Insurance Policies as Contracts
THE RHA REVIEW
Volume 6, No. 1, Fourth Quarter 1999
By Robert N. Hughes, CPCU, ARM
The images created by the liquid tones of Duke Ellington's elegant jazz tune, "Sophisticated Lady," were powerful … even for a preteen age kid. I always had visions of some classy female bedecked in diamonds and a tight-fitting floor-length dress, smoke curling from a long, extended cigarette holder, seductively descending a winding staircase. That song and its accompanying image were my principal sources for an early understanding of the meaning of the word sophisticated. Today, however, in the realm of insurance litigation (where I spend much of my time), the word has taken on a new and, at least for the policyholder, ominous aspect. But I digress. Let's back up a bit and I'll try to begin this tale at the beginning rather than in the middle.
We begin our story with the proposition that insurance policies are contracts. (And, for the sake of simplicity, let's discuss only liability insurance policies.) I doubt that comes as a surprise. You probably also know that there are different sorts of contracts. There are those in which the two parties essentially sit down together, negotiate until an agreement is reached and then reduce that agreement to a contract. By contrast, there are contracts that are written by one party expressing the obligations of that party, and the other party "takes it or leaves it." In the latter case, the acceptance of the terms by the non-drafting party is usually marked by the payment of some consideration, such as a premium.
Insurance policies, almost without exception, fall into the latter category. The insurance company or its representatives write the policy and offer it to the insured. The insured simply pays the premium. Such contracts are called "contracts of adhesion."
Written contracts are composed of words and phrases, and we all know that words and phrases can be understood differently by different persons. For instance, if I tell my son to "please bring me the table from the library," he might bring me the small nested table on which I generally eat my supper while watching the Texas Rangers embarrass themselves. But he might bring me the timetable for airline arrivals and departures. My request was ambiguous. Insurance policies are also ambiguous. For instance, does the word sudden mean "quick and instantaneous," or does it mean "coming unexpectedly?" Do the words body of water mean only such things as rivers, lakes and oceans, or can they also mean microscopic molecules of water located deep in the ground, commonly known as groundwater? These and many other ambiguities are the subject of almost constant litigation in which various trial, appeals and supreme courts labor to discover the appropriate meanings of insurance policies.
Courts resolve ambiguities in various ways, and we can talk about that another day. For now, however, let us consider what happens when the ambiguity cannot be resolved. In such cases, the nondrafting party to a contract is protected by a doctrine of law called contra proferentum. This is a Latin phrase meaning "against the proffering party." The principle of the doctrine is that ambiguities are always interpreted against the drafter of the ambiguous language.
As you can now imagine, the question of who wrote the policy is extremely important. Policyholders generally take the position that every policy was written by the insurer. Insurance companies and underwriters, however, often take the position that anything other than the professionally printed standard-form policy is a "manuscript" policy, written by someone other than themselves.
Without getting down to the specifics of all the arguments, I'm sure you get the point. The drafter of the policy is generally the loser in the resolution of ambiguities. Whether sudden means "quick" or "unexpected" depends on what best suits the policyholder.
But wait. There are some saving factors from the drafter's standpoint. The law in many states provides that a nondrafter who is a "sophisticated" buyer is deemed to be on equal footing with the drafter, and contra proferentum does not apply. (You thought we'd never get there, didn't you?) The term sophisticated is itself ambiguous, but the meaning that apparently applies in this case is "finely experienced and aware." So if insurers can convince a court that their policyholder is a "sophisticated" buyer, they might not have to suffer the consequences of having sold ambiguous contracts.
That brings us to the point of all this (finally, you say). The point is that many risk managers and brokers insist on telling the world that they have written their own policies. Further, they go on ad nauseam about their great knowledge and high degree of sophistication. Although such statements might seem benign, many have actually seriously damaged their companies' ability to claim coverage on their liability insurance policies. What's more, the problem continues and will have the same result in the future.
Take, for instance, the Fortune 100 company whose "manuscript" liability policies are nothing more than sections of standard policies that have been clipped and reassembled in a different order. The revised assemblage does make for a somewhat more readable policy, and this would have been fine had it ended there. Unfortunately, the risk manager had a habit of crowing to his superiors that he himself had created a manuscript policy "uniquely tailored to the needs of ______" and "virtually unavailable in the general insurance market." As you can imagine, those posturings were used by insurers to invoke the "authorship" and "sophisticated insured" defenses.
Sadly, this egoist's name is legion. Litigation records are filled with the utterances of risk managers and brokers bragging to their bosses or their clients about their own "sophistication" and expertise. These same people often also claim that their programs are rare and unique. Never mind the fact that the policies contain insurance industry standard wordings that have been deemed by many courts to be ambiguous. Unfortunately, these claims of authorship by policyholder employees or brokers often make the invocation of the doctrine of contra proferentum difficult at best. Furthermore, even when insurer authorship is clear, claims of super-sophistication may eliminate or damage the saving graces of contra proferentum.
So you know from whence I come. You've heard it. The hot-shot risk manager of the Fortune 100 company who makes speeches hyping the uniqueness of his company's insurance program. The broker who describes a "cut and paste" form in her correspondence as "our wording." The president of the captive insurer who describes his company's rather typical program as "entirely unique." Frankly, all these people would serve their company's interests far better by just keeping their mouths shut. The fact is that in my almost 40 years in and around the insurance business I have seen fewer than five liability policies that I would consider to be truly unique and worthy of the designation "manuscript," and not a single one of those was drafted by the policyholder.
No one would argue that the Duke and his music were unsophisticated. And those of you who are lucky can sit back with a glass of cold Chardonnay, put on an Ellington CD and let the insurer and policyholder lawyers "duke" it out. For others, unfortunately, the contracts are ambiguous, it is unclear who wrote them and the word sophisticated rings through the halls of justice. There are millions of dollars at stake. The problem is sophisticated, all right … serious, too.