The Insurance Disputes Law Review: USA
In the United States, insurance disputes are primarily governed by state law. Each state has its own statutory and common law applicable to insurance-related matters. Because the relevant law varies from state to state, practitioners must conduct a careful evaluation of potentially applicable law at the outset of an insurance dispute.
Most insurance disputes in the US are litigated in the first instance in state or federal trial courts. Disputes may also be subject to arbitration if the insurance contract contains an arbitration clause. Where an insurance contract requires the parties to arbitrate but applicable state statutory law prohibits insurance-related arbitration, courts will address whether state law supersedes or pre-empts federal law or treaties favouring arbitration.
US courts recently have addressed a number of significant insurance-related issues, including the method of applying an exhaustion requirement so as to trigger coverage under excess policies, waiver of privilege in insurance disputes and the calculation of damages under property insurance policies. Going forward, courts undoubtedly will continue to address the parameters of cyber-related coverage, the opioid epidemic and issues related to long-tail claims. In addition, insurers may find themselves increasingly embroiled in coverage disputes arising out of climate change events and the novel coronavirus disease (covid-19).
The legal framework
i Sources of insurance law and regulation
The regulation of insurance in the US is primarily performed by the states. In 1945, the US Congress passed the McCarran-Ferguson Act, which provides that 'No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance.' Under the McCarran-Ferguson Act, federal law preempts state insurance law only if it specifically relates to 'the business of insurance'.
The law of insurance in the US generally falls into one of two broad categories: (1) the regulation of entities that participate in the business of insurance; and (2) the regulation of the policyholder–insurer relationship. State law pertaining to the regulation of entities is generally comprised of statutes enacted by state legislatures and administrative regulations issued by state agencies, such as departments of insurance.
Each state also has statutory and common law applicable to the policyholder–insurer relationship. State statutes address a range of topics, including, among others, the disclosure obligations of the parties to an insurance contract, the nature of a policyholder's notice obligations and the circumstances in which a victim of tortious conduct may sue a tortfeasor's insurer directly. State common law is an important source of law for resolving disputes between policyholder and insurer. Practitioners must carefully assess potentially applicable law at the outset of a dispute, as insurance law (whether common law or statutory) varies by jurisdiction.
ii Insurable risk
In the US, the validity of an insurance contract ordinarily is premised on the existence of an insurable interest in the subject of the contract. An insurable interest may be defined as any lawful and substantial economic interest in the safety or preservation of the subject of the insurance free from loss, destruction or pecuniary damage. The insurable interest doctrine was first adopted by courts and has since been codified in state statutes. The purpose of the insurable interest requirement, as articulated by courts and commentators, is to discourage wagering and the destruction of life and property and avoid economic waste.
iii Fora and dispute resolution mechanics
Litigation of insurance disputes
The US judicial system is comprised of two separate court systems. The US itself has a system comprised of federal courts and each of the 50 states has its own system comprised of state courts. Although there are important differences between federal and state courts, they share some key characteristics. Each judicial system has trial courts in which cases are originally filed and tried, a smaller number of intermediate appellate courts that hear appeals from the trial courts and a single appellate court of final review.
Unlike state courts, which include courts of general jurisdiction that can address most kinds of cases, federal courts principally have jurisdiction over two types of civil cases. First, federal courts may hear cases arising out of the US Constitution, federal laws or treaties. Second, federal courts may address cases that fall under the federal 'diversity' statute, which generally authorises courts to hear controversies between citizens of different US states and controversies between citizens of the US and citizens of a foreign state. For diversity jurisdiction to exist, there must be 'complete' diversity between litigants (i.e., no plaintiff shares a state of citizenship with any defendant) and the 'amount in controversy' must exceed US$75,000.
Most insurance disputes are litigated in the first instance in federal or state trial courts. Federal courts commonly exercise jurisdiction over insurance disputes under the diversity statute. In this context, an insurance company, like any other corporation, is deemed to be a citizen of both the state in which it is incorporated and the state in which it has its principal place of business.
An insurance action that is originally filed in state court may be 'removed' to federal court based on diversity of citizenship of the litigants. In the absence of diversity of citizenship or some other basis of federal court jurisdiction, insurance disputes are litigated in state courts. The venue is typically determined by the place of injury or residence of the parties, or may be dictated by a forum selection clause in the governing insurance contract. The law applied to the dispute may likewise be dictated by a choice-of-law clause in the insurance contract or, in the absence of such a clause, determined by a court based on relevant choice-of-law principles.
Arbitration of insurance disputes
Some insurance contracts contain arbitration clauses, which are usually strictly enforced. The Federal Arbitration Act (FAA) and similar state statutes empower courts to enforce arbitration agreements by compelling the parties to arbitrate. If an insurance contract contains a broadly worded arbitration clause, virtually every dispute related to or arising out of the contract typically may be resolved by arbitrators rather than a court of law. One issue that has been a point of contention in matters involving an arbitration clause is whether a non-signatory to the agreement may be compelled to arbitrate a dispute with parties to the agreement. Resolution of this issue frequently turns on whether the non-signatory is deemed to be a third-party beneficiary to the agreement or is equitably estopped from arguing that its status as a non-signatory precludes enforcement of arbitration because it seeks to benefit from other provisions of the agreement.
While all US states recognise the validity and enforceability of arbitration agreements in general, some states have made a statutory exception for arbitration clauses in insurance contracts. Complex legal issues may arise when an insurance contract obligates parties to arbitrate but applicable state statutory law prohibits the arbitration of insurance-related disputes. Although state laws that prohibit arbitration are generally pre-empted by the FAA, by virtue of the Supremacy Clause in the US Constitution, state anti-insurance arbitration statutes may be saved from pre-emption by the McCarran-Ferguson Act. As noted, the McCarran-Ferguson Act provides that state laws enacted 'for the purpose of regulating the business of insurance' do not yield to conflicting federal statutes unless a federal statute specifically relates to the business of insurance. Because the FAA does not specifically relate to insurance, courts have held that the FAA may be 'reverse preempted' by a state anti-insurance arbitration statute if the state statute has the purpose of regulating the business of insurance. As discussed in Section IV, courts are split regarding whether the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention), an international treaty that mandates the enforcement of arbitration agreements, may be reverse pre-empted pursuant to the McCarran-Ferguson Act.
Where an insurance dispute is resolved through arbitration, the resulting award is generally considered to be binding, although there are grounds to vacate or modify an award under the FAA, similar state statutes and the New York Convention. The FAA describes four limited circumstances in which an arbitration award may be vacated by a court: (1) where the award was procured by corruption, fraud or undue means; (2) where there was evident partiality or corruption in the arbitrators; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown or in refusing to hear evidence pertinent and material to the controversy; or if by any other misbehaviour the rights of any party have been prejudiced; or (4) where the arbitrators exceeded their powers or so imperfectly executed them that a mutual, final and definite award upon the subject matter submitted was not made. One area of legal uncertainty is whether a court may vacate an award based on an arbitrator's 'manifest disregard' of the law. Although the manifest disregard standard is not listed in the FAA, some courts have ruled that an award may be vacated on this basis.
US courts recently have addressed a number of significant insurance-related issues, including the method of applying an 'exhaustion' requirement so as to trigger coverage under excess policies, waiver of privilege in insurance disputes and the calculation of damages under property insurance policies.
i Horizontal v. vertical exhaustion
When coverage for more than one policy period is triggered, and the loss exceeds the highest limit of any of the triggered primary policies, disputes have arisen as to whether an excess insurer is required to respond to the loss before all the available primary coverage has been exhausted (horizontal exhaustion), or whether exhaustion of the specific underlying coverage triggers the excess insurer's policy obligations (vertical exhaustion).
In Montrose Chemical Corporation of California v. Superior Court of Los Angeles County, the Supreme Court of California ruled that based on applicable policy language, a policyholder was entitled to coverage under a higher level policy once it had exhausted directly underlying excess policies for the same policy period, and was not required to exhaust every lower level excess policy during the relevant time frame. Although the language of the various policies at issue differed in some respects, each provided that Montrose must exhaust the limits of its underlying insurance before accessing excess coverage. Additionally, the excess policies provided that 'other insurance' must be exhausted before excess coverage could be accessed. The parties disputed whether the 'other insurance' clauses required Montrose to exhaust lower level insurance coverage from other policy periods before seeking excess coverage for any given policy period.
The California Supreme Court endorsed a 'vertical exhaustion' approach under which Montrose was entitled to access any excess policy once it had exhausted other policies with lower attachment points in the same policy period. The court noted that none of the 'other insurance' clauses explicitly addressed whether Montrose was required to exhaust insurance with lower attachment points in different policy periods. For example, the court explained that language requiring exhaustion of 'all underlying insurance' could 'fairly be read to refer only to other directly underlying insurance in the same policy period that was not specifically identified in the schedule of underlying insurance' (emphasis in original). As such, the court declined to interpret the 'other insurance' clauses as 'a clear and explicit direction to adopt a requirement of horizontal exhaustion in cases of long-tail injury'.
ii Privilege disputes
In recent months, courts have addressed the scope of attorney–client and work product privilege in the context of insurance coverage disputes, shedding light on the extent to which parties may be compelled to produce documents created by or exchanged with counsel.
In Ex parte Dow Corning Alabama, Inc, the Supreme Court of Alabama ruled that an insurer does not waive privilege of settlement-related documents by seeking contribution for settlement costs, even though the availability of any such contribution depends, in part, on the reasonableness of the settlement. The parties requesting production of the privileged documents argued that by seeking contribution for the settlement – a claim that requires a showing of the settlement's reasonableness – the content of the privileged settlement documents had been placed 'at issue.' They further contended that the reports and recommendations of counsel relating to liability exposure and potential verdict range were relevant to evaluating the reasonableness of the settlement. The Alabama Supreme Court ruled that reasonableness is judged by an objective standard, such that the subjective advice of counsel is unnecessary in the reasonableness evaluation. The court further reasoned that non-privileged materials generated in the course of the underlying personal injury claim would be sufficient to determine potential liability and the reasonableness of the settlement.
In Ranger Construction Industries v. Allied World National Assurance Company, a Florida federal court ruled that an insurer is not required to demonstrate that it reasonably anticipated litigation in order to assert attorney–client privilege. The dispute turned on whether an insurer is entitled to maintain attorney–client privilege over documents if, at the time the attorney was retained or rendered legal advice, the insurer did not reasonably anticipate litigation. The court held that attorney–client privilege is governed by Florida statutory law, which requires communications to be 'made in the rendition of legal services' without any 'anticipated litigation' requirement (see Fla. Stat. § 90.502(2) (2018)). However, the court noted that 'heightened scrutiny' is required when an insurance company asserts attorney–client privilege. This heightened scrutiny requires courts to evaluate whether the communication would have been made but for the contemplation of legal services and whether the content relates to legal services, as opposed to business or non-legal activities.
Courts have also recently addressed the scope of privilege in the context of insurer bad faith claims. Last year, the Supreme Court of South Carolina ruled that an insurer does not automatically waive attorney–client privilege when it denies coverage and asserts good faith in the context of a bad faith claim; rather, privilege is waived only when the insurer's defence necessarily relies on information received from counsel. In In re: Mt Hawley Insurance Co, the insured sought to discover the basis for a coverage denial that the insurer maintained was in good faith. The insurer refused to produce certain documents on the basis of attorney–client privilege. The South Carolina Supreme Court answered the following certified question in the negative: 'Does South Carolina law support application of the “at issue” exception to attorney–client privilege such that a party may waive the privilege by denying liability in its answer?' The court held that the mere denial of liability in a pleading does not constitute a waiver of the attorney–client privilege. Rather, waiver occurs only when an insurer 'claims its actions were the result of its reasonable and good-faith belief that its conduct was permitted by law and its subjective belief based on . . . information and advice received from . . . lawyers.' The court imposed an additional requirement that the party seeking waiver of attorney–client privilege make a prima facie showing of bad faith.
iii Actual cash value calculation: depreciation of labour costs
A series of decisions issued in recent months have addressed, and reached conflicting conclusions as to whether insurers may depreciate labour costs in calculating 'actual cash value' (ACV) under a property policy.
The Tennessee Supreme Court ruled that policy language did not expressly permit the depreciation of labour costs in determining ACV in Lammert v. Auto-Owners (Mutual) Insurance Company. In that case, one policy defined ACV as 'the cost to replace damaged property with new property of similar quality and features reduced by the amount of depreciation applicable to the damaged property immediately prior to loss.' The other policy did not define ACV but stated that ACV includes a deduction for depreciation. Neither policy specifically mentioned labour costs. The Tennessee Supreme Court ruled that the language in both policies was ambiguous and that inclusion of the terms 'damaged property' and 'prior to loss' suggested that depreciation applies only to materials because labour is intangible and labour costs are post-loss expenses. Additionally, the court noted that the policies' definition of depreciation as 'a decrease in value because of age, wear, obsolescence or market value' indicated that it did not include labour because labour does not age, wear or become obsolete. Construing these ambiguities in favour of the insureds, the court concluded that depreciation could be applied only to the costs of materials.
In contrast, the Supreme Court of North Carolina ruled that an ACV provision was unambiguous and included the depreciation of labour in Accardi v. Hartford Underwriters Insurance Company. Although ACV was not defined in the policy, a roof coverage endorsement stated that:
your policy includes Actual Cash Value (ACV) Loss Settlement for covered windstorm or hail losses to your Roof. This means if there is a covered windstorm or hail loss to your roof, [Hartford] will deduct depreciation from the cost to repair or replace the damaged roof. In other words, [Hartford] will reimburse for the actual cash value of the damaged roof surfacing less any applicable policy deduction.
The court concluded that this definition, when read in conjunction with the entire policy, was unambiguous in allowing depreciation of both labour and materials.
The international arena
Complex jurisdictional issues may arise when an international insurance contract mandates arbitration of disputes but applicable state law prohibits such arbitration. In these circumstances, courts must address the interplay between governing state law and the New York Convention, which obligates the enforcement of foreign arbitration agreements. More specifically, such disputes require a determination of whether the New York Convention pre-empts state law such that arbitration is required, or conversely, whether state law reverse pre-empts the New York Convention pursuant to the McCarran-Ferguson Act, such that disputes may be litigated in a court of law.
Federal courts of appeals are divided on this critical issue of international insurance law. The Court of Appeals for the Fifth Circuit recently ruled that an arbitration clause was enforceable notwithstanding a state statute banning insurance arbitration and a 'conformity-to-statute' clause in the insurance policy. In McDonnel Group, LLC v. Great Lakes Insurance SE, UK Branch, the insurers argued that the dispute, relating to the scope of coverage under a builder's risk policy, was subject to arbitration pursuant to the policy's arbitration provision. However, the policyholder argued that the arbitration provision was invalid because (1) Louisiana statutory law expressly prohibits arbitration agreements in insurance policies covering property located within the state, and (2) the operative policy contains a conformity-to-statute provision stating that '[i]n the event any terms of this Policy are in conflict with the statutes of the jurisdiction where the Insured Property is located, such terms are amended to conform to such statutes'.
The Fifth Circuit ruled that reverse pre-emption under the McCarran-Ferguson Act did not apply. The Court reasoned that reverse pre-emption is limited to US federal legislation and does not encompass an international treaty such as the New York Convention. The Court therefore dismissed the coverage dispute in favour of arbitration.
The other federal appellate courts that have addressed whether reverse pre-emption pursuant to the McCarran-Ferguson Act extends to international disputes involving the New York Convention have reached conflicting conclusions. Compare Stephens v. Am Int'l Ins Co, with ESAB Grp Inc v. Zurich Ins PLC.
Trends and outlook
i Third-party liability coverage
Asbestos and environmental coverage actions, along with products and construction defect coverage actions, remain the most significant in the complex third-party liability coverage space. In this context, future litigation is likely to continue to involve the proper method of allocating losses among multiple insurers and between insurers and policyholders. In fact, Ohio's highest court recently addressed the allocation of losses across numerous policy periods in Lubrizol Advanced Materials v. National Union Fire Insurance Co of Pittsburgh, PA. In addition, given the continued proliferation of cases alleging widespread property damage or personal injury resulting from a policyholder's business or actions, courts are likely to be faced with coverage disputes relating to the number of occurrences under general liability policies. Finally, as advancements in the fields of medicine, technology and science continue, litigation against companies whose products allegedly cause property damage or personal injury will continue to flood state and federal courts. Resulting coverage litigation is likely to require courts to address the applicability of pollution exclusions in non-traditional contexts (i.e., outside the traditional environmental contamination scenario). In recent years, courts have grappled with application of the pollution exclusion to novel contexts such as property damage caused by defective drywall and injuries caused by lead paint or by the release of carbon monoxide and other toxic fumes. These and other non-traditional contamination claims will continue to define the scope of a standard pollution exclusion across US jurisdictions.
ii Cyber breaches, data loss and computer fraud
Data breach incidents, cyberattacks and hacking activities designed to obtain financial gain or access to sensitive personal information continue to proliferate at an unprecedented rate. As such, courts undoubtedly will be called upon to address the parameters of both first-party property and third-party liability insurance coverage for myriad cyber-related claims. A growing body of case law is defining the scope of coverage for losses arising out of fraudulently induced wire transfers under computer fraud provisions. In the coming months and years, courts will continue to apply governing state law to decide whether various coverage or exclusionary provisions in general liability and crime policies encompass specific factual scenarios. Additionally, novel questions of law are likely to arise, such as whether cyber-related losses, including damage to software or other computer system components, constitutes covered 'property damage' under general liability or first-party policies; whether and under what circumstances hackers' intentional taking of sensitive data constitutes a publication of private information sufficient to trigger personal and advertising injury coverage; the timing and number of losses or occurrences under applicable policy language; and the scope of coverage under directors and officers policies for cyber-related claims against a company by its shareholders or by regulatory agencies. Furthermore, the applicability of certain exclusions, including those related to acts of war or terrorism, professional services or disputes based on contract, are likely to take centre stage in emerging cyber-coverage disputes.
Some of these novel questions were recently addressed in Quality Plus Services, Inc v. National Union Fire Insurance Company of Pittsburgh, PA. There, a Quality Plus employee received five fraudulent emails over the course of weeks, instructing her to make wire transfers to banks in Mexico and Hong Kong. Quality Plus sought coverage under a funds transfer fraud provision, which covered loss 'resulting directly from a Fraudulent Instruction directing a financial institution to transfer, pay or deliver Funds.' The court ruled that the operative 'occurrence' was the transmission of the emails by the criminals (rather than Quality Plus's instructions to the banks to transfer the funds). However, the court ruled that coverage could not be decided as a matter of law based on several disputed issues of fact. First, the location from which the sender transmitted the emails was uncertain given possible fabrication of IP addresses. The location of the origin of the emails would be outcome determinative as to coverage based on a territory provision, which required occurrences to be within the United States. Second, the parties disputed the number of occurrences – namely whether the losses resulted from five separate occurrences because different individuals were responsible for sending each fraudulent email, or conversely whether there was only one occurrence because the emails were sent by the same person acting alone or in concert with others. The court concluded that the number of occurrences issue would ultimately turn on evidence relating to common identifying characteristics (or lack thereof) in the emails.
iii Climate change
Climate change is an emerging concern for insurers, based on the increasing frequency of wildfires, storms, floods and other natural disasters. As such, future litigation is likely to implicate the scope of coverage under both first-party property and third-party liability policies for the catastrophic losses – both physical and economic – associated with such natural disaster events.
With respect to first-party policies, disputes may involve interpretation of policy provisions relating to causation, particularly where losses are caused by a complex interaction of perils, such as wind, rain and storm surge. Given that property policies often provide coverage for certain perils while excluding others, future litigation arising from weather-related events are likely to implicate this issue. Indeed, complex issues of interrelated causation frequently took centre stage in prior coverage disputes arising out of Hurricane Katrina and other major storms to impact the US.
Coverage under third-party policies for damage caused by severe weather events are likely to be the source of litigation in coming years. In this context, a central issue for courts may be whether climate change or greenhouse gas emission claims give rise to a covered occurrence for purposes of liability coverage. The sole US court to address this issue thus far ruled that an insurer had no duty to defend or indemnify a policyholder for underlying nuisance claims relating to carbon dioxide and greenhouse gas emissions. In AES Corp v. Steadfast Insurance Co, the court reasoned that the underlying claims did not allege an occurrence because the damage was not accidental, but rather the natural and foreseeable consequence of the policyholder's intentional emissions. Other courts may confront similar coverage claims arising out of policyholders' detrimental contributions to climate change. Outcomes are likely to depend on not only the particular factual scenario presented, but also policy language and applicable law. More specifically, future decisions are likely to turn, in part, on governing law relating to whether conduct may deemed an accidental occurrence if the resulting harm is expected or foreseeable, even if not intended.
Similar coverage disputes may arise in connection with pending cases against oil and gas industry giants, who face civil and regulatory litigation over their alleged role in global warming. Litigation has also been filed against the federal government and various state governments based on the alleged failure to safeguard the environment. To the extent that these defendants seek insurance coverage, complicated issues pertaining to justiciability, fortuity, actual property damage and trigger and allocation of coverage are likely to follow.
iv Opioid litigation
The opioid epidemic has given rise to mass litigation against pharmaceutical manufacturers and distributors, often brought by local, state and federal government agencies seeking to recover the enormous expenses that have resulted from opioid addiction. These lawsuits have, in turn, spurred coverage suits against insurers for defence and indemnification of the underlying claims. Courts have begun to address the extent to which opioid epidemic claims trigger a general liability insurer's contractual obligations.
Notably, at least one court has rejected liability coverage for claims against a pharmaceutical company for opioid epidemic-related losses. In Travelers Property Casualty Company of America v. Actavis, Inc, the court ruled that allegations that a drug manufacturer engaged in deceptive marketing in order to expand the sale of opioids did not allege a covered 'accident' under the policies. The court further held that even if some of the claims could be construed as alleging an accident, coverage was barred by a products exclusion, which applied to bodily injury arising out of or resulting from the insured's products.
The global spread of the novel coronavirus disease (covid-19) has had major impacts on businesses, financial markets and international commerce, which in turn, has led to a flood of suits against insurers for coverage of losses. A central issue in this emerging area of coverage litigation is whether there has been physical damage to insured property. The physical damage requirement is inherent in most business interruption provisions, which insure against a loss of business income caused by covered physical damage to the insured's own property. A physical loss requirement is also included in most civil authority provisions, which cover loss of income resulting from restrictions on access to insured premises by a government or civil authority.
The first wave of covid-19-related coverage litigation has centred on whether the loss of use of property that has become uninhabitable or unusable because of actual or potential covid-19 contamination constitutes a 'physical loss' for purposes of business interruption coverage. The answer to this question will ultimately depend on several factors, including the particular facts related to the property at issue, applicable policy language and governing law. Additionally, the question of whether covid-19 contamination can be classified as 'physical' will turn on the scientific and medical knowledge that develops as to the virus and its transmission. In the first decision issued in this context, Gavrilides Management Company LLC v. Michigan Insurance Company, a Michigan court rejected a restaurant owner's claim for business interruption losses, finding that it did not sustain direct physical loss or damage. The court noted that there were no allegations of actual contamination on the premises and that the business losses were the result of the government-mandated shutdown.
In addition to physical loss, most property policies require damage to be caused by a 'peril not otherwise excluded' in order to trigger business interruption coverage. Therefore, policy exclusions may preclude coverage for business interruption losses even where the physical loss requirement is met. Moreover, if losses are caused by a combination of factors, coverage decisions will likely involve application of ensuing loss and concurrent causation provisions. Finally, future covid-19 litigation is likely to implicate valuation issues in relation to proof and extent of business losses, as well as number of occurrences disputes – an issue that will have important implications for deductible payments and application of policy limits.