to impose “damages”, are on account of “property damage,” and are adjudicated in the context of “suit[s].” Recent cases have continued to address these recurring issues.

In Cinergy Corp. v. Associated Electric & Gas Insurance Services, Ltd. (Ind. May 1, 2007), the Indiana Supreme Court considered whether the insured’s liability in that case was in the nature of “damages.” The Indiana court granted the insured a somewhat pyrrhic victory in finding that the insurers in theory had obligations to defend, but holding that the liability for which the insured ostensibly was liable was not of the nature of a monetary obligations to which liability insurance applies. The court gave the insured some sympathy in dealing with the policy language: “Synthesizing the policies’ insuring agreements with their respective definitions of capitalized words and phrases is a daunting task, replete with often confusing, redundant, and sometimes circular concepts.” Slip op. at 7.

But the court held that the liability in the civil action in which the insured was involved was not of the nature and kind covered by liability policies. “There is essential agreement among the parties . . . that the primary thrust of the federal lawsuit is to require the [insured] to incur the costs of installing government-mandated equipment intended to reduce future emissions of pollutants and prevent future environmental harm.” Slip op. at 11. In assessing whether there was coverage, the court adopted the now-familiar distinction between (covered) “remedial” and (uncovered) “prophylactic” measures. The court ruled that the government’s action against the insured was “directed at preventing future public harm, not at obtaining control, mitigation, or compensation for past or existing environmentally hazardous emissions.” Slip op. at 14. Consequently, the court found that the liability of the insured was not as a result of “the happening of an accident, event, or exposure to conditions but rather [was directed at] the prevention of such an occurrence.” Slip op. at 15.

In effect, the court found that the liability involved was not as a result of any past or existing property damage, but rather was based only on complying with legal requirements to conduct its operations safely. (Alternatively, the court could be said to have found that there was no property damage yet for which the insured was being held liable.) Accordingly, “the costs of installing government mandated equipment intended to reduce future emissions of pollutants and to prevent resulting future environmental harm” does not constitute covered sums for which the insured is liable because of property damage. Slip op. at 16.

The “remedial” versus “prophylactic” distinction in the environmental context is often elusive (and for that reason alone courts should be chary of denying coverage for bona fide liability). While it is true that insurance policies are not funding mechanisms for the costs of operating in compliance with the law, where property damage has occurred and an element of the damages on account thereof include measures to prevent the recurrence of damage, then the costs of those future-oriented remedies should be (and generally are) covered. When one is dealing with water contamination or air contamination, for example, it may be that the remedy includes measures to reduce the concentrations of the deleterious substance released by the insured; by limiting additional releases of that substance, the water system, for example, is able to dilute the contaminants through ordinary recharges of the system and reduce the concentration below the level of “damage.” In this way, stopping the on-going contribution of the deleterious substance can be thought of as a remedy for past damage (because this type of preventive remedy allows the damage to be mitigated). Were one to freeze-frame the issue, however, and look only at the remedy (and not the reason for the remedy), it might be argued that the measure is “prophylactic,’ that is, is meant to prevent the future release of contaminants.

For purposes of analyzing the availability of insurance-coverage, however, the question is why is the insured responsible for containing future releases. Where there has already been damage for existing releases of contaminants, “stop[ping] that ongoing release is not mere prophylaxis.” Watts Industries, Inc. v. Zurich American Ins. Co., 121 Cal. App. 4th 1029 (2004)
.

In legal proceedings where the insured faces liability for “damages,” primary CGL insurers will have a duty to defend. Where there is no possibility, however, that the action against the insured can eventuate in a judgment covered by the insurer’s duty to indemnify, then the insurer will not have an obligation to defend. Because in Cinergy the Indiana Supreme Court held that the costs at issue were purely prophylactic and not “damages because of property damage,” the court ruled that the insurers had no duty to defend (though rejecting the rationale of the court below that there was a duty to pay defense costs only as an incident to the obligation to indemnify and thus only after the underlying action was concluded). Cinergy, slip op. at 16.

Even if the insured faces bona fide damages, the duty to defend applies to “suits,” and naturally insurers and insureds have joined issue on whether various types of proceedings constitute “suits” to which the duty to defend extends. Most courts have recognized that enforcement proceedings that can eventuate in a “damages” award are in the nature of a “suit” against the insured, but some courts have equated the term “suit” with “lawsuit” and held that only actions in a court of law – as opposed to an administrative proceeding – can constitute a “suit.” That said, even these jurisdictions may allow a claim for the cost of defense of a non-traditional or non-court proceeding where “suit” is defined more broadly to encompass other forms of liability-seeking actions or where the insurer’s obligation to pay includes obligations to reimburse “expenses” incurred in the defense, without those expenses being tethered only to court-proceedings. The recent decision of the California Court of Appeal in Ameron Int’l v. Insurance Co. of State of PA (Cal. App. May 15, 2007) analyzes a number of different formulations of insuring obligations, cast against the backdrop of decisions holding that the undefined term “suit” is limited only to actions in a court of law. Ameron is a useful reminder to policyholder and insurer lawyers that we need to parse the language of the contract carefully in determining the obligations to provide coverage vel non.

Posted by Marc Mayerson at 12:31 AM | Comments (1) | TrackBack

On Suits and Prophylactics: Recurring Environmental Coverage Issues

Commercial general liability policies provide coverage for the insured’s liability for “damages” on account of bodily injury and property damage and require the insurer to provide a defense to “suits” seeking such damages. Since the beginning of the environmental liability coverage wars some twenty-five years ago, insurers have disputed whether their insureds’ environmental liabilities seek to impose “damages”, are on account of “property damage,” and are adjudicated in the context of “suit[s].” Recent cases have continued to address these recurring issues.

In Cinergy Corp. v. Associated Electric & Gas Insurance Services, Ltd. (Ind. May 1, 2007), the Indiana Supreme Court considered whether the insured’s liability in that case was in the nature of “damages.” The Indiana court granted the insured a somewhat pyrrhic victory in finding that the insurers in theory had obligations to defend, but holding that the liability for which the insured ostensibly was liable was not of the nature of a monetary obligations to which liability insurance applies. The court gave the insured some sympathy in dealing with the policy language: “Synthesizing the policies’ insuring agreements with their respective definitions of capitalized words and phrases is a daunting task, replete with often confusing, redundant, and sometimes circular concepts.” Slip op. at 7.

But the court held that the liability in the civil action in which the insured was involved was not of the nature and kind covered by liability policies. “There is essential agreement among the parties . . . that the primary thrust of the federal lawsuit is to require the [insured] to incur the costs of installing government-mandated equipment intended to reduce future emissions of pollutants and prevent future environmental harm.” Slip op. at 11. In assessing whether there was coverage, the court adopted the now-familiar distinction between (covered) “remedial” and (uncovered) “prophylactic” measures. The court ruled that the government’s action against the insured was “directed at preventing future public harm, not at obtaining control, mitigation, or compensation for past or existing environmentally hazardous emissions.” Slip op. at 14. Consequently, the court found that the liability of the insured was not as a result of “the happening of an accident, event, or exposure to conditions but rather [was directed at] the prevention of such an occurrence.” Slip op. at 15.

In effect, the court found that the liability involved was not as a result of any past or existing property damage, but rather was based only on complying with legal requirements to conduct its operations safely. (Alternatively, the court could be said to have found that there was no property damage yet for which the insured was being held liable.) Accordingly, “the costs of installing government mandated equipment intended to reduce future emissions of pollutants and to prevent resulting future environmental harm” does not constitute covered sums for which the insured is liable because of property damage. Slip op. at 16.

The “remedial” versus “prophylactic” distinction in the environmental context is often elusive (and for that reason alone courts should be chary of denying coverage for bona fide liability). While it is true that insurance policies are not funding mechanisms for the costs of operating in compliance with the law, where property damage has occurred and an element of the damages on account thereof include measures to prevent the recurrence of damage, then the costs of those future-oriented remedies should be (and generally are) covered. When one is dealing with water contamination or air contamination, for example, it may be that the remedy includes measures to reduce the concentrations of the deleterious substance released by the insured; by limiting additional releases of that substance, the water system, for example, is able to dilute the contaminants through ordinary recharges of the system and reduce the concentration below the level of “damage.” In this way, stopping the on-going contribution of the deleterious substance can be thought of as a remedy for past damage (because this type of preventive remedy allows the damage to be mitigated). Were one to freeze-frame the issue, however, and look only at the remedy (and not the reason for the remedy), it might be argued that the measure is “prophylactic,’ that is, is meant to prevent the future release of contaminants.

For purposes of analyzing the availability of insurance-coverage, however, the question is why is the insured responsible for containing future releases. Where there has already been damage for existing releases of contaminants, “stop[ping] that ongoing release is not mere prophylaxis.” Watts Industries, Inc. v. Zurich American Ins. Co., 121 Cal. App. 4th 1029 (2004)
.

In legal proceedings where the insured faces liability for “damages,” primary CGL insurers will have a duty to defend. Where there is no possibility, however, that the action against the insured can eventuate in a judgment covered by the insurer’s duty to indemnify, then the insurer will not have an obligation to defend. Because in Cinergy the Indiana Supreme Court held that the costs at issue were purely prophylactic and not “damages because of property damage,” the court ruled that the insurers had no duty to defend (though rejecting the rationale of the court below that there was a duty to pay defense costs only as an incident to the obligation to indemnify and thus only after the underlying action was concluded). Cinergy, slip op. at 16.

Even if the insured faces bona fide damages, the duty to defend applies to “suits,” and naturally insurers and insureds have joined issue on whether various types of proceedings constitute “suits” to which the duty to defend extends. Most courts have recognized that enforcement proceedings that can eventuate in a “damages” award are in the nature of a “suit” against the insured, but some courts have equated the term “suit” with “lawsuit” and held that only actions in a court of law – as opposed to an administrative proceeding – can constitute a “suit.” That said, even these jurisdictions may allow a claim for the cost of defense of a non-traditional or non-court proceeding where “suit” is defined more broadly to encompass other forms of liability-seeking actions or where the insurer’s obligation to pay includes obligations to reimburse “expenses” incurred in the defense, without those expenses being tethered only to court-proceedings. The recent decision of the California Court of Appeal in Ameron Int’l v. Insurance Co. of State of PA (Cal. App. May 15, 2007) analyzes a number of different formulations of insuring obligations, cast against the backdrop of decisions holding that the undefined term “suit” is limited only to actions in a court of law. Ameron is a useful reminder to policyholder and insurer lawyers that we need to parse the language of the contract carefully in determining the obligations to provide coverage vel non.

Posted by Marc Mayerson at 12:31 AM | Comments (1) | TrackBack

May 21, 2007

Odoriferous Occurrence

Anaerobic decomposition produces among other things hydrogen sulfide gas. It is this gas that makes flatulents distinctive from, shall we say, the bouquet of a rose. This was illustrated in a recent coverage case involving a Minnesota pig farm that created a concrete lagoon with capacity to hold 1.5 million gallons of manure. Three-quarters of a mile away was a neighbor’s home.

The homeowners were none too pleased with the “extremely noxious and offensive odors and gases” that impeded their enjoyment of their home; so they sued the pig farmer for, among other things, creating a nuisance. The farmer turned to its insurer to defend arguing there was covered property damage – the homeowners’ loss of the use and enjoyment of their property (i.e., loss of use of tangible property that is not physically injured) arising from an occurrence.

Overturning part of the ruling of the trial court in favor of the insurance company, the Minnesota Court of Appeals held that the choice to locate the manure lagoon, while deliberate, resulted in an occurrence. Wakefield Pork, Inc. v. RAM Mut. Ins. Co., (Minn. App. May 15, 2007). The lagoon was in compliance with state environmental regulation and zoning ordinances. As a result the Minnesota court reasoned: “it would be inconsistent for this court to acknowledge, on the one hand, that appellant’s hog operation is legally operated and fully compliant with all applicable regulations, but to conclude, on the other hand, that appellant acted with a willful disregard or intent to harm its neighbors.” Slip op. Reasoning that the insurance company would have known at the time of underwriting that pig farms produced noxious gases, the court was reluctant to hold that the ordinary operations of the farm was uninsurable.

Nevertheless, the court held that the policy did not provide coverage because of the pollution exclusion, which barred coverage for liability on account of “fumes.” Because foul odors – or porcine odors – were gases released from the decomposition process, the Minnesota court held these were plainly encompassed within the pollution exclusion. As a result, the insurer had no duty to defend.

Posted by Marc Mayerson at 2:04 PM | Comments (0) | TrackBack

Odoriferous Occurrence

Anaerobic decomposition produces among other things hydrogen sulfide gas. It is this gas that makes flatulents distinctive from, shall we say, the bouquet of a rose. This was illustrated in a recent coverage case involving a Minnesota pig farm that created a concrete lagoon with capacity to hold 1.5 million gallons of manure. Three-quarters of a mile away was a neighbor’s home.

The homeowners were none too pleased with the “extremely noxious and offensive odors and gases” that impeded their enjoyment of their home; so they sued the pig farmer for, among other things, creating a nuisance. The farmer turned to its insurer to defend arguing there was covered property damage – the homeowners’ loss of the use and enjoyment of their property (i.e., loss of use of tangible property that is not physically injured) arising from an occurrence.

Overturning part of the ruling of the trial court in favor of the insurance company, the Minnesota Court of Appeals held that the choice to locate the manure lagoon, while deliberate, resulted in an occurrence. Wakefield Pork, Inc. v. RAM Mut. Ins. Co., (Minn. App. May 15, 2007). The lagoon was in compliance with state environmental regulation and zoning ordinances. As a result the Minnesota court reasoned: “it would be inconsistent for this court to acknowledge, on the one hand, that appellant’s hog operation is legally operated and fully compliant with all applicable regulations, but to conclude, on the other hand, that appellant acted with a willful disregard or intent to harm its neighbors.” Slip op. Reasoning that the insurance company would have known at the time of underwriting that pig farms produced noxious gases, the court was reluctant to hold that the ordinary operations of the farm was uninsurable.

Nevertheless, the court held that the policy did not provide coverage because of the pollution exclusion, which barred coverage for liability on account of “fumes.” Because foul odors – or porcine odors – were gases released from the decomposition process, the Minnesota court held these were plainly encompassed within the pollution exclusion. As a result, the insurer had no duty to defend.

Posted by Marc Mayerson at 2:04 PM | Comments (0) | TrackBack

October 26, 2006

Trigger and Allocation for Asbestos, Other Bodily Injury, and Property Damage: Recent Cases and the Policyholders' Winning Argument

“Who pays” and “how much” continue to be central questions in insurance-recovery litigation by policyholders for asbestos, environmental clean up, pharmaceutical, lead-paint, toxic-tort and other conditions that produce loss over time. Because insurance contracts are governed by state law, the coverage wars apparently will continue until each inch of turf is won or lost. Most recently, the Delaware Supreme Court has weighed in on the question of trigger of coverage (“who pays”) for asbestos- liability claims, the Minnesota Supreme Court has addressed allocation of loss (“how much”) among triggered policies, and the New Hampshire Supreme Court has now been asked to address the allocation question, too.

The Delaware and Minnesota cases suffer from an overly conceptualist approach to looking at the questions presented; instead of applying the contract language, these courts have applied “models” of how the coverage should apply. As these cases show, misframing the question to be answered results in answers that are not entirely satisfactory or coherent.

Starting with Delaware: The question presented in Shook & Fletcher Asbestos Settlement Trust v. Safety National Cas. Corp. (Del. Sept. 26, 2006) was what event must occur during the policy period in order for an occurrence policy to be activated (triggered). An insurer has no obligation to perform unless the claim against the insured triggers (or potentially triggers) its coverage. Shook & Fletcher was decided under Alabama law. As noted by the Delaware court, in prior coverage litigation “after full briefing and argument, the Alabama court held that the ‘exposure coverage theory’ would apply, instead of the ‘continuous trigger’ or ‘triple trigger’ theory.” Slip op. at 3-4.

The Delaware Supreme Court in trying to predict Alabama law sought to resolve the question in part by counting noses among state Supreme Courts and federal appellate courts. As the court explained: “We have analyzed the cases where the parties disagreed upon which trigger theory the court actually adopted. Our analysis shows that the exposure trigger is the majority rule.” Slip op. at 9. The court found that Pennsylvania, New Jersey, Delaware, and the Third and D.C. Circuit’s have adopted a continuous trigger; but the Court’s analysis of the other cases led it to conclude that the following jurisdictions have adopted an exposure trigger for asbestos bodily injury claims: Louisiana, Massachusetts, Maryland, Illinois, Fourth Circuit, Fifth Circuit (Texas), Fifth Circuit (Louisiana), Sixth Circuit (Ohio), Sixth Circuit (Michigan), Eleventh Circuit (Alabama), and the First Circuit.

Holding aside that I quarrel with the court’s table and analysis of cases, the court thus concluded: “We rely on the rationale of those cases and the fact that the exposure trigger is the majority rule.” Slip op at 11.

The Delaware court offers no analysis of the issue on its own but rather tries to predict what the Alabama Supreme Court might do. In this context, it is passing strange that the court does not address on the merits its own prior continuing-injury trigger decisions or come to grips with the rule of construction – applicable in Alabama – that if the policy language admits of more than one reasonable construction the court is to construe the language in favor of coverage. Compare Hercules Inc. v. AIU Ins. Co. (Del. Aug. 15, 2001) (finding plain language compels an “all sums” allocation as do equitable considerations). Is the Delaware court now saying that its own prior decision was unreasonable?

In Shook & Fletcher, no effort was made to look at the policy language. And the language is straightforward: insurance policies like those in Shook & Fletcher are triggered if injury occurs during the policy period. Trigger is the issue of what event must take place during the policy period, and the policy is clear – it is not the occurrence, the exposure, or the accident: trigger is “injury.” While “injury” may follow from “exposure,” the difference is one between cause and effect, and typically liability policies are triggered by the effect. (The number of occurrences is determined by causes, but that is a different legal and contractual issue.)

Policyholders should not argue, as I have sometimes seen them do, that there are as many as eight different trigger theories out there and the job of the court is to pick one. Rather, the policy language is absolutely clear that injury is the trigger, and the only question is whether, in the particular context before the court, can whatever happened during the policy year under scrutiny reasonably be construed to be “injury.”

So, the right way for policyholders to argue is not to serve up the question as “which trigger applies: exposure, manifestation, continuous”? The right question is: “Because the trigger is injury, did injury occur during this policy period?” For policies in effect during the period of exposure, one argues that following exposure the body suffers injury. For policies in the period after exposure but while the asbestos fibers persist in the body, one argues that the continued presence of asbestos in the body produces a reaction such that that further effect constitutes injury that year. For policies in effect during the period that an asbestos-related disease is diagnosed, one argues that under the definition of bodily injury – which includes “bodily injury [and] disease” – there is disease and thus injury during the policy period.

It doesn’t matter whether we are arguing about asbestos, or pharmaceutical, or lead paint, or toxic torts: the question of trigger under “occurrence” CGL policies is injury.

A policy’s being triggered does not answer the question of how much the triggered policy is required to pay for the insured’s loss. The “how much” question is known variously as “allocation” or “scope of coverage.” The Minnesota Supreme Court recently weighed in on allocation of coverage, but in doing so it had to deal with prior authority holding that a continuing-injury scenario triggered multiple policies across time and that presumptively each insurer’s obligation to perform was dependent on the quantum of injury that occurred in its policy year. So for illustration, if damage occurred in a steady-stream way for 10 years and caused $10 million in damages, then $1 million would be allocated per year, no matter that in some years the insured bought much more coverage or that in other years the primary layer was, e.g., $200,000 and in other years it was $50,000.

In Wooddale Builders, Inc. v. Maryland Cas. Co. (Minn. Oct. 8, 2006), the court confronted a number of questions concerning the implementation of this kind of scheme: if the damage occurs during only part of a year, does the carrier have to pay its full limit? What happens for years in which there is no coverage? Can the insured buy more coverage once it has knowledge of the problem?

The Court framed the basic issue as follows:

The relationship [among the policies] can be expressed – and perhaps best understood – in terms of a simple equation: A/B x C = D. In this equation, A is each insurer’s time on the risk, B is the total period over which liability is allocated, C is the total damages to be allocated, and D is the damages allocated to each individual insurer.

The court first addressed whether the coverage period is cut off at some moment due to the insured’s knowledge of the risk of liability. In Wooddale, the case involved damage to a number of homes that had been built, and the court ruled that once the insured had knowledge that a home had been damaged no further insurance available. The court ruled – in error – that damage was expected or intended (and thus excluded) once the insured had knowledge that some homes had been damage: “The practical effect of the policy language excluding expected damage and the rationale behind the known loss/loss in progress doctrine is that no additional insurance policies are triggered by continuing damage to homes for which claims had been made before those policies took effect. . . . We therefore hold that only insurers that provided coverage to Wooddale between the closing date of a particular home and Wooddale’s receipt of notice of claim with respect to that property are on the risk for that claim.” (fn. omitted).

(The court’s cutoff based on these theories is wrong because expected/intended damage is meant to stop the insured from acting or setting in motion the chain of events leading to damage rather than policing the insured’s knowledge of a ticking time bomb – the right mechanism to protect insurers on this point is nondisclosure; and known loss is not properly applied here either because from an insurance perspective there is insurable risk, and thus no known loss, so long as there is uncertainty as to whether, when or how much liability will be found – again, all subject to non disclosure rules. See Transamerica Ins. Group v. Meere, 694 P.2d 181, 186 (Ariz. 1984) (“"The exclusion 'is designed to prevent an insured from acting wrongfully with the security of knowing that his insurance company will "pay the piper" for the damages.'''); Bob Hedges, Back-Dated Coverage as Insurance, 34 CPCU J. 181, 181 (1981). And the court does not address equities such as whether the policyholder paid premium in effect for this risk exposure that the carrier gets to pocket under the court’s analysis.)

The court further examined the consequence on an insurer’s obligation to pay from the trigger cutting off during its policy period, or put differently is the insurer that provides coverage for only part of a policy year required to pay its full limit? Here, the court got the answer right, but because its rationale is embedded within the pro-rata-by-quantum-of-damage methodology its reasoning is a bit unsatisfactory. The court offered only the rationale that it was aware of no basis for concluding that a full limit does not apply. “Instead, each of the policies provides coverage for ‘property damage’ that ‘occurs during the policy period,’ indicating that the insurer has agreed to indemnify the insured for damages that occur during the entire policy period, including the part of the policy period that runs after notice of the claim.”

The court does not address the case law on “stub policies,” that is, the limits available in a part year policy by analogy (as opposed to a full year policy with only part damage). Stub policy case law uniformly recognizes that the carrier’s policy limits are at risk every day of the policy, and that the premium is paid for the availability of the full limits each day. See United States Mineral Products Co. v. American Ins. Co., 792 A.2d 500, 502 (N.J. Super. App. Div. 2002); Stonewall Ins. Co. v. ACMC, 73 F.2d 1178, 1216-17 (2d Cir. 1995); Cadet Mfg. Co. v. Am. Ins. Co., 391 F. Supp. 2d 884, 890 (W.D. Wash. 2005). More importantly, the allocation method that the court has previously embraced does suggest only a partial limit for part-year damage, and the court does little to explain other than offer its ipse dixit.

The court reached the parallel conclusion for policies in effect during the year in which damage first occurred, likewise holding that the full limits were available in the allocation formula.

Finally, the court considered whether periods of no insurance counted in the allocation formula, and the court divided periods of no insurance into (i) periods where the insured elected not to purchase insurance voluntarily (self-insurance) and (ii) periods where due to market forces there was no insurance to be purchased. The court concluded that allocating to periods of self-insurance was fair but that allocating to periods of no insurance was not, and so periods where there was no insurance get removed from the denominator of the allocation formula.

This has always been an unsatisfying approach, in part because it makes the contractual obligations of a party with a closed period dependent upon failures in insurance markets years later perhaps (because if a later period of no insurance is not included in the allocation formula each insurer’s relative share of the pie goes up). It accomplishes the objective of avoiding penalizing the insured for no “fault” of its own, but it also is somewhat naïve in its assessment of insurance markets and whether some underwriter somewhere might be willing to insure some risk for some ridiculous price (as the London market saying goes, there is no bad risk, just a bad price). So even though there was a worldwide conspiracy among insurers and reinsurers to cut off asbestos coverage in the mid 1980s, if an underwriter wanted to sell asbestos insurance doing so would not violate any positive law or prohibition against meretricious contracts. These are, to my way of thinking, too unstable of bases to support a rationale for how to apply an insurance contract that may have been written decades before.

Overall the Minnesota court made the following simplifying assumptions in its mathematical formula:

a. Each policy in effect during when any damage occurred is exposed for its whole limit.

b. Policies incepting after the insured expected claims have no obligation to perform.

c. A policyholder should be treated as if it were an insurance company if it voluntarily elected not to purchase insurance in the commercial markets.

d. A policyholder should not be treated as an insurer if the reason it did not purchase insurance is through no fault of its own.

Based on these elaborations, the court held that as to the duty to indemnify each carrier’s obligation to pay can be derived. (The court however embraced a per-capita allocation for defense.)

The Minnesota court recognized that its elaborations meant that its formulaic approach was becoming unmoored from the principles from which it derived. (No matter; such is the privilege of being the last word.) As the court said:

We are aware it is possible under our construction of factor B that an insurer is liable for more than those damages than would otherwise be deemed to have occurred during its policy period. This is possible because our definition of factor B, the period over which damages are to be allocated, excludes periods during which the insured lacks coverage because no such coverage was available. We are also aware that this result may be contrary to the broad language we used in [prior authority] to describe the ‘actual injury’ [trigger] rule, namely, that under this rule each insurer is liable ‘only for those damages which occurred during its policy period.’ [citation omitted] However, as we [there] indicated . . . ., the allocation of liability between insurers requires a flexible approach. [citation] Further, as we noted [previously], it is inaccurate to conclude that a CGL insurer can never be liable for damages occurring outside of a policy period. [citation] We deem the facts of this case to justify a departure from the typical ‘actual injury’ approach.

So is there a principled way to come to grips with the language of the insurance policy and figure out a principled manner to determine the obligation of each carrier where a single loss situation produces damage and injury both during and outside of its policy period? This is now the question that the New Hampshire Supreme Court has been asked in an environmental-coverage case. See EnergyNorth Natural Gas Inc. v. Certain Underwriters at Lloyd's Underwriters, 2006 U.S. Dist. LEXIS 73468 (D.N.H.)

I believe there is an approach to the contract language that takes the language seriously yet produces results that are (I submit) intellectually consistent.

The first principle is that insurance policies create rights in the insured, and it is the insured’s right to exercise. Insurance policies are not issued in dependence on the existence of coverage in other years; no credit is given on the premium from having more coverage in the past year than not or coverage from carriers with better credit ratings. Policyholders don’t promise carriers to purchase insurance policies in the future. And insurers are not understood to be third-party beneficiaries of each other’s contract, even though those contracts are with the same party, the policyholder. See Signal Co., Inc. v. Harbor Ins. Co., 27 Cal. 3d 359, 369 (1980); L.E. Myers Co. v. Harbor Ins. Co., 394 N.E. 2d 1200 (Ill. 1979).

The second, and more important, principle is that insurance policies insure against the risk that the insured will be held liable for injury or damage during the policy period; policies do not insure against the risk of injury or damage occurring per se. As one leading treatise explains, “[t]he hazard insured against under the liability feature is not injury or loss . . . but liability or responsibility of the insured for loss or injury.” 6B J. Appleman & J.A. Appleman, Insurance Law and Practice §4254 at 26-27 (Rev. ed. 1979). The policy language makes this plain. CGL policies contain a broad promise to pay “all sums” that “the insured shall become legally obligated to pay as damages because of bodily injury . . . to which this insurance applied caused by an occurrence.” In other words, subject to the applicable limit of liability, the policy covers the totality of damages incurred by an insured “because of,” i.e. “by reason of” or “on account of,” bodily injury within the policy period. The question then is, what is the insured’s liability because of the injury during the policy period. This is key and shows both where Minnesota law goes wrong and creates the hydraulic pressure on the court to backfill we see so clearly in Wooddale.

These two principles illuminate the right way to argue the point for policyholders (and I submit the right way for courts to resolve the question). Instead of the Minnesota court’s mathematical formula, one takes a single policy and asks the following question: Is there bodily injury or property damage that occurred during the policy period, and if so what is the insured’s liability for the bodily injury or property damage that happened? (Contrary to what some insurers have argued, the “Policy Period; Territory” provision does not alter the question, because that provision ensures that the trigger is damage, not the negligent act, see State v. Glens Falls Ins. Co., 609 P.2d 598, 600-01 (Ariz. App. 1980), and while the language in the insuring agreement referring to property damage “to which this insurance applies” refers implicitly to the “policy period; territory” provision, that does nothing to the question on which I focus, viz., what is the insured’s liability “because of” the property damage to which the insurance applies.) I don’t need to reflexively or exclusively rely on the insurance policy’s promise to pay “all sums” or “those sums” – that is handy language but is not the key issue. The key is always and only, what is the insured’s liability because of bodily injury/property damage during the policy period.

As a matter of tort (not insurance) law, in most of the situations we deal with the answer to that question is this: for bodily injury or property damage that occurred during the particular carrier’s policy period, the insured’s liability is equal to the entirety of the plaintiff’s claim. This is the result of the rule of tort law that imposes joint and several liability upon tort defendants. John Crane v. Scribner, 800 A.2d 727, 741 (Md. 2002) (“it is as impossible to ascertain which fiber ultimately caused which cell, over time, to escape the body’s defenses and turn cancerous, as it is to determine when that occurred”).

Note that I am not saying that insurers are jointly and severally liable under their policies; that would be to import a tort concept to the contract context, and I don’t think that is quite precise enough. But what is central is that the insured is jointly and severally liable, and such liability is imposed where the injury or damage at issue is indivisible from injury or damage that occurred in other policy periods (or from other tortfeasors). See United States v. Alcan Aluminum Corp., 964 F.2d 252, 268-69 (3d Cir. 1992); Matter of Bell Petroleum Services, Inc., 3 F. 3d 889-896 (5th Cir. 1993); O’Neil v. Piccillo, 883 F.2d 176 (1st Cir. 1989) (interesting discussions all re indivisible damage/injury and the imposition of joint-and-several liability under tort law).

Nothing in the policies reduces the carrier’s obligation to pay simply because injury may also have occurred outside the policy period; the sole determinant of the extent of coverage is what is the insured’s liability because of injury during the policy period. The policy language addressing the application of the policy limits for a covered claim nowhere confines the carrier’s obligation to pay to some aliquot share based on the quantum of injury occurring in its policy years. E.g., ACandS v. Aetna Cas. & Sur. Co., 764 F.2d 968, 974 (3d Cir. 1985) (Even where sums paid by the insured party are partly attributable to injury that occurred in another policy period, “the language of the policy makes [that fact] irrelevant.”).

This is made particularly clear in the “Limits” section of standard liability insurance policies. The “Limits of Liability” section of policies typically provides that, for a covered bodily-injury (or property damage) “occurrence,” the policy will pay for “all damages . . . because of bodily injury sustained by one or more persons as the result of any one occurrence.” The sole limitation on each policy’s obligation to pay is that the payout on the claim “shall not exceed the limit of bodily injury liability stated in the declarations as applicable to ‘each occurrence.’” The Limits provision further elaborates by stating:

For the purpose of determining the limit of the company’s liability [under the policy], all bodily injury . . . arising out of continuous or repeated exposures to substantially the same general conditions shall be considered as arising out of one occurrence.

Here the policy language unambiguously favors coverage: The amounts any given CGL policy pays are expressed in dollars “per occurrence.” The insuring agreement and the limits-of-liability provisions together teach that, where there is covered injury in the policy period, the policy pays “all sums” for “all damages sustained by one . . . person . . . as the result of any one occurrence,” subject only to the per-occurrence limit.

In fact, even if the policies were uncertain as to the proper method of allocation, a reasonable interpretation of the policies requires an “all sums” approach. And of course insurers have been in the position to protect themselves by drafting clear and explicit language that addresses how the obligation to perform should be measured where there is indivisible damage triggering their coverage. Compare Rochester German Ins. Co. v. Schmidt, 175 F. 720, 725-726 (4th Cir. 1909). Principles of insurance law, therefore, require that the interpretation of uncertain or ambiguous policy provisions favoring the insured must govern.

This contract-based approach to allocation also “solves” the question of horizontal versus vertical exhaustion: that is, where policies are triggered across time, must the insured collect first from all the primaries before tapping any excess coverage (and thus absorb cumulated deductibles and insolvent primary layers) or may the insured select a single year of coverage and access the triggered primary and overlying excess (either in a single year or in more than one). General-liability policies do not speak to this issue, and so we return to the principle that the contract rights belong to the insured; consequently, the insured has the option to select or target its triggered policies however it sees fit. In each instance, one asks the same questions: is the policy triggered, and if so how much does the policy pay per occurrence for the insured’s liability because of the (indivisible) damage/injury that year? Any targeted policy may seek to pursue equitable contribution against other carriers that could have been targeted but were not. Indeed, I submit that part of the peace of mind offered by broad CGL insurance is precisely the insured’s ability to collect its full per-occurrence limits and then go home – leaving further redistribution to the carriers to sort out.

This approach also gives the framework to address stacking or cumulation of policy limits, for looking at each contract the stacking or cumulation of policy limits again is straightforward. See United Services Automobile Ass’n v. Riley (Md. June 1, 2006). Until the insured is fully indemnified for its damages because of injury/damage during the policy year, the insured is entitled to collect on its coverage. In other words, stacking is only an issue if an insurer has clear anti-stacking language in its policy.

The bottom line of all of this is that policyholders should look hard at the contract without preconceived notions and see how each individual insurance contract’s obligation to perform is measured. Bearing in mind the crucial question of divisible versus indivisible harm and damage – and its impact on answering what is the insured’s liability for injury or damage during the policy period – insurance policies require insurers to perform if any “injury” occurred during the policy period and to pay their entire per-occurrence policy limit until such time as the insured has been fully indemnified or the insurance policy’s limits exhausted.

We confront the particular language of particular policies every time we settle a claim or file a complaint. Each contract should be analyzed using the toolkit I’ve sketched out here, and then you should move on to the next contract. Shampoo. Rinse. Repeat.

Posted by Marc Mayerson at 4:24 PM | Comments (4) | TrackBack

Trigger and Allocation for Asbestos, Other Bodily Injury, and Property Damage: Recent Cases and the Policyholders' Winning Argument

“Who pays” and “how much” continue to be central questions in insurance-recovery litigation by policyholders for asbestos, environmental clean up, pharmaceutical, lead-paint, toxic-tort and other conditions that produce loss over time. Because insurance contracts are governed by state law, the coverage wars apparently will continue until each inch of turf is won or lost. Most recently, the Delaware Supreme Court has weighed in on the question of trigger of coverage (“who pays”) for asbestos- liability claims, the Minnesota Supreme Court has addressed allocation of loss (“how much”) among triggered policies, and the New Hampshire Supreme Court has now been asked to address the allocation question, too.

The Delaware and Minnesota cases suffer from an overly conceptualist approach to looking at the questions presented; instead of applying the contract language, these courts have applied “models” of how the coverage should apply. As these cases show, misframing the question to be answered results in answers that are not entirely satisfactory or coherent.

Starting with Delaware: The question presented in Shook & Fletcher Asbestos Settlement Trust v. Safety National Cas. Corp. (Del. Sept. 26, 2006) was what event must occur during the policy period in order for an occurrence policy to be activated (triggered). An insurer has no obligation to perform unless the claim against the insured triggers (or potentially triggers) its coverage. Shook & Fletcher was decided under Alabama law. As noted by the Delaware court, in prior coverage litigation “after full briefing and argument, the Alabama court held that the ‘exposure coverage theory’ would apply, instead of the ‘continuous trigger’ or ‘triple trigger’ theory.” Slip op. at 3-4.

The Delaware Supreme Court in trying to predict Alabama law sought to resolve the question in part by counting noses among state Supreme Courts and federal appellate courts. As the court explained: “We have analyzed the cases where the parties disagreed upon which trigger theory the court actually adopted. Our analysis shows that the exposure trigger is the majority rule.” Slip op. at 9. The court found that Pennsylvania, New Jersey, Delaware, and the Third and D.C. Circuit’s have adopted a continuous trigger; but the Court’s analysis of the other cases led it to conclude that the following jurisdictions have adopted an exposure trigger for asbestos bodily injury claims: Louisiana, Massachusetts, Maryland, Illinois, Fourth Circuit, Fifth Circuit (Texas), Fifth Circuit (Louisiana), Sixth Circuit (Ohio), Sixth Circuit (Michigan), Eleventh Circuit (Alabama), and the First Circuit.

Holding aside that I quarrel with the court’s table and analysis of cases, the court thus concluded: “We rely on the rationale of those cases and the fact that the exposure trigger is the majority rule.” Slip op at 11.

The Delaware court offers no analysis of the issue on its own but rather tries to predict what the Alabama Supreme Court might do. In this context, it is passing strange that the court does not address on the merits its own prior continuing-injury trigger decisions or come to grips with the rule of construction – applicable in Alabama – that if the policy language admits of more than one reasonable construction the court is to construe the language in favor of coverage. Compare Hercules Inc. v. AIU Ins. Co. (Del. Aug. 15, 2001) (finding plain language compels an “all sums” allocation as do equitable considerations). Is the Delaware court now saying that its own prior decision was unreasonable?

In Shook & Fletcher, no effort was made to look at the policy language. And the language is straightforward: insurance policies like those in Shook & Fletcher are triggered if injury occurs during the policy period. Trigger is the issue of what event must take place during the policy period, and the policy is clear – it is not the occurrence, the exposure, or the accident: trigger is “injury.” While “injury” may follow from “exposure,” the difference is one between cause and effect, and typically liability policies are triggered by the effect. (The number of occurrences is determined by causes, but that is a different legal and contractual issue.)

Policyholders should not argue, as I have sometimes seen them do, that there are as many as eight different trigger theories out there and the job of the court is to pick one. Rather, the policy language is absolutely clear that injury is the trigger, and the only question is whether, in the particular context before the court, can whatever happened during the policy year under scrutiny reasonably be construed to be “injury.”

So, the right way for policyholders to argue is not to serve up the question as “which trigger applies: exposure, manifestation, continuous”? The right question is: “Because the trigger is injury, did injury occur during this policy period?” For policies in effect during the period of exposure, one argues that following exposure the body suffers injury. For policies in the period after exposure but while the asbestos fibers persist in the body, one argues that the continued presence of asbestos in the body produces a reaction such that that further effect constitutes injury that year. For policies in effect during the period that an asbestos-related disease is diagnosed, one argues that under the definition of bodily injury – which includes “bodily injury [and] disease” – there is disease and thus injury during the policy period.

It doesn’t matter whether we are arguing about asbestos, or pharmaceutical, or lead paint, or toxic torts: the question of trigger under “occurrence” CGL policies is injury.

A policy’s being triggered does not answer the question of how much the triggered policy is required to pay for the insured’s loss. The “how much” question is known variously as “allocation” or “scope of coverage.” The Minnesota Supreme Court recently weighed in on allocation of coverage, but in doing so it had to deal with prior authority holding that a continuing-injury scenario triggered multiple policies across time and that presumptively each insurer’s obligation to perform was dependent on the quantum of injury that occurred in its policy year. So for illustration, if damage occurred in a steady-stream way for 10 years and caused $10 million in damages, then $1 million would be allocated per year, no matter that in some years the insured bought much more coverage or that in other years the primary layer was, e.g., $200,000 and in other years it was $50,000.

In Wooddale Builders, Inc. v. Maryland Cas. Co. (Minn. Oct. 8, 2006), the court confronted a number of questions concerning the implementation of this kind of scheme: if the damage occurs during only part of a year, does the carrier have to pay its full limit? What happens for years in which there is no coverage? Can the insured buy more coverage once it has knowledge of the problem?

The Court framed the basic issue as follows:

The relationship [among the policies] can be expressed – and perhaps best understood – in terms of a simple equation: A/B x C = D. In this equation, A is each insurer’s time on the risk, B is the total period over which liability is allocated, C is the total damages to be allocated, and D is the damages allocated to each individual insurer.

The court first addressed whether the coverage period is cut off at some moment due to the insured’s knowledge of the risk of liability. In Wooddale, the case involved damage to a number of homes that had been built, and the court ruled that once the insured had knowledge that a home had been damaged no further insurance available. The court ruled – in error – that damage was expected or intended (and thus excluded) once the insured had knowledge that some homes had been damage: “The practical effect of the policy language excluding expected damage and the rationale behind the known loss/loss in progress doctrine is that no additional insurance policies are triggered by continuing damage to homes for which claims had been made before those policies took effect. . . . We therefore hold that only insurers that provided coverage to Wooddale between the closing date of a particular home and Wooddale’s receipt of notice of claim with respect to that property are on the risk for that claim.” (fn. omitted).

(The court’s cutoff based on these theories is wrong because expected/intended damage is meant to stop the insured from acting or setting in motion the chain of events leading to damage rather than policing the insured’s knowledge of a ticking time bomb – the right mechanism to protect insurers on this point is nondisclosure; and known loss is not properly applied here either because from an insurance perspective there is insurable risk, and thus no known loss, so long as there is uncertainty as to whether, when or how much liability will be found – again, all subject to non disclosure rules. See Transamerica Ins. Group v. Meere, 694 P.2d 181, 186 (Ariz. 1984) (“"The exclusion 'is designed to prevent an insured from acting wrongfully with the security of knowing that his insurance company will "pay the piper" for the damages.'''); Bob Hedges, Back-Dated Coverage as Insurance, 34 CPCU J. 181, 181 (1981). And the court does not address equities such as whether the policyholder paid premium in effect for this risk exposure that the carrier gets to pocket under the court’s analysis.)

The court further examined the consequence on an insurer’s obligation to pay from the trigger cutting off during its policy period, or put differently is the insurer that provides coverage for only part of a policy year required to pay its full limit? Here, the court got the answer right, but because its rationale is embedded within the pro-rata-by-quantum-of-damage methodology its reasoning is a bit unsatisfactory. The court offered only the rationale that it was aware of no basis for concluding that a full limit does not apply. “Instead, each of the policies provides coverage for ‘property damage’ that ‘occurs during the policy period,’ indicating that the insurer has agreed to indemnify the insured for damages that occur during the entire policy period, including the part of the policy period that runs after notice of the claim.”

The court does not address the case law on “stub policies,” that is, the limits available in a part year policy by analogy (as opposed to a full year policy with only part damage). Stub policy case law uniformly recognizes that the carrier’s policy limits are at risk every day of the policy, and that the premium is paid for the availability of the full limits each day. See United States Mineral Products Co. v. American Ins. Co., 792 A.2d 500, 502 (N.J. Super. App. Div. 2002); Stonewall Ins. Co. v. ACMC, 73 F.2d 1178, 1216-17 (2d Cir. 1995); Cadet Mfg. Co. v. Am. Ins. Co., 391 F. Supp. 2d 884, 890 (W.D. Wash. 2005). More importantly, the allocation method that the court has previously embraced does suggest only a partial limit for part-year damage, and the court does little to explain other than offer its ipse dixit.

The court reached the parallel conclusion for policies in effect during the year in which damage first occurred, likewise holding that the full limits were available in the allocation formula.

Finally, the court considered whether periods of no insurance counted in the allocation formula, and the court divided periods of no insurance into (i) periods where the insured elected not to purchase insurance voluntarily (self-insurance) and (ii) periods where due to market forces there was no insurance to be purchased. The court concluded that allocating to periods of self-insurance was fair but that allocating to periods of no insurance was not, and so periods where there was no insurance get removed from the denominator of the allocation formula.

This has always been an unsatisfying approach, in part because it makes the contractual obligations of a party with a closed period dependent upon failures in insurance markets years later perhaps (because if a later period of no insurance is not included in the allocation formula each insurer’s relative share of the pie goes up). It accomplishes the objective of avoiding penalizing the insured for no “fault” of its own, but it also is somewhat naïve in its assessment of insurance markets and whether some underwriter somewhere might be willing to insure some risk for some ridiculous price (as the London market saying goes, there is no bad risk, just a bad price). So even though there was a worldwide conspiracy among insurers and reinsurers to cut off asbestos coverage in the mid 1980s, if an underwriter wanted to sell asbestos insurance doing so would not violate any positive law or prohibition against meretricious contracts. These are, to my way of thinking, too unstable of bases to support a rationale for how to apply an insurance contract that may have been written decades before.

Overall the Minnesota court made the following simplifying assumptions in its mathematical formula:

a. Each policy in effect during when any damage occurred is exposed for its whole limit.

b. Policies incepting after the insured expected claims have no obligation to perform.

c. A policyholder should be treated as if it were an insurance company if it voluntarily elected not to purchase insurance in the commercial markets.

d. A policyholder should not be treated as an insurer if the reason it did not purchase insurance is through no fault of its own.

Based on these elaborations, the court held that as to the duty to indemnify each carrier’s obligation to pay can be derived. (The court however embraced a per-capita allocation for defense.)

The Minnesota court recognized that its elaborations meant that its formulaic approach was becoming unmoored from the principles from which it derived. (No matter; such is the privilege of being the last word.) As the court said:

We are aware it is possible under our construction of factor B that an insurer is liable for more than those damages than would otherwise be deemed to have occurred during its policy period. This is possible because our definition of factor B, the period over which damages are to be allocated, excludes periods during which the insured lacks coverage because no such coverage was available. We are also aware that this result may be contrary to the broad language we used in [prior authority] to describe the ‘actual injury’ [trigger] rule, namely, that under this rule each insurer is liable ‘only for those damages which occurred during its policy period.’ [citation omitted] However, as we [there] indicated . . . ., the allocation of liability between insurers requires a flexible approach. [citation] Further, as we noted [previously], it is inaccurate to conclude that a CGL insurer can never be liable for damages occurring outside of a policy period. [citation] We deem the facts of this case to justify a departure from the typical ‘actual injury’ approach.

So is there a principled way to come to grips with the language of the insurance policy and figure out a principled manner to determine the obligation of each carrier where a single loss situation produces damage and injury both during and outside of its policy period? This is now the question that the New Hampshire Supreme Court has been asked in an environmental-coverage case. See EnergyNorth Natural Gas Inc. v. Certain Underwriters at Lloyd's Underwriters, 2006 U.S. Dist. LEXIS 73468 (D.N.H.)

I believe there is an approach to the contract language that takes the language seriously yet produces results that are (I submit) intellectually consistent.

The first principle is that insurance policies create rights in the insured, and it is the insured’s right to exercise. Insurance policies are not issued in dependence on the existence of coverage in other years; no credit is given on the premium from having more coverage in the past year than not or coverage from carriers with better credit ratings. Policyholders don’t promise carriers to purchase insurance policies in the future. And insurers are not understood to be third-party beneficiaries of each other’s contract, even though those contracts are with the same party, the policyholder. See Signal Co., Inc. v. Harbor Ins. Co., 27 Cal. 3d 359, 369 (1980); L.E. Myers Co. v. Harbor Ins. Co., 394 N.E. 2d 1200 (Ill. 1979).

The second, and more important, principle is that insurance policies insure against the risk that the insured will be held liable for injury or damage during the policy period; policies do not insure against the risk of injury or damage occurring per se. As one leading treatise explains, “[t]he hazard insured against under the liability feature is not injury or loss . . . but liability or responsibility of the insured for loss or injury.” 6B J. Appleman & J.A. Appleman, Insurance Law and Practice §4254 at 26-27 (Rev. ed. 1979). The policy language makes this plain. CGL policies contain a broad promise to pay “all sums” that “the insured shall become legally obligated to pay as damages because of bodily injury . . . to which this insurance applied caused by an occurrence.” In other words, subject to the applicable limit of liability, the policy covers the totality of damages incurred by an insured “because of,” i.e. “by reason of” or “on account of,” bodily injury within the policy period. The question then is, what is the insured’s liability because of the injury during the policy period. This is key and shows both where Minnesota law goes wrong and creates the hydraulic pressure on the court to backfill we see so clearly in Wooddale.

These two principles illuminate the right way to argue the point for policyholders (and I submit the right way for courts to resolve the question). Instead of the Minnesota court’s mathematical formula, one takes a single policy and asks the following question: Is there bodily injury or property damage that occurred during the policy period, and if so what is the insured’s liability for the bodily injury or property damage that happened? (Contrary to what some insurers have argued, the “Policy Period; Territory” provision does not alter the question, because that provision ensures that the trigger is damage, not the negligent act, see State v. Glens Falls Ins. Co., 609 P.2d 598, 600-01 (Ariz. App. 1980), and while the language in the insuring agreement referring to property damage “to which this insurance applies” refers implicitly to the “policy period; territory” provision, that does nothing to the question on which I focus, viz., what is the insured’s liability “because of” the property damage to which the insurance applies.) I don’t need to reflexively or exclusively rely on the insurance policy’s promise to pay “all sums” or “those sums” – that is handy language but is not the key issue. The key is always and only, what is the insured’s liability because of bodily injury/property damage during the policy period.

As a matter of tort (not insurance) law, in most of the situations we deal with the answer to that question is this: for bodily injury or property damage that occurred during the particular carrier’s policy period, the insured’s liability is equal to the entirety of the plaintiff’s claim. This is the result of the rule of tort law that imposes joint and several liability upon tort defendants. John Crane v. Scribner, 800 A.2d 727, 741 (Md. 2002) (“it is as impossible to ascertain which fiber ultimately caused which cell, over time, to escape the body’s defenses and turn cancerous, as it is to determine when that occurred”).

Note that I am not saying that insurers are jointly and severally liable under their policies; that would be to import a tort concept to the contract context, and I don’t think that is quite precise enough. But what is central is that the insured is jointly and severally liable, and such liability is imposed where the injury or damage at issue is indivisible from injury or damage that occurred in other policy periods (or from other tortfeasors). See United States v. Alcan Aluminum Corp., 964 F.2d 252, 268-69 (3d Cir. 1992); Matter of Bell Petroleum Services, Inc., 3 F. 3d 889-896 (5th Cir. 1993); O’Neil v. Piccillo, 883 F.2d 176 (1st Cir. 1989) (interesting discussions all re indivisible damage/injury and the imposition of joint-and-several liability under tort law).

Nothing in the policies reduces the carrier’s obligation to pay simply because injury may also have occurred outside the policy period; the sole determinant of the extent of coverage is what is the insured’s liability because of injury during the policy period. The policy language addressing the application of the policy limits for a covered claim nowhere confines the carrier’s obligation to pay to some aliquot share based on the quantum of injury occurring in its policy years. E.g., ACandS v. Aetna Cas. & Sur. Co., 764 F.2d 968, 974 (3d Cir. 1985) (Even where sums paid by the insured party are partly attributable to injury that occurred in another policy period, “the language of the policy makes [that fact] irrelevant.”).

This is made particularly clear in the “Limits” section of standard liability insurance policies. The “Limits of Liability” section of policies typically provides that, for a covered bodily-injury (or property damage) “occurrence,” the policy will pay for “all damages . . . because of bodily injury sustained by one or more persons as the result of any one occurrence.” The sole limitation on each policy’s obligation to pay is that the payout on the claim “shall not exceed the limit of bodily injury liability stated in the declarations as applicable to ‘each occurrence.’” The Limits provision further elaborates by stating:

For the purpose of determining the limit of the company’s liability [under the policy], all bodily injury . . . arising out of continuous or repeated exposures to substantially the same general conditions shall be considered as arising out of one occurrence.

Here the policy language unambiguously favors coverage: The amounts any given CGL policy pays are expressed in dollars “per occurrence.” The insuring agreement and the limits-of-liability provisions together teach that, where there is covered injury in the policy period, the policy pays “all sums” for “all damages sustained by one . . . person . . . as the result of any one occurrence,” subject only to the per-occurrence limit.

In fact, even if the policies were uncertain as to the proper method of allocation, a reasonable interpretation of the policies requires an “all sums” approach. And of course insurers have been in the position to protect themselves by drafting clear and explicit language that addresses how the obligation to perform should be measured where there is indivisible damage triggering their coverage. Compare Rochester German Ins. Co. v. Schmidt, 175 F. 720, 725-726 (4th Cir. 1909). Principles of insurance law, therefore, require that the interpretation of uncertain or ambiguous policy provisions favoring the insured must govern.

This contract-based approach to allocation also “solves” the question of horizontal versus vertical exhaustion: that is, where policies are triggered across time, must the insured collect first from all the primaries before tapping any excess coverage (and thus absorb cumulated deductibles and insolvent primary layers) or may the insured select a single year of coverage and access the triggered primary and overlying excess (either in a single year or in more than one). General-liability policies do not speak to this issue, and so we return to the principle that the contract rights belong to the insured; consequently, the insured has the option to select or target its triggered policies however it sees fit. In each instance, one asks the same questions: is the policy triggered, and if so how much does the policy pay per occurrence for the insured’s liability because of the (indivisible) damage/injury that year? Any targeted policy may seek to pursue equitable contribution against other carriers that could have been targeted but were not. Indeed, I submit that part of the peace of mind offered by broad CGL insurance is precisely the insured’s ability to collect its full per-occurrence limits and then go home – leaving further redistribution to the carriers to sort out.

This approach also gives the framework to address stacking or cumulation of policy limits, for looking at each contract the stacking or cumulation of policy limits again is straightforward. See United Services Automobile Ass’n v. Riley (Md. June 1, 2006). Until the insured is fully indemnified for its damages because of injury/damage during the policy year, the insured is entitled to collect on its coverage. In other words, stacking is only an issue if an insurer has clear anti-stacking language in its policy.

The bottom line of all of this is that policyholders should look hard at the contract without preconceived notions and see how each individual insurance contract’s obligation to perform is measured. Bearing in mind the crucial question of divisible versus indivisible harm and damage – and its impact on answering what is the insured’s liability for injury or damage during the policy period – insurance policies require insurers to perform if any “injury” occurred during the policy period and to pay their entire per-occurrence policy limit until such time as the insured has been fully indemnified or the insurance policy’s limits exhausted.

We confront the particular language of particular policies every time we settle a claim or file a complaint. Each contract should be analyzed using the toolkit I’ve sketched out here, and then you should move on to the next contract. Shampoo. Rinse. Repeat.

Posted by Marc Mayerson at 4:24 PM | Comments (4) | TrackBack

June 29, 2006

Equitas Financials -- 2006 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, various participants in the Lloyd’s enterprise established several companies for the purpose of reinsuring the then-open syndicate years of account and managing the runoff of claims under those and prior years’ insurance policies. In 1997, the liabilities of a Lloyds’ owned-entity called Lioncover were reinsured into Equitas too.

Equitas issues an annual report and accompanying press release that discusses its results to date. Some of the highlights this year:

* Equitas’ retained surplus – that is, the amounts of its assets minus its expected liabilities – was reduced to £458 million.

* The retained surplus expressed as a percentage of net claims outstanding fell to 12 percent. In other words, Equitas expects its net claims to total roughly £3.8 billion. (p.6)

* Equitas paid £672 million in settlement of claims, including payment for 32 direct asbestos claims and 15 direct pollution claims. (p.4, 7) In this context, this means payments in commutation of policy obligations. (Some of these payments likely were to policyholders with both asbestos and pollution liabilities, and perhaps with more than one stream of liabilities, so one should not assume that Equitas did deals with 47 (32 + 15) different policyholders.) In the reporting period, Equitas completed more asbestos-driven policy buyouts than in any previous year (p.6) In these asbestos buyouts, Equitas is making payment on the assumption that Federal asbestos-reform legislation is not passed, but if such legislation does pass it will receive a give back from the settling policyholders totaling £280 million. (p. 43)

* Even considering these settlements, Equitas increased its asbestos reserves by £103 million, roughly the same amount that it increased reserves last year (£116 million), which makes up 53 percent of Equitas’s total reserves (with environmental and other health-hazards constituting another 24 percent of the reserves) (p. 41). The present value of the asbestos reserves is £2.2 billion, with a nominal value of £3.4 billion (p.5). For the first time in seven years, Equitas increased its reserves for environmental liabilities too. Equitas assumes it will be making payments for these classes of claims for at least another 40 years (p.41). Further, Equitas assumes that the mean term of its liabilities, “that is the weighted average period to settlement where the weights are the undiscounted expected cash flows in each future period,” will be approximately 11 years, one year longer than the assumption made a year ago.

* Equitas continues its aggressive liquidation of its reinsurance asset, with an undiscounted asset of £700 million and a discounted value of £360 million (p. 7, 14). Reinsurers’ share of claims paid was reduced from last year from £209 million to £190 million, a reduction that is not surprising given the reduction in claims payment from Equitas and the dwindling value of the remaining reinsurance. One can express sympathy with Equitas for its problems in collecting from its reinsurers: “We see a growing trend for some reinsurers to dispute claims for no other reason than to demand discounts in the hope we will be afraid of the costs of collecting these balances.” (p.7)

* Equitas identifies the amount of “profit” it has made on settlements, profit in this context being the amount of reserves freed from a settlement at a figure less than the reserved amount. £435 million of Equitas’ surplus is acknowledged by it to be attributable to settlements it has made over the past four years at amounts less than the reserves it had previously established for the claims. Last year, settlements contributed £81 million to Equitas’s bottom line. (p.4) In other words, 95 percent (!) of Equitas’s net surplus is attributable to these reserving-freeing settlements.

* There are several related threads to follow to grasp the significance of this figure. When Equitas was established in 1996, it is known that the money it raised was reverse engineered based on predictions on what it could collect in settlements with brokers, managing agencies, and the reinsured names. The initial Equitas premium indication was widely viewed as being unacceptable to the individual participants at Lloyd’s, so the Equitas premium number was reduced to a level that the “names” would accept. When Equitas began operations in 1996, it had a “solvency” margin of 5.6%, meaning its then projections of liabilities were 5.6% less than its assets. In order to open for business, Equitas could not be insolvent the first day, so its reserves had to be reduced to allow it to (barely) show a solvency margin.

* Equitas has since hiked its reserves substantially, particularly for asbestos. Reserve adjustments affect the year they are made (p. 35), so a settlement with policyholder X in 2003 that yielded a settlement profit of, e.g., $10 million should be recognized as yielding a settlement profit of a significantly greater amount if the associated reserves would have floated upwards with other reserve adjustments in subsequent years. So Equitas’s announcement of its settlement profit in the prior year understates the true profit amount, since the policyholder sold out its coverage for an even greater discount than it may have anticipated at the time of settlement.

* So, the reserve number for any given settling policyholder is likely to have been underestimated for either of two reasons: (i) all reserves were understated in the reverse engineering process to generate an acceptable Equitas “finality” premium and (ii) reserves subsequently have been adjusted upward either to compensate for that (conscious) underestimation or because then-unforeseen events yield higher valuations of the claim streams.

* Given that virtually all of Equitas’s solvency margin (and surplus) is attributable to policyholders’ settling out their coverage too cheaply, one can fairly say that the only thing keeping Equitas afloat is policyholders’ settling for too little (even from Equitas’s perspective).

* In this light, and perhaps in response to my constant harping on this issue (a theme I don’t see elsewhere), the CEO of Equitas offers the following defense of its claims-settlement practices:

“When we settle claims, whether those coming into us, or those we make on reinsurance policies, sometimes we pay or receive more than we had reserved, and other times less. . . . [S]ome deals were ‘winners’ (producing a contribution to surplus) while others were ‘losers’, but in the aggregate we achieved a win.” (p.4).

* I would challenge even the verity of the statement that some were ‘losers’ (for the reasons above) but at all events in the aggregate it is indisputable that Equitas’s effectiveness in snookering policyholders into settling for less than the reserve is Equitas’s margin.

* Given the tremendous success that Equitas has had in extinguishing major liabilities with its reinsureds’ direct policyholders (it has settled with all 10 of the largest direct asbestos policyholders identified in 2001 (p.2)), Equitas has now turned its attention to its “inwards” reinsurance with US insurance companies. (p. 10) Since the time of the annual report, Equitas has achieved a major settlement with The Hartford (and which resulted in Hartford’s realizing less than its booked reinsurance receivable). So perhaps policyholders can take solace that they are in good company.

Notes: My commentary is available for Equitas Financials 2005 and 2004.

On March 31, 2006, 1 pound equaled $1.74.

Posted by Marc Mayerson at 2:16 PM | Comments (0) | TrackBack

Equitas Financials -- 2006 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, various participants in the Lloyd’s enterprise established several companies for the purpose of reinsuring the then-open syndicate years of account and managing the runoff of claims under those and prior years’ insurance policies. In 1997, the liabilities of a Lloyds’ owned-entity called Lioncover were reinsured into Equitas too.

Equitas issues an annual report and accompanying press release that discusses its results to date. Some of the highlights this year:

* Equitas’ retained surplus – that is, the amounts of its assets minus its expected liabilities – was reduced to £458 million.

* The retained surplus expressed as a percentage of net claims outstanding fell to 12 percent. In other words, Equitas expects its net claims to total roughly £3.8 billion. (p.6)

* Equitas paid £672 million in settlement of claims, including payment for 32 direct asbestos claims and 15 direct pollution claims. (p.4, 7) In this context, this means payments in commutation of policy obligations. (Some of these payments likely were to policyholders with both asbestos and pollution liabilities, and perhaps with more than one stream of liabilities, so one should not assume that Equitas did deals with 47 (32 + 15) different policyholders.) In the reporting period, Equitas completed more asbestos-driven policy buyouts than in any previous year (p.6) In these asbestos buyouts, Equitas is making payment on the assumption that Federal asbestos-reform legislation is not passed, but if such legislation does pass it will receive a give back from the settling policyholders totaling £280 million. (p. 43)

* Even considering these settlements, Equitas increased its asbestos reserves by £103 million, roughly the same amount that it increased reserves last year (£116 million), which makes up 53 percent of Equitas’s total reserves (with environmental and other health-hazards constituting another 24 percent of the reserves) (p. 41). The present value of the asbestos reserves is £2.2 billion, with a nominal value of £3.4 billion (p.5). For the first time in seven years, Equitas increased its reserves for environmental liabilities too. Equitas assumes it will be making payments for these classes of claims for at least another 40 years (p.41). Further, Equitas assumes that the mean term of its liabilities, “that is the weighted average period to settlement where the weights are the undiscounted expected cash flows in each future period,” will be approximately 11 years, one year longer than the assumption made a year ago.

* Equitas continues its aggressive liquidation of its reinsurance asset, with an undiscounted asset of £700 million and a discounted value of £360 million (p. 7, 14). Reinsurers’ share of claims paid was reduced from last year from £209 million to £190 million, a reduction that is not surprising given the reduction in claims payment from Equitas and the dwindling value of the remaining reinsurance. One can express sympathy with Equitas for its problems in collecting from its reinsurers: “We see a growing trend for some reinsurers to dispute claims for no other reason than to demand discounts in the hope we will be afraid of the costs of collecting these balances.” (p.7)

* Equitas identifies the amount of “profit” it has made on settlements, profit in this context being the amount of reserves freed from a settlement at a figure less than the reserved amount. £435 million of Equitas’ surplus is acknowledged by it to be attributable to settlements it has made over the past four years at amounts less than the reserves it had previously established for the claims. Last year, settlements contributed £81 million to Equitas’s bottom line. (p.4) In other words, 95 percent (!) of Equitas’s net surplus is attributable to these reserving-freeing settlements.

* There are several related threads to follow to grasp the significance of this figure. When Equitas was established in 1996, it is known that the money it raised was reverse engineered based on predictions on what it could collect in settlements with brokers, managing agencies, and the reinsured names. The initial Equitas premium indication was widely viewed as being unacceptable to the individual participants at Lloyd’s, so the Equitas premium number was reduced to a level that the “names” would accept. When Equitas began operations in 1996, it had a “solvency” margin of 5.6%, meaning its then projections of liabilities were 5.6% less than its assets. In order to open for business, Equitas could not be insolvent the first day, so its reserves had to be reduced to allow it to (barely) show a solvency margin.

* Equitas has since hiked its reserves substantially, particularly for asbestos. Reserve adjustments affect the year they are made (p. 35), so a settlement with policyholder X in 2003 that yielded a settlement profit of, e.g., $10 million should be recognized as yielding a settlement profit of a significantly greater amount if the associated reserves would have floated upwards with other reserve adjustments in subsequent years. So Equitas’s announcement of its settlement profit in the prior year understates the true profit amount, since the policyholder sold out its coverage for an even greater discount than it may have anticipated at the time of settlement.

* So, the reserve number for any given settling policyholder is likely to have been underestimated for either of two reasons: (i) all reserves were understated in the reverse engineering process to generate an acceptable Equitas “finality” premium and (ii) reserves subsequently have been adjusted upward either to compensate for that (conscious) underestimation or because then-unforeseen events yield higher valuations of the claim streams.

* Given that virtually all of Equitas’s solvency margin (and surplus) is attributable to policyholders’ settling out their coverage too cheaply, one can fairly say that the only thing keeping Equitas afloat is policyholders’ settling for too little (even from Equitas’s perspective).

* In this light, and perhaps in response to my constant harping on this issue (a theme I don’t see elsewhere), the CEO of Equitas offers the following defense of its claims-settlement practices:

“When we settle claims, whether those coming into us, or those we make on reinsurance policies, sometimes we pay or receive more than we had reserved, and other times less. . . . [S]ome deals were ‘winners’ (producing a contribution to surplus) while others were ‘losers’, but in the aggregate we achieved a win.” (p.4).

* I would challenge even the verity of the statement that some were ‘losers’ (for the reasons above) but at all events in the aggregate it is indisputable that Equitas’s effectiveness in snookering policyholders into settling for less than the reserve is Equitas’s margin.

* Given the tremendous success that Equitas has had in extinguishing major liabilities with its reinsureds’ direct policyholders (it has settled with all 10 of the largest direct asbestos policyholders identified in 2001 (p.2)), Equitas has now turned its attention to its “inwards” reinsurance with US insurance companies. (p. 10) Since the time of the annual report, Equitas has achieved a major settlement with The Hartford (and which resulted in Hartford’s realizing less than its booked reinsurance receivable). So perhaps policyholders can take solace that they are in good company.

Notes: My commentary is available for Equitas Financials 2005 and 2004.

On March 31, 2006, 1 pound equaled $1.74.

Posted by Marc Mayerson at 2:16 PM | Comments (0) | TrackBack

June 5, 2006

Discovery of Other-Insured Claim Files in Insurance and Bad-Faith Disputes

Among the typical skirmishes in insurance-coverage litigation is the scope of discovery. In seeking discovery in insurance-coverage cases and for insurance bad-faith claims, policyholders seek information from insurers about the underwriting of the policy at issue and the carrier’s handling of the policyholder’s claim for coverage. Disputes arise once the policyholder moves beyond those materials to information showing the general practice of the insurer, how the insurer’s response to the particular insured compares with how it has handled other claims, and the insurer’s own understanding of the policy language as evidenced through claims-handling manuals, training materials, and other types of interpretative aids. See generally Saldi v. Paul Revere Life Ins. Co., 224 F.R.D. 169 (E.D. Pa. 2004); Colonial Life v. Superior Court(Perry) 31 Cal. 3d 785 (1982); Carey-Canada v. Cal. Union Ins., 118 FRD 242 (D.D.C. 1986). One recurring subject has been other-claims information, that is, information in claim files dealing with other insureds.

Policyholders argue that such extrinsic evidence is both discoverable and potentially admissible. A recent case from the Federal Court in the District of Columbia had occasion to address the discoverability information from insurers that is stored electronically. In J.C. Associates v. Fidelity & Guarantee Ins. Co., 2006 WL 1445173 (D.D.C. May 25, 2006), Magistrate Judge John M. Facciola ordered the production of various “other claim” file information in the context of a dispute over application of the “absolute pollution exclusion.” In the earlier days of environmental coverage litigation, policyholders and insurers reached détente on production of the “ten and ten” – the ten oldest environmental claim files and the ten most recent. In this era of ediscovery, however, the J.S. Associates case looked more generally to information that was stored electronically.

In addressing the relevance of claim-file information in general, Magistrate Judge Facciola ruled:
[

T]he information plaintiff seeks is clearly relevant. For example, information as to how defendant interpreted the absolute pollution exclusion would qualify as an admission under Rule 801 of the Federal Rules of Evidence and relevant to the claim presented by plaintiff if that interpretation is different from the interpretation that the defendant is asserting in this case.

Id. at *1. The insurer had searched its computerized index of its 1.4 million claim files, which yielded 454 similar claims. The originals were not stored in electronic format, and the court considered the costs of manually reviewing the 454 claim files for relevant information as against the amount in controversy, $124,000. To balance the competing interests, the court required the insurer to scan the originals into a searchable format and directed it to search that population using the terms “1) pollution, 2) pollutant, 3) pesticide, and 4) insecticide.” Id.

For any of the 454 converted files that contained one of the search terms, the insurer was required to manually review the material for privilege. The insurer further was told to log the costs of the privilege review, but to count attorney time only for work “that requires an attorney’s skill and judgment.” Id. at *2. Citing the judge’s own prior decision in McPeek v. Ashcroft, 202 F.R.D. 31, 34 (D.D.C. 2001), the court reserved ruling on further discovery and the costs of any such discovery.

While the law is not uniform, the J.C. Associates decision is consistent with courts that recognize that extrinsic evidence from insurance companies may be offered to show (i) an ambiguity or uncertainty in policy terms, (ii) a coverage-promoting meaning when considered in context, or (iii) the reasonableness of the insured’s proffered construction. The evidence may also block a carrier from advocating a coverage-defeating construction in the particular case. Statements by the carrier may constitute admissions, as Judge Facciola found, or statements against interest. E.g., Gerrish Corp. v. Universal Ins. Co., 947 F.2d 1023 (2d Cir. 1991); Phoenix Ins. Col. v. Glens Falls Ins. Co., 253 F. Supp. 1014, 1019 (M.D. Fla. 1966) (state filings); Greer v. Northwestern Nat’l Ins. Co., 743 P.2d 1244 (Wash. 1987); Allegheny Airlines Inc. v. Forth Corp., 663 F.2d 751, 755 (7th Cir. 1981); Aetna Cas. & Sur. Co. v. Haas, 422 S.W.2d 316, 320 (Mo. 1968); Grinnell Mut. Reinsurance Co. v. Voeltz, 431 N.W.2d 783, 787-89 (Iowa 1988); Ford Motor Co. v. Northbrook Ins. Co., 838 F.2d 829, 833 (6th Cir. 1988).

More generally, “the interpretation given to the same contract by one of the parties in its dealings with third parties . . . has some weight – as demonstrating the past interpretation of at least one of the parties, and also suggesting the reasonableness of that interpretation.” Tymshare, Inc. v. Covell, 727 F.2d 1145, 1150 (D. C. Cir. 1984) (Scalia, J.).

The policyholder’s burden is to offer a construction of the policy language that is both linguistically permissible and reasonable. In discharging its burden of showing a reasonable construction, a policyholder’s proffering extrinsic evidence out of the mouths of insurer witnesses or from their pens or keyboards can be helpful. As one court stated in a related context, “[a]ny suggestion that an insured’s identical interpretation is unreasonable is absurd.” Montrose Chem. Corp. v. Admiral Ins. Co., 5 Cal. Rptr. 2d 358, 369 (Cal. App. 1992).

Often judges seem to take the position that they understand what a particular policy provision must mean when they see it. But that is not the relevant legal question; the task for the judge is not to pick the best construction or the one he or she thinks makes the most sense. Rather, the hermeneutical task is: what construction does the language admit and is the construction being offered a reasonable one? To this end, evidence from claim files and other materials from insurers sheds light – and thus is discoverable and potentially admissible on motions for summary judgment and at trial.

Posted by Marc Mayerson at 5:05 PM | Comments (2) | TrackBack

Discovery of Other-Insured Claim Files in Insurance and Bad-Faith Disputes

Among the typical skirmishes in insurance-coverage litigation is the scope of discovery. In seeking discovery in insurance-coverage cases and for insurance bad-faith claims, policyholders seek information from insurers about the underwriting of the policy at issue and the carrier’s handling of the policyholder’s claim for coverage. Disputes arise once the policyholder moves beyond those materials to information showing the general practice of the insurer, how the insurer’s response to the particular insured compares with how it has handled other claims, and the insurer’s own understanding of the policy language as evidenced through claims-handling manuals, training materials, and other types of interpretative aids. See generally Saldi v. Paul Revere Life Ins. Co., 224 F.R.D. 169 (E.D. Pa. 2004); Colonial Life v. Superior Court(Perry) 31 Cal. 3d 785 (1982); Carey-Canada v. Cal. Union Ins., 118 FRD 242 (D.D.C. 1986). One recurring subject has been other-claims information, that is, information in claim files dealing with other insureds.

Policyholders argue that such extrinsic evidence is both discoverable and potentially admissible. A recent case from the Federal Court in the District of Columbia had occasion to address the discoverability information from insurers that is stored electronically. In J.C. Associates v. Fidelity & Guarantee Ins. Co., 2006 WL 1445173 (D.D.C. May 25, 2006), Magistrate Judge John M. Facciola ordered the production of various “other claim” file information in the context of a dispute over application of the “absolute pollution exclusion.” In the earlier days of environmental coverage litigation, policyholders and insurers reached détente on production of the “ten and ten” – the ten oldest environmental claim files and the ten most recent. In this era of ediscovery, however, the J.S. Associates case looked more generally to information that was stored electronically.

In addressing the relevance of claim-file information in general, Magistrate Judge Facciola ruled:
[

T]he information plaintiff seeks is clearly relevant. For example, information as to how defendant interpreted the absolute pollution exclusion would qualify as an admission under Rule 801 of the Federal Rules of Evidence and relevant to the claim presented by plaintiff if that interpretation is different from the interpretation that the defendant is asserting in this case.

Id. at *1. The insurer had searched its computerized index of its 1.4 million claim files, which yielded 454 similar claims. The originals were not stored in electronic format, and the court considered the costs of manually reviewing the 454 claim files for relevant information as against the amount in controversy, $124,000. To balance the competing interests, the court required the insurer to scan the originals into a searchable format and directed it to search that population using the terms “1) pollution, 2) pollutant, 3) pesticide, and 4) insecticide.” Id.

For any of the 454 converted files that contained one of the search terms, the insurer was required to manually review the material for privilege. The insurer further was told to log the costs of the privilege review, but to count attorney time only for work “that requires an attorney’s skill and judgment.” Id. at *2. Citing the judge’s own prior decision in McPeek v. Ashcroft, 202 F.R.D. 31, 34 (D.D.C. 2001), the court reserved ruling on further discovery and the costs of any such discovery.

While the law is not uniform, the J.C. Associates decision is consistent with courts that recognize that extrinsic evidence from insurance companies may be offered to show (i) an ambiguity or uncertainty in policy terms, (ii) a coverage-promoting meaning when considered in context, or (iii) the reasonableness of the insured’s proffered construction. The evidence may also block a carrier from advocating a coverage-defeating construction in the particular case. Statements by the carrier may constitute admissions, as Judge Facciola found, or statements against interest. E.g., Gerrish Corp. v. Universal Ins. Co., 947 F.2d 1023 (2d Cir. 1991); Phoenix Ins. Col. v. Glens Falls Ins. Co., 253 F. Supp. 1014, 1019 (M.D. Fla. 1966) (state filings); Greer v. Northwestern Nat’l Ins. Co., 743 P.2d 1244 (Wash. 1987); Allegheny Airlines Inc. v. Forth Corp., 663 F.2d 751, 755 (7th Cir. 1981); Aetna Cas. & Sur. Co. v. Haas, 422 S.W.2d 316, 320 (Mo. 1968); Grinnell Mut. Reinsurance Co. v. Voeltz, 431 N.W.2d 783, 787-89 (Iowa 1988); Ford Motor Co. v. Northbrook Ins. Co., 838 F.2d 829, 833 (6th Cir. 1988).

More generally, “the interpretation given to the same contract by one of the parties in its dealings with third parties . . . has some weight – as demonstrating the past interpretation of at least one of the parties, and also suggesting the reasonableness of that interpretation.” Tymshare, Inc. v. Covell, 727 F.2d 1145, 1150 (D. C. Cir. 1984) (Scalia, J.).

The policyholder’s burden is to offer a construction of the policy language that is both linguistically permissible and reasonable. In discharging its burden of showing a reasonable construction, a policyholder’s proffering extrinsic evidence out of the mouths of insurer witnesses or from their pens or keyboards can be helpful. As one court stated in a related context, “[a]ny suggestion that an insured’s identical interpretation is unreasonable is absurd.” Montrose Chem. Corp. v. Admiral Ins. Co., 5 Cal. Rptr. 2d 358, 369 (Cal. App. 1992).

Often judges seem to take the position that they understand what a particular policy provision must mean when they see it. But that is not the relevant legal question; the task for the judge is not to pick the best construction or the one he or she thinks makes the most sense. Rather, the hermeneutical task is: what construction does the language admit and is the construction being offered a reasonable one? To this end, evidence from claim files and other materials from insurers sheds light – and thus is discoverable and potentially admissible on motions for summary judgment and at trial.

Posted by Marc Mayerson at 5:05 PM | Comments (2) | TrackBack

May 17, 2006

Taming the Lion(cover): Lioncover, Lloyd's, Equitas, and the Central Fund(s)

W. Mark Felt or Hal Holbrook playing him said to "follow the money," which has proven difficult in the instance of Lloyd's of London, and a task made all the more important as asbestos and environmental liabilities continue to fall upon corporate policyholders in the US that purchased broad insurance in the 1950s, 60s and 70s through the London market. While lawyers and policyholders may be familiar with Equitas, the reinsurance runoff and claims-handling vehicles set up in the late 1990s to deal with liabilities arising under historical Lloyd's policies, I have long believed that a key for litigators is something called Lioncover, a reinsurance vehicle originally set up to bailout important players at Lloyd's who were involved in Peter Cameron Webb "managed" syndicate years of account. Lioncover, which I understand to be a wholly owned subsidiary of the Corporation of Lloyd's and which houses the PCW business, initially was not reinsured into Equitas when Equitas was set up as part of the "Reconstruction and Renewal" of the Lloyd's operation. It was later poured into the Equitas structure but also is explicitly backed by the Lloyd's enterprise itself. Lioncover is a lever one can use to uncover the financial vehicles backing old Lloyd's policies (which contra to popular myth are not backed solely by the assets of Equitas or by the trust funds in the US). Lloyd's annual report for 2005 contains a few interesting crumbs worthy of note for Lloyd's/Equitas watchers.

First, Lioncover's liability payments in 2005 total slightly more than 525 million pounds or roughly $1 billion (US). These principally were attributable to asbestos, environmental, and health-hazard claims. (p. 114; note 14)

Second, this amount is not reflected on Lloyd's net balance sheet because the directors of Lioncover conclude that, because Equitas says it will pay the claims, it can take that reinsurance recoverable as an offset on its balance sheet. (p. 120) As Lloyd's annual report states:

At present, ERL [Equitas Reinsurance Ltd.] and its subsidiary undertaking, Equitas Limited, which is responsible for the run-off of the reinsured business, continue to pay claims in full and the directors of ERL have stated that they believe that the assets should be sufficient to meet all liabilities in full. Accordingly, the directors of Lioncover have considered it appropriate to recognise the amounts recoverable from ERL in full. Should ERL ever cease to meet in full its obligations in respect of the PCW syndicates, Lioncover would be responsible to its policyholders for meeting any amounts remaining unpaid.

The establishment of Lioncover and its reinsurance into Equitas does not cutoff the policyholder's right to make claim under the policy as against the Lloyd's enterprise. (This is consistent with what I have been counseling that one should not look at Equitas' assets alone when evaluating whether to include a credit-risk discount in a deal done with Equitas.)

Third, in the event Equitas does fail to perform, then Lioncover may seek to obtain payment from the "Central Fund," which helps back the policies issued through Lloyd's. As part of the Reconstruction and Renewal process, there is an "old" Central Fund and a "new" Central Fund, and Lioncover can claim under both, though the Council of Lloyd's purports to have discretion not to pay under the new fund unless the current membership agrees. As the report explains:

Following the implementation of ‘Reconstruction and Renewal’, Names underwriting in respect of 1992 and prior years, Lioncover and Centrewrite were reinsured into Equitas. If Equitas were unable to discharge in full the liabilities which it has reinsured, any resulting shortfall in respect of Lioncover or Centrewrite could be met out of both the ‘Old’ Central Fund and the New Central Fund under the terms of their respective Lloyd’s bond. Both the ‘Old’ Central Fund and the New Central Fund would also be available to meet the claims of policyholders of Names who are party to hardship agreements executed before 4 September 1996, to the extent that such an event resulted in a shortfall. However, unless the members of the Society resolve in a general meeting to make the New Central Fund available, only the ‘Old’ Central Fund would be available to meet the claims of policyholders of Names who are not party to hardship agreements executed before 4 September 1996. The Council has determined that any losses resulting from such indemnities will be met by the Lloyd’s Central Fund. (p. 132, note 29)

There certainly is an open question whether there really is discretion not to pay under the new Central Fund, but the reason we care about this is that it is the current membership of Lloyd's that would be responsible for topping up the fund in the event of a shortfall (and that there would be a shortfall is a likely result if the new fund were tapped).

Note that simultaneously Lioncover's liabilities would need to be shown on Lloyd's balance sheet and the capital of the members would be hit, thus doubly impairing the financial ratings of the Lloyd's enterprise.

Fourth, my sense continues to be that, if Equitas stops making payments or determines that it has more mouths to feed than money (or owns up to that reality), following what happened with Lioncover and how it has been intermingled with "new" Lloyd's will be a key focus for discovery and trial when policyholders seek payment on their old Lloyd's policies and are shunted off to the admittedly penurious Equitas. The story of insiders being bailed out through Lioncover and new Lloyd's assumption of those liabilities and seeming manipulation of its own financial statements (by taking the reinsurance recoverable as a full, undiscounted offset while Equitas otherwise is proclaiming its own credit risk) will be the stuff of trial. The promises Lloyd's makes when selling policies are supposed to be backed up by the vaunted "chain of security," which means the assets of the current membership of the Lloyd's enterprise. Compare Industrial Guarantee Corp. v Lloyd's(1924) 19 Lloyd's List Law Reports 78 (Bailhache J).

The Lloyd's enterprise's efforts to "ringfence" the historic liabilities and to protect the current corporate members may yet prove successful -- at least to the extent that policyholderscooperate in obtaining less than the full value of their insurance; the chain of security will back the policies US companies purchased only once those companies bring litigation to force the Lloyd's enterprise to honor the promises made in the broad insurance policies sold to American companies (or in the unlikely event that regulators step in). Certainly, the halcyon days of Cuthbert Heath saying "pay all our policyholders in full" are long, long gone.

A somewhat expanded version of this commentary