Law and Insurance

California Court Rescues CGL Coverage From the Jaws of Broad Auto Exclusion

Essex Insurance Company v. City of Bakersfield, 154 Cal. App. 4th 696 (Cal. App. 2007)

This case illustrates the court's use of California's "reasonable expectations" doctrine to restore a city's coverage under its commercial general liability (CGL) policy for liability arising the others' use of automobiles, despite a policy amendment that excluded liability arising from the use of any autos.  This case also serves as a useful illustration of, by way of deviation from, when CGL policies typically cover car accidents and when auto policies should apply.

In this case, the city was hosting an annual fundraising event and posted exit signs from the event that channeled departing traffic onto a state highway.  The driver of a tractor trailer swerved to avoid a departing vehicle resulting in a collision and injuries.  Lawsuit followed including allegations against the city for creating a dangerous condition that helped  cause the accident.  No city vehicles were involved, and none of the vehicles or divers involved were connected with the city.  City sought a defense from its CGL insurer, Essex, which denied coverage on the basis of an exclusion in the policy for bodily injury "arising out of the ownership, non-ownership, maintenance, use or entrustment to others of any auto."

In an insurance coverage action, the lower court applied the exclusion as written and granted judgment to the insurer.  Even though the allegation against the city did not involve the use of an auto, clearly the injuries "arose out of" the auto accidents.  Note that the city's commercial auto policy would not cover this kind of accident because it did not involve an "auto" owned, rented or used by the city.  So how did the City of Bakersfield manage to purchase a liability insurance package with a gap so large you could drive a truck through it, so to speak?

Typically, CGL and auto insurance are designed to be mutually exclusive.  Policyholders expect to be covered for bodily-injury claims one way or the other.  The typical CGL policy responds to injury actions that do not involve the insured's use of a motor vehicle; if the accident allegedly arose out of the insured's use of a covered auto, including loading and unloading of same, then its auto policy should cover the accident.  (The standard "Aircraft, Auto, or Watercraft" exclusion in a CGL policy excludes injuries "arising from the ownership, maintenance, use or entrustment to others of any ... 'auto' ... owned or operated by or rented or loaned to any insured.")  The typical auto policy covers, more or less, what the CGL policy excludes.

Under this standard arrangement, one would expect Bakersfield to be covered by the CGL policy because the accident did not arise from an auto connected with the city.  However, for whatever reason, Bakersfield's CGL policy excluded accidents arising from any autos whatsoever, including those that would not trigger coverage under the city's auto policy. 

The appellate court found that the city had a "reasonable expectation" that its CGL policy would cover accidents allegedly caused by a dangerous condition not involving any city autos and reversed the lower court.  The reviewing court noted that the city could not purchase insurance from any source that would cover this kind of accident, if the auto exclusion was allowed to stand as written.  That is true.  But I question the court's explanation that the city would have reasonably expected the amended exclusion to apply only to those accidents that in some way involved city vehicles.  The broader amendment seemed tailored to do just that.  A state, like Texas, that does not have this kind of reasonable-expectation magic wand would leave the city without coverage, at least in the absence of some kind of fraud-in-the-inducement evidence that the insurer told the policyholder that the exclusion would not have this broad effect.

The lesson for the policyholder is to lay its CGL and auto policies side-by-side and make sure cost-saving amendments (I am guessing the city got a lower premium fro the broader exclusion) do not leave unintended coverage gaps.

Analysts Predict SEC Will Require Corporate Disclosures of Global Warming Risks

In mid September, a number of state pension funds, treasurers, attorneys general, and interested organizations petitioned the US Securities and Exchange Commission (SEC) to issue an interpretive release clarifying that material climate-related information must be included in corporate disclosures under existing law.  See SEC Petition for Interpretive Guidance.  Earlier this month, the Kiplinger Report stated that the SEC would issue such guidelines under pressure from investor groups, who want to know the companies most at risk for future climate-change lawsuits and what they are doing to reduce carbon emissions.  See Kiplinger Report on SEC Disclosures.  Other analysts have echoed that prediction.

Risk from global warming is, of course, a huge potential insurance nightmare (or opportunity), both from a property/casualty standpoint and that of corporate governance.  Insurance companies themselves may be targeted for failing to disclose foreseeable environmental risks.  SEC action could exacerbate the risk potential.  One of the last times the SEC issued a bombshell interpretive-guidance release was after Enron when the agency announced that disclosure of off-balance-sheet transactions had always been material information under existing law (leaving the plaintiff's bar to infer that corporations that had failed to make such disclosures were potentially liable). 

What will happen to companies that did not disclose climate-impact information in their 2007 disclosures but do so in a big way in 2008?  If 2008 witnesses a recession, then unhappy shareholders may put the blame for sliding stock prices on failures to disclose environmental risk factors, whether this is justified or not.  Either way, the increase in securities lawsuits almost certain to follow will test the softening D&O insurance market.  Interesting times lie ahead.

Property/Casualty Insurance Market Predicted to Remain Soft in 2008

In a press release last week, Watson Wyatt Worldwide, a respected insurance and financial services company, predicted continuation of rate decreases for casualty insurance coverage in 2008. See Watson Wyatt Worldwide Report.  "It's clearly a buyer's market," comments Orin Linden, property and casualty practice leader of Watson Wyatt's consulting group in New York.  Mr. Linden predicts that competition and "healthy capacity" should force insurers to continue lowering premiums by as much as 5 to 10 percent.  The report also indicates that this trend will continue in other segments of the insurance industry, including workers' compensation, directors & officers liability, and reinsurance.

"With the marketplace showing little sign of hardening, it may be an ideal time for buyers to review their risk management program structure and insurance policies," Linden said.  "Buyers clearly get better terms in softening markets.  However, they need to be well-positioned so that when the market firms up, they have a plan to move forward."

Court Lays Out Blueprint for ERISA Preemption of State Court Remedies

Martinez v. Unum Life Insurance Company of America, No. H-07-1988 (S. D. Tex. November 9, 2007)

I do not usually comment on cases featuring health and disability claimants trying to bust through the ERISA-preemption barrier (because it almost never works), but this case so clearly lays out the legal hurtles (in the 5th Circuit at least) that it is worth a look.  As a rule, Judge Atlas's opinions are well reasoned and supported with relevant case authority.

The court notes that Mark Martinez appears to be a sympathetic plaintiff.  He is insured under a Group Long Term Disability Insurance Policy purchased by his employer from Unum Life.  He alleges that he suffers from advanced heart failure and uncontrolled diabetes.  He received benefits for these ailments until they were "arbitrarily terminated" in 2002.  His doctors provided written opinions that he needed intensive medical therapy and could not engage in any productive work.  The insurer refused to reinstate his benefits.  Mr. Martinez sued in state court for negligence and gross negligence, breach of contract, breach of the common law duty of good faith and fair dealing, fraud and misrepresentation, as well as deceptive trade practices under Texas consumer protection provisions in the Insurance Code.

Unum Life removed the case to federal court and asserted that all state law claims be dismissed because the plaintiff's sole remedies are those provided under the Employee Retirement Income Security Act of 1974, 29 U.S.C. Sec. 1101("ERISA").  Basically, any health and disability insurance benefits provided under an employment benefit plan are governed by ERISA.  The plaintiff argued that ERISA contains a "savings clause": "Except as provided [elsewhere in the ERISA statute], nothing in this title shall be construed to exempt or relieve any person from any law of any state which regulates insurance . . ."  However, the court says, "Despite the sympathetic facts Plaintiff presents about his condition, Plaintiff's arguments are unavailing."  The court then marshals the following legal precedents that doom the Plaintiff's arguments:

• Section 502 [of ERISA], by providing a civil enforcement cause of action, completely preempts any state cause of action seeking the same relief, regardless of how artfully pleaded as a state action.  McGowin v. ManPower Int'l, Inc., 363 F.3d 556, 559 (5th Cir. 2002);
• ERISA preempts any state laws insofar as they relate to any employee benefit plan, and a claim "relates to a plan" when the claim itself is premised on the existence of an employee benefit plan.  Christopher v. Mobil Oil Corp., 950 F.2d 1209, 1220 (5th Cir. 1992);
• Negligence and gross negligence claims based on a plan administrator's handling of claims are completely preempted by ERISA.  Haynes v. Prudential Health Care, 313 F.3d 330, 336-37 (5th Cir. 2002);
• ERISA preempts claims related to denial of benefits brought under the Texas Deceptive Trade Practices Act and the Texas Insurance Code.  Hogan v. Kraft Foods, 969 F.2d 142, 144-45 (5th Cir. 1992);
• Good faith and fair dealing and fraud/misrepresentation claims are also preempted.  McGowin, 363 F. 3d at 559; Hogan, 969 F.2d at 144-45;
• State law extracontractual claims for punitive damages are preempted by ERISA.  Rogers v. Hartford Life & Accident Ins. Co., 167 F.3d 933, 944 (5th Cir. 1999)

Why do claimants want to break out of ERISA?  Because they must prove that the plan administrator's denial of benefits was arbitrary and capricious (which is tougher to prove than negligence), and if they win, they get the benefits they should have had, plus (maybe) attorneys' fees. 

House Bill Would Create Federal Guarantees for Disaster Insurance Program

Yesterday, the U.S. House of Representatives passed on a vote of 258 to 155 a bill designed to backstop private property insurance in the event of huge natural catastrophes like Hurricane Katrina or the San Diego fires.  Opponents of HR 335 (known as Homeowners' Defense Act of 2007), including the White House, say the legislation would shift business from the private market to the federal government and would unfairly benefit disaster-prone states like Florida and Louisiana at the expense of other states.

Under the program, individual states would enter pooling arrangements to provide reinsurance for private insurers (reinsurance covers part of the insurers' risk in issuing private insurance).  If a catastrophic event results in damages above a certain threshold (measured by disaster costs that exceed 1.5 times the amount of premiums collected from homeowners and businesses in the previous year), the affected state could apply for loans from the federal government.

The bill's sponsor's, Reps. Ron Klein (D-Fla.) and Tim Mahoney (D.Fla), assert that the measure is necessary to reassure private insurers that affordable reinsurance is available and to absorb the costs of the largest natural disasters without the need for post-hoc government bailouts.  The insurance industry is divided over the legislation.  The Big "I" (Independent Insurance Agents and Brokers of America) support the bill; The AIA (American Insurance Association) believes the Act will not create incentives as advertised for private insurance markets.

Sens. Hillary Clinton (D-NY) and Bill Nelson (D-Fla.) have introduced similar legislation in the Senate.  President Bush has indicated he will veto the measure.

For more information on this bill, see NY Times House Approves Creation of a Federal Disaster Insurance Program.

8-Corner Rule of Interpretation Trumps Actual Facts Under Homeowners Policy

Gomez v. Allstate Texas Lloyds, #2-06-233 (Tex. App., November 1, 2007) (see case at Gomez v. Allstate)

This case turns on Texas's strict application of the "complaint allegation" or "8-corner" rule that a court must determine a liability insurer's duty to defend with reference only to the terms of the insurance policy and the factual allegations in the lawsuit. In this case, 6 year old Austin Gomez was playing at a friend's house and was injured when the friend's mom placed him on a four-wheeler with no protective gear and allowed him to operate the vehicle.  Austin's parents sued.  The homeowner insurer defended under a reservation of rights but sought a declaratory judgment that the injuries were excluded from coverage under a motor vehicle exclusion.  The Gomez parents argued that the motor vehicle in question was a recreational type vehicle, which was excepted from the exclusion and therefore covered when the vehicle is "owned by an insured while on the residence premises."  In fact, Austin was on a street at the time of the accident.

The court agreed with the insurer that the exclusion was unambiguous, and the exception to the exclusion applied only if the accident occurred on the insured premises.  However, the court also agreed with the plaintiffs that the lawsuit did not allege that the accident occurred away from the premises.  Accordingly, the court reversed summary judgment for the insurer and remanded the case for trial.

California Supreme Court Strikes Down Contractual Exculpation of Gross Negligence: Texas Is Still On the Fence

City of Santa Barbara v. Superior Court (Janeway), 161 P.3d 1095 (Cal. 2007).  See case at Janeway Decision.

In July of this year, the California High Court held that contractual releases of future claims for gross negligence in the context of sports and recreational programs were unenforceable as against public policy.  The case is well worth reading not only because of the court's thorough analysis of competing legal principles under California law (the freedom to contract vs. maintaining a reasonable standard of care in community life requiring wrongdoers to recompense injured parties), but also for its wide-ranging examination of the law of other states.  However, the court had little to say about Texas law on this issue because the Texas Supreme Court has never addressed the issue, and Texas state courts are divided. (A good analysis of this issue under Texas law is provided in Ryan S. Holcombe, "The Validity and Effectiveness of PreInjury Releases of Gross Negligence in Texas," 50 Baylor L. Rev. 233 (Winter 1998).

In Texas, as in most other states, a contract involving recreational or sports activities may contain a release or indemnity clause (a release voids liability entirely; an indemnity shifts liability to another) that is enforceable against ordinary negligence if it meets Texas's peculiar "Fair Notice" requirements. (For a discussion of these requirements, see Risk Shifting Agreements).  In effect, the release (indemnity) must expressly state that it releases (indemnifies against) the releasee's own negligence, and the release must be stated in boldface or other conspicuous language.

"Ordinary negligence" is the failure to use that degree of care that a reasonable person would exhibit under the same or similar circumstances.  "Gross negligence," under Texas's (again) peculiar standard is defined in Sec. 41.001 of the Texas Civil Practice and Remedies Code as:

conduct (A) which when viewed objectively from the standpoint of the actor at the time of its occurrence involves an extreme degree of risk, considering the probability and magnitude of the potential harm to others; and (B) of which the actor has actual, subjective awareness of the risk involved, but nevertheless proceeds with conscious indifference to the rights, safety, or welfare of others.

California and most other states define gross negligence as either a "want of even scant care" or "an extreme departure from the ordinary standard of conduct."  In the Janeway case, a girl drowned while participating in a county summer camp for developmentally disabled children.  Camp counselors were aware of the girl's propensity to seizures, and the girl's designated mentor was aware that the girl had suffered a mild seizure a short time before the incident, but she was allowed to dive into a pool and drowned when the counselor's attention was diverted for a few seconds.  The Court held that the parents' release was effective to release ordinary negligence but not gross negligence.

Some courts in Texas reason that negligence and gross negligence are not separate torts, and a release that is effective against ordinary negligence should also release gross negligence.  See Newman v. Tropical Visions, Inc., 891 S.W.2d 713 (Tex. App. --San Antonio 1994, write denied).  At least one other court has held that a release from gross negligence is against public policy and should not be enforced.  See, e.g., Smith v. Golden Triangle Raceway, 708 S.W.2d 574 (Tex. App.--Beaumont 1986, no writ).  The Texas High Court has yet to decide the issue.

My best guess is that Texas will follow California on this issue.  Cases like Newman that put negligence and gross negligence in the same bucket rely on pre-1990's thinking before the Texas Supreme Court decided Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 23 (Tex. 1994), which established a brighter line between negligence and gross negligence.  The Moriel court observed that juries were not given a sufficient criterion for deciding when punitive damages for gross negligence were appropriate.  Logically, the reasoning in Moriel suggests that negligence and gross negligence should be considered separate categories.