What are you buying?

In a world where most insurance policies are based on standardised forms, policies look more like off-the-rack products than individually negotiated contracts. When disputes arise over insurance policies, we review the text of the policy, the intent of the parties, the contact’s purpose, extrinsic evidence, and public policy pretty much in that order.

This is the standard way of interpreting an ambiguous contract. But insurance policies do not operate as contracts. The basic components of an American contract are:

The concept of mutual assent, or a meeting of the minds, relates to the idea of a bargained-for exchange in a contract. When it comes to insurance policies, the transaction is the sale of some level of risk shifting and distribution, rather than an entry into any particular business relationship. There is rarely any actual mutual assent: most insurance policies are not bargained-for exchanges.

This runs contrary to basic contract law. There is, therefore, an argument that an insurance policy is not a standard contract.

This position is a radical departure from typical captive insurance law: virtually all insurance professionals regard insurance policies as contracts. But is there any real bargain occurring if you have three policies from which to choose, two of which cover X and one of which does not? This is functionally the same as purchasing a blue widget over a green widget for personal reasons.

Product-like characteristics of insurance policies are not constrained to the realm of admitted carriers captive insurers frequently run into this issue as well. If a captive retains $250,000 to $750,000 and purchases excess coverage for a $1 to $3 million policy, then the captive manager is wise to use standard ISO language in order to preclude the possibility of a lack of coverage in the event of a dispute.

Reliance on ISO language is less about lazy underwriters using form-based policies and more about careful consideration of varying coverage gaps in the event of ambiguous drafting of coverage.

Vague language
Given that insurance is something that is bought, the absence of coverage where the insured thought coverage existed resembles a product defect. Consequently, there is an argument that coverage actions should be brought on product liability grounds instead of the common contractual theories.

Insurance policies occupy a contract-product grey area. The policies are aleatory, adhesion contracts with standardised language. Similar contracts, such as user agreements, have been attacked as unfair and against public policy, as well as unconscionable in certain jurisdictions.

Frankly, these arguments provide the courts with too much discretion to be useful. However, it is useful to view standardised contracts as things, as opposed to simple contracts, reflecting the reality that modern contracts are mass-produced items. Under this scheme, there is a case that courts should view policies as products as well as contracts, and apply defective product analysis to find coverage in the event of contrary or ambiguous policy language.

In this sense, courts police insurance policy content by reference to whether the insurance policy does what it sets out to do. A failure to provide adequate warnings of potential coverage gaps could constitute an exposure to the excess or reinsuring carrier.

From a captive insurer’s standpoint, coverage frequently makes no sense: who would deny their own claim? But once excess or reinsurance contracts are in place, coverage makes an enormous difference. All too frequently, large claims are denied on specious grounds based on ambiguous text that means something different in literally every jurisdiction in which the policy is effective.

This creates legitimately bad situations for captive insurers stuck with broad-based, vague policy language that is necessary for basic coverage but too vague to provide coverage when it matters.

The concept of insurance as a thing is a radical departure from standard coverage analysis. However, it arises out of the reality that insurance contracts are not negotiated in any meaningful way. Bickering over reinsurance, rates, and coverages is akin to price-shopping for various widgets.

Coverage considerations should always be reviewed when developing insurance programmes. Captives are frequently too small to afford unexpected gaps in coverage. Regardless of the merits of the product liability analysis for insurance coverage, the reality is that captive programmes need the assurance that the coverage purchased does what it says it will do.

Matthew Queen is general counsel at Venture Captive Management. He can be contacted at:  mqueen@venturecaptive.com