Friday, January 22, 2016

Thoughts on the upcoming Restatement of the Law of Liability Insurance

Last week I posted about the January 22 Insurance Law Symposium sponsored by the American College of Coverage and Extra-Contractual Counsel.  It was a great conference, with excellent panel discussions on emerging issues in coverage law and on ethical issues relating to the tripartite relationship. 

Several of the discussions were devoted to the Restatement of the Law of Liability Insurance, which is currently being completed.  Although I had been vaguely aware that the Restatement was in the works, it was fascinating to get the details. 

Restatements are books that provide guidance on a particular area of law.  They are published by the American Law Institute, and are highly regarded by judges.  Where an issue of law is undetermined in a particular state, judges will often turn to Restatements as at least a starting point (and not infrequently an end point) for their analysis.

Restatements provide general principals of law followed by comments that explain the principle more fully and give examples of how it is applied. 

One of the presenters at the conference, Kyle Logue of the University of Michigan Law School, is one of the two reporters for the Restatement of the Law of Liability Insurance.  That means that he is responsible for drafting, getting comments, redrafting, getting more comments, redrafting . . .  He discussed the history of the project and how the reporters make choices about the content of the Restatement.

When it is completed the Restatement will have four chapters:  Basic liability contract rules, management of potentially insured liability claims, general principals regarding the risks insured, and advanced contract issues.  The first three chapters are in close to final form.  The draft document is available on Westlaw (and maybe Lexis; I didn't quite catch it). 

By the end of Professor Logue's presentation I had the distinct idea that the existence of the Restatement will work in favor of insurers at the expense of insureds. 

The Restatement of the Law of Liability Insurance differs from other Restatements in an important manner: it sets forth principles that can easily be made inapplicable, without the intervention of legislation or judicial opinions.  And that action can be done in in response to the very principles set forth in the Restatement. 

According to Professor Logue, with the exception of rules with respect to contract interpretation and bad faith, any principle in the Restatement can be overcome by changing policy language. 

As an example, the Restatement provides that in long tail losses a pro rata time on the risk method of allocation should be used.  (A long tail loss is a loss, such as a hazardous waste site, that occurs over a number of years before being discovered.  Because of the length of the occurrence many annual insurance policies are triggered and the damages must be allocated among them.)  

While pro rata time on the risk allocation is the law in Massachusetts, many states use the all sums approach to allocation.  Pro rata allocation tends to favor insurers, because the insured is responsible for the percentage of loss allocated to periods of time when there is no coverage due to lost policies, insurers who have since gone out of business, or applicable exclusions in some policy years.  All sums allocation tends to favor insureds, because they can choose one insurer to bear the initial burden of paying the loss up to the policy limits; it is up that insurer to reallocate the loss among other insurers on the risk.

The reason the Restatement will benefit insurers at the expense of policy-holders is not because the particular allocation principle the drafters chose favors insurers; that's just an example of a split rule where the drafters chose one side.  The Restatement will benefit insurers because it provides that any rule it sets forth can be changed by new policy language.  So if a policy expressly states that an all sums method of allocation will be used, then the Restatement's principle of pro rata allocation will not apply.

Insurers, however, will not change policy language that favors them.  For example, they will not adopt policy language requiring all sums allocation. 

And, in general, it's insurers that write the policies.  ISO forms, standard forms used in many insurance policies, are developed by Verisk Analytics, a company that provides services to insurers, not policy-holders.

There is no ISO equivalent for policy-holders.  While some large entities can and do negotiate policy provisions with their insurers, such negotiations do not result in the issuance of standard forms used in many policies.  Smaller business and consumers very rarely negotiate terms.   

Insurers are repeat players in the industry and therefore have the incentive and the economic means to change policy terms that policy-holders simply do not have.  Homeowners insurers in Massachusetts probably adjusted tens of thousands of water dam claims last winter.  But each homeowner made only one claim.  An individual homeowner has no incentive to try to change policy terms that worked against him or her; new terms in a future policy will not affect the adjustment of a loss that has already happened.  But the insurance industry, in anticipation of more ice dam claims, has every reason, and the economic power, to change policy terms that don't favor it.

Therefore insurers will change the policy provisions where the Restatement principles favor the policy-holders, but the reverse is not true.  In time, the policy terms that the Restatement interprets in a manner that favors insurers will remain, while the policy terms that the Restatement interprets in a manner that favors policy-holders will be changed.

For that reason, regardless of whether the Restatement principles as written collectively favor insurers or policy-holders, or are overall neutral, the eventual net effect of the very existence of the Restatement will be to benefit insurers to the detriment of insureds. 

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