How to Read and Understand American Insurance Policies

Insurance mitigates risk.  First person insurance comes into play if a person suffers a loss because something happens to them.  Examples include homeowner’s insurance, health insurance, disability insurance, and an employee fidelity bond. Third person insurance comes into play if something happens to someone else and a person faces potential liability.  The focus here is on the latter type of insurance.  But it’s not limited to business owners or people who give professional advice.  Even homeowner’s insurance and car insurance have liability coverage.  So, it is useful to understand how insurance works and how to read and understand insurance policies. 

At first glance, policies can be very confusing. There is, however, a method to the madness. Policies generally have the same overall structure and contents, although, obviously, their effect will be different.  Discussed below are types of insurance, policy interpretation, and the declarations page, as well as common insuring agreements, conditions, and exclusions.

CGL versus D&O versus E&O.

A Commercial General Liability or Comprehensive General Liability (“CGL”) policy generally covers bodily injury and property damage arising out of premises, operations and products, as well as personal injury/advertising injury.  A CGL policy is generally related to accidents that happen in the course of running a business.  It is the one most likely to be implicated if a customer slips and falls. 

An Errors and Omissions (“E&O”) policy generally covers professional liability, meaning rendering or failing to render professional services.  An E&O policy is generally implicated where a business which gives advice to others or represents the needs of others is sued, i.e. an accountant or an architect is sued by a client or customer.

A Directors and Officers (“D&O”) policy generally covers wrongful acts by a company’s decision makers in their capacity as such.  D&O policies were traditionally written just to cover directors and officers.  D&O coverage can also be purchased by a company to provide coverage for claims specifically against the company; that’s called “entity coverage” and we’ve been seeing it more frequently. 

CGL policies are generally written on standard forms which have been developed by the insurance industry over the years in reaction to court rulings. They are pretty cookie cutter and there is not much different between insurance companies. D&O and E&O policies also can have standardized provisions but often contain more customized provisions.

Policy Interpretation.

Insurance policies are contracts and are governed by contract law. However, there are a few important doctrines relevant to the interpretation of insurance policies in particular.  Theses doctrines evolved out of what the courts consider to be the “special relationship” which exists between an insurer and an insured. This is due to the unique trust and confidence placed in insurance companies as well as the great reliance placed on the insurer.  Generally, they tip the scales in favor of the insured in the event that there is ambiguous or uncertain language.

The Declarations Page.

This provides key information about your coverage.

• The Insured—This is the first place to look. The insured can be a company, an individual (or group of individuals), or both. Sometimes there will be a designation of “additional named insureds.” They are usually added when the primary insured has acquired other businesses, or associates with other individuals, for which it wants coverage under the policy.
• Policy Limits—The policy limits explain how much money the insurance company promised to pay.  The limits can be per claim but subject to an over- all aggregate limit.  That means that the amount that will be paid out may be limited both by the per claim limit and by other claims that were made during the policy period.     
• Deductible/Self-insured Retention—This provision concerns how much you are responsible for before the insurance kicks in.  An insured is required to bear some initial cost of a loss.  Premiums are lower for policies with higher retentions.  The idea behind high retention policies is that the policies are there in the event of a large and potentially catastrophic lawsuit, but the smaller cases are assumed to be the responsibility of the insured to handle without the insurer’s involvement.  The more claims a company makes to its insurer, even if the claim ultimately is resolved within the retention, may result in increased premiums. Therefore, the higher the self-insured retention, the more analysis will be required before deciding whether to tender the claim to the insurer.  Conversely, depending on the potential magnitude of the case the opposite analysis applies. For such cases, fire all weapons. There is little downside to providing notice under any policy which may even remotely afford any protection for the client. An insurer’s response under a policy to a long-shot claim can be pleasantly surprising.
• Policy Period—There are generally two dates on the declarations page- the start date for coverage and the end date for coverage.  The first step in analyzing whether a claim is covered under a liability policy is to determine whether the coverage-triggering event took place during the policy period.  If it did not, the policy does not provide coverage.  Coverage may be written on an “occurrence,” (CGL policy) or “claims-made” or “claims-made and reported” basis (D&O/E&O). 
• A common definition for “occurrence” is “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”  So, for a CGL policy, the coverage-triggering event is the accident, regardless of when you are sued. 
• In contrast, a “claims-made” policy focuses on when a claim is asserted against you.  Note that a “claim” will be specifically defined in the policy.  It does not just mean the filing of a lawsuit; it is usually defined as a written demand for monetary or non-monetary relief (i.e. “cease and desist”).  If the policy is “claims-made and reported” it is critical that the claim be reported to the insurance company during the policy period or, in some instances, a very short time after the policy expires.  Otherwise, notice given after any required time period does not excuse the insurer’s obligations under the policy unless it can show actual prejudice from the delay.
• Coverages/forms/endorsements—This is the up-front index of the guts of the policy.  It shows coverage and modifications to coverage and the dreaded exclusions which can take away coverage. The hard part of reading policies is that they all have to be read and interpreted together. 

The Insuring Clause.

The insuring clause identifies the basic scope of the policy’s coverage.  It is often deceptively short, as it relies on definitions elsewhere in the policy and it is qualified by conditions, exclusions, and endorsements.  As you parse each insuring clause, maintain focus on the insured qualification (i.e. who is covered); the damages qualification (i.e. the type of loss or harm covered); and the activity qualification (i.e. the type of activity or peril covered).

Insuring clauses are given broad interpretation by the courts.  But what the insuring clause giveth, conditions, exclusions (and potentially the endorsements) taketh away.  An endorsement can be a stand-alone coverage or limitation, or it might be used to change a definition or even an entire insuring clause.  When a coverage question arises, the burden is on the insured initially to demonstrate that the claimed loss is within the coverage provided by the policy’s insuring clause. If the insured satisfies this burden, the burden then shifts to the insurer to demonstrate that an exclusion applies.

Examples of a CGL insuring clause are:

• “COVERAGE A- BODILY INJURY AND PROPERTY DAMAGE LIABILITY 1. Insuring Agreement a. We will pay on behalf of the insured the ‘ultimate net loss’ in excess of the ‘retained limit’ because of ‘bodily injury’ or ‘property damage’ to which this insurance applies.”
• “COVERAGE B – PERSONAL AND ADVERTISING INJURY LIABILITY  1. Insuring Agreement a. We will pay on behalf of the insured the ‘ultimate net loss’ in excess of the ‘retained limit’ because of ‘personal and advertising injury’ to which this insurance applies.”

Examples of D&O insuring clauses are:

“Management Liability Insuring Agreement”

• Individuals: “The Insurer shall pay on behalf of the Insured Persons Loss for which the Insured Persons are not indemnified by the Company and which the Insured Persons become legally obligated to pay on account of any Claim first made against them, individually or otherwise, during the Policy Period, the Automatic Discovery Period, or, if exercised, the Additional Extended Discovery Period, for a Management Practices Act taking place before or during the Policy Period.”
• Company: “If Company Liability Coverage is granted as set forth in the Declarations, the Insurer shall pay on behalf of the Company Loss for which the Company becomes legally obligated to pay on account of any Claim . . . for a Management Practices Act taking place before or during the Policy Period.”

An example of an E&O insuring clause is:

“PROFESSIONAL LIABILITY COVERAGE PART”

“The Insurer will pay on behalf of the Insured, that Loss, in excess of the retention and up to the applicable limit of liability, resulting from any Claim first made against the Insured during the Policy Period, or any Extended Reporting Period, if applicable, for a Wrongful Act by the Insured, or by someone for whose Wrongful Act the Insured is legally responsible provided…”

Exclusions.

Exclusions describe matters not covered.  Some exclusions are designed to avoid coverage for risks the insurer does not wish to insure at all (including ones that are not permissible under state law, i.e. to indemnify you for your own fraud) and others are designed to limit coverage for risks normally covered by other insurance.  To be given effect, an exclusion must be “conspicuous, plain and clear.”  It is also normally interpreted strictly so that any ambiguity therein will be resolved against the insurer. 

Some exclusions are subject to exceptions, which restore some of the coverage otherwise taken away by the exclusion. “Exceptions” to exclusions are somewhat analogous to coverage provisions for purposes of policy interpretation, and are therefore interpreted broadly in favor of coverage. Some exclusions apply only to particular insuring agreements in the policy while some exclusions apply to any and all coverages in the policy.  Exclusions only come into play if the loss otherwise falls within the insuring agreement. 

Common exclusions in a CGL policy are for intentional acts (“‘bodily injury’ or ‘property damage’ expected or intended from the standpoint of the insured …), contractual liability (“bodily injury’ or ‘property damage’ for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement….”), and there are dozens of others, including worker’s compensation, pollution, damage to the insured’s own property, professional services, etc.

Common exclusions in D&O or E&O policies are for: breach of contract; personal gain; dishonest, criminal or fraudulent conduct; willful or intentional wrongdoing; fines, penalties and punitive damages; and known wrongful acts/prior and pending litigation.

Conditions.

Conditions outline the general duties of the insured and insurer under the policy, including in connection with the issuance of the policy and the presentation and adjustment of the claim.  They can be a trigger for coverage to even begin, or they can be obligations that continue throughout the existence of the claim.

Common conditions include:

• Notice.  Notice by you to your insurer is a prerequisite for an insurer’s duties to arise.  Claims-made policies typically require “prompt” notice of any claim.
• Cooperation.  The clause requires you to give “full cooperation and all information and particulars” the insurance company may reasonably request from the Insureds “in order to conduct its investigation or to reach a settlement of the Claim.”  
• No voluntary payments.  The clause provides that “the Insurer shall not be liable for any settlement, Defense Costs, assumed obligation, admitted liability, voluntary payment, or confessed or agreed Damages or judgment to which it has not consented.”  The purpose is to prevent collusion between the injured party and the insured, as well as to give the insurer control over the outcome of the case. 

Endorsements.

These can be additional terms that apply to the policy which are wholly new, or they can be changes to the policy.  For example, they can change a definition or even an insuring clause.   Make sure you have all of the endorsements and forms identified by name or number on the declarations page!

Duty to Defend versus Duty to Indemnify for Defense Costs.

Primary CGL policies frequently allocate the duty to defend to the insurer.  The insurer must defend the claim if there is any possibility of coverage.  And the costs of defense are generally separate from policy limits.  But, the insurer controls the defense and will almost always appoint its own counsel of choice to defend the claim. The law is clear that the insurance company must defend even if the claim is only potentially covered by the policy and even if only some of the claims are covered, and the insurer ordinarily must defend the entire action even if uncovered claims are joined with the covered claims.  So, the duty to defend a claim is broader than the duty to ultimately pay out on a claim.

In contrast, D&O policies and E&O policies frequently allocate the duty to defend to the insured.  That means the insured will be responsible for retaining counsel (subject to the insurance company’s approval) and “defense costs” reasonably incurred to defend against a covered claim will be defined in the policy as an element of loss.  When there is no separate duty to defend, defense costs are considered an element of a covered loss and eat into the amount available to pay a claim.

Hopefully, this article provides some small measure of greater understanding about American liability insurance and insurance policies.

 

Article by: Kyle Fisher (partner) and Marci Reichbach (associate).