Consider the Risks - An Insurance Law Blog

In a recent decision, (Aroa Marketing, Inc. v. Hartford Ins. Co. of Midwest, 198 Cal. App. 4th 781 (2011)), the California Court of Appeals upheld a trial court dismissal (without leave to amend) of an insured’s suit for breach of the duties of defense and indemnity against its CGL insurer regarding underlying claims by an exercise video model of unauthorized uses of her image. The insured, Aroa Marketing, argued that the CGL insurer’s Personal and Advertising Injury coverage applied to the underlying claim. Specifically, the coverage applied to:

“personal and advertising injury” arising out of [o]ral, written or electronic publication of material that violates a person’s right of privacy.

The model alleged that her image was to be used only at the January 2007 consumer electronics show. However, in breach of contract with Aroa, she claimed that her image was used to sell and market other products including products unrelated to the equipment featured in the video, and demanded compensation for the unauthorized use. The model’s suit against Aroa included causes of action for statutory and common law misappropriation of likeness, breach of contract, unjust enrichment and unfair competition. She claimed that Aroa’s alleged unauthorized use diminished her marketability and her publicity value, and that she was “deprived of her right to publicity. Aroa supra at *1.

After receiving notice of the underlying suit, the insurer, Hartford Insurance Company of the Midwest (Hartford of Midwest) issued a denial letter based on the intellectual property exclusion in its policy. Aroa eventually settled the underlying suit, and then sued Hartford of Midwest which responded with a demurrer (seeking dismissal of the claim) on the grounds that the model’s underlying claims did not fall within the scope of the Personal and Advertising Injury coverage of its policy, and that such claims were expressly excluded by the policy’s intellectual property rights exclusion. The trial court dismissed Aroa’s complaint against the insurer without leave to amend, and Aroa appealed.

The California Court of Appeals sided with Aroa on the preliminary question of whether the underlying claims were within the basic scope of the Personal and Advertising Injury section of the policy. This coverage section provides coverage for certain enumerated offenses, including “[o]ral, written or electronic publication of material that violates a person’s right of privacy.” Aroa supra at *3. The court, citing the California Supreme Court’s decision in Comedy III Production v. Gary Sanderup, Inc., 25 Cal. 4th 387 (2001), traced the origin of the common law right of publicity to individual privacy rights recognized in the law.

The insured’s success in placing the claim within the scope of the insuring agreement was short-lived, however, because the court also found the underlying claims to be squarely within the scope of the policy’s intellectual property exclusion.

This provision (added to most standard CGL policies in 2001) excludes:

[p]ersonal and advertising injury [arising out of] any violation of any intellectual property rights such as copyright, patent, trademark, trade name, trade secret, service mark, or other designation of origin or authenticity.

Aroa argued that the exclusion was inapplicable because it failed to specifically mention rights of publicity. The court properly dispatched this argument noting that the use of the words “such as” before the specific examples of “copyright” etc. in the exclusion was “expressly non-exclusive” and that the California Supreme Court had previously determined that the right of publicity was an intellectual property right. Aroa, supra at *4. Noting that California law had settled the question of whether the right of publicity was an intellectual property right, the court found that the trial court did not abuse its discretion in refusing Aroa’s request for leave to amend. “[T]there is no reasonable possibility that Aroa can amend the complaint to allege the necessary facts to state a valid cause of action against Hartford of Midwest for failure to defend or indemnify it in the [underlying] lawsuit.” Id. at *5.

While the decision does not break new ground, it does provide an important scope check regarding the relatively recent addition of an intellectual property exclusion to the CGL policy. This result may also provide a boon to media liability insurers who expressly insure the content of the insured’s advertising in areas involving privacy rights and some, but not all, intellectual property rights. That is not to say that such content coverage policies would automatically respond to claims like those against Aroa. At its essence, the model’s underlying claims alleged the breach of an express contract between the model and the insured. Most content coverages expressly exclude such core business risks of the insured.

Much has been written lately about Stranger (Owned or Originated) Life Insurance, (“STOLI” or “SOLI”), a concept by which an investor seeks to profit from a life insurance policy on the life of another, with whom the investor has no personal relationship. Generically, a STOLI transaction involves an investor (or an agent for potential investors) identifying a person late in life, or with limited remaining life expectancy, who is able to successfully obtain a substantial life insurance policy and financially inducing that person to obtain the policy with the proceeds ultimately, or under certain defined circumstances payable to the investor. If the costs of procuring and maintaining the life insurance policy are less than the death benefit paid to the investor, the investor realizes a gain. In this sense, the investor profits from the death of another.

While many legitimate investments are based on the investor taking a position on and profiting from the outcome of a certain contingency, the law has traditionally tried to distinguish the concept of investment, or even gambling, from that of insurance, which is generally viewed as protection against loss.

There are a number of facets of insurance law which recognize this distinction between insurance for profit or wagering and insurance against loss, and all of them are directed at precluding the use of insurance to obtain financial gain in the face of negative societal outcomes. For example, both state laws and exclusions found in property insurance policies prohibit arson for profit.

Another example is found in the application of limitations (by policy provision and/or state law) regarding so called “replacement cost coverage,” under property insurance policies. It might be feasible to buy up a city block of properties in a distressed area, for far less than it would cost to replace the structures on such properties, and to obtain replacement cost property insurance for such properties. The owner of this city block would thus be in a better position after a massive fire than before, if his insurance company replaced the destroyed buildings with new construction. There are however rules and/or statutes designed to mitigate the profit potential in this scenario. While the insured in this example would ordinarily be paid and could even be advanced, the actual loss sustained (usually measured as replacement cost less depreciation) the difference, (e.g. total replacement cost) is only paid if the insured actually replaces the damaged structures. Under this scenario, unless the insured actually replaces, its insurance recovery is limited to the depreciated value of its investment. When the insured actually replaces, the replacement cost insurance is only reimbursing for an actual loss (the increased cost of replacement). While the insured still benefits from replacement cost in this instance, (it now owns a modern and thus more valuable city block notwithstanding its location in a distressed area), society also benefits as well because the block was in fact fully rebuilt, thereby improving the neighborhood and the city’s tax base. The insurance in this instance is neither an investment, nor a wager and is only a protection against loss.

The concept of “insurable interest” is another example of a legal doctrine designed to preclude the use of insurance as investment or wager. Insurable interest is the common law doctrine that limits recoveries to those who have a measurable pre-existing interest in the subject matter to be insured. The insurable interest doctrine would preclude an investor or speculator from Boston from obtaining a fire insurance policy on an abandoned home in Detroit and profiting from an infamous Devils Night fire. Because the Bostonian neither owns nor has any pre-policy relationship with the Detroit property, he has no insurable interest in it. Thus even if he could get an insurer to issue a policy on the Detroit property, in the event of a fire, the insurer will be able to successfully challenge the loss payment because the insured had no insurable interest in the property at the time the policy was written or at the time of the loss.

The requirement of an insurable interest is not meant to limit the use of insurance to certain kinds of interests in property. For example, under Massachusetts law, prior to policy procurement, “any person has an insurable interest in property, by the existence of which he receives a benefit, or by the destruction of which he will suffer a loss, whether he has or has not any title in, or lien upon, or possession of the property itself.” See Womble v. Dubuque Fire & Marine Ins. Co., 37 N.E.2d 263 (1941). Indeed, the Court in Womble noted the flexibility of and rationale behind the insurable interest concept: “The requirement of an insurable interest when the risk is assumed arose merely to prevent the use of insurance for illegitimate purposes. It should not be extended beyond the reasons for it by excessively technical construction.”

In the context of life insurance, illegitimate purposes include creating a financial incentive for the death of another. As the U.S. Supreme Court noted long ago in Grigsby v. Russell, 222 US 149, 155 (1911):

A contract of insurance upon a life in which the insured has no interest is a pure wager that gives the insured a sinister counter interest in having the life come to an end.

The definition of insurable interest in the life insurance context is a matter of state law, either by common law or by statute. New York’s statutory definition is typical:

The term, “insurable interest” means:
(A) in the case of persons closely related by blood or by law, a substantial interest engendered by love and affection;
(B) in the case of other persons, a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.

NY Insurance Law § 3205 (a) (McKinney 2010)

So what happens when a SOLI or STOLI transaction meets the doctrine of insurable interest, head on? In one recent case, Kramer v. Phoenix Life Ins. Co., 2010 N.Y. Slip Op. 8376 (Nov. 17, 2010) New York’s highest court refused to invalidate several SOLI transactions, involving more than $56 million in life insurance on the life of a prominent New York attorney which was procured a few years before his death for the ultimate benefit of investors. A copy of the slip opinion appears here.

In responding to certified questions from the U.S. Second Circuit Court of Appeals the New York Court of Appeals found that New York law did not prohibit a person from obtaining life insurance on his own life for the sole purpose of transferring such insurance to investors. Notwithstanding a strongly worded dissent, the Court found such transactions to be compliant with existing New York statutory requirements which expressly permitted immediate transfers of interests in life insurance as long as it was initially procured by the insured, who by definition has an insurable interest in his own life:

[W]e recognize the importance of the insurable interest doctrine in differentiating between insurance policies and mere wagers …, and that there is some tension between the law’s distaste for wager policies and its sanctioning an insured’s procurement of a policy on his or her own life for the purpose of selling it. It is not our role, however, to engraft an intent or good faith requirement onto a statute that so manifestly permits an insured to immediately and freely assign such a policy.

While the STOLI or SOLI industry may find substantial comfort from the decision in Kramer, it may be too early to pop the champagne in New York or elsewhere, and the flexible concept of “insurable interest” may yet put such contracts in jeopardy. First, as noted by the Court in Kramer, the New York legislature had, by the time the decision was issued, acted to broadly define and prohibit “stranger-originated life insurance” and to preclude insured initiated life settlement contracts (sales of insured procured policy proceeds) until two years after policy issuance in most cases. See NY Insurance Law §7813, §7815 ( effective May 18, 2010). Similar statutes are in place or under consideration in other states, and other state courts may not be as lenient in interpreting the insurable interest doctrine. As the dissent noted:

There are good reasons why the common law, as reflected in both Warnock and Grigsby, invalidated stranger-originated life insurance. Even if we ignore the possibility that the owner of the policy will be tempted to murder the insured, this kind of “insurance” has nothing to be said for it. It exists only to enable a bettor with superior knowledge of the insured’s health to pick an insurance company’s pocket.

Courts in the US have a very long track record against allowing insurance to be used as an investment or a wager, and when insurable interest meets stranger owned or originated life insurance, it may not be a matter of “hail-fellow-well-met.”

This post considers the 7th Circuit’s July 15, 2010 decision in Medmarc Casualty Insurance Company v. Avent America, Inc., which can be found here. But first a word or two about the title. The phrase “A Whim and a Prayer” is actually a mangled version of “A Wing and a Prayer” which is from a popular 1943 song about a shot-up pilot that limps back to base, according to Professor Paul Brian’s entertaining and insightful Common Errors in English Usage, a link to which appears here. As Professor Brian correctly notes, “whim” and “prayer” don’t belong together. And indeed that is one of the messages of the Court’s opinion in Medmarc.

Illinois, whose law was being applied by the 7th Circuit in Medmarc, had developed a rule that the duty to defend should not depend on the “whim” of the plaintiff’s counsel in crafting the complaint, and that a court, in considering the duty to defend, should look beyond the specific words used in the underlying complaint to determine whether coverage existed. See Int’l Ins. Co. v. Rollprint Packaging Prods., Inc., 728 N.E.2d 680, 688 (Ill. App. Ct. 2000). The court refused to apply the “whim” rule and rejected defense coverage under a CGL policy applicable to “damages ‘because of bodily injury’” regarding a class action claim against Avent, whose “prayer” for relief was limited economic losses to parents who purchased but did not use plastic baby bottles because they were found to contain BPA, a substance alleged to have health risks.

The court noted:

Although Illinois courts have recognized that a duty to defend should not be at the mercy of the drafting whims of plaintiffs’ attorneys, these omissions were not mere whims. In the underlying cases, the plaintiffs’ attorneys have limited their claims solely to economic damages that resulted from the plaintiffs purchasing a product from which they cannot receive a full benefit because they were falsely led to believe that it was safe. This is not a drafting whim (or mistake) on the part of the plaintiffs’ attorneys, but rather a serious strategic decision to pursue only this limited claim. The strategic intention behind this decision is clear from the plaintiffs’ concession in the underlying suit that they are seeking only economic damages and do not claim any bodily injury.

Medmarc Slip Op. at 16 (citations omitted).

In reaching its decision, the 7th Circuit considered and rejected the insured’s argument that coverage was warranted because its CGL coverage included the broader “damages because of bodily injury” language instead of “damages for bodily injury” found in other forms. The court recognized the distinction and noted that “because of” is more broadly construed:

Avent is correct that courts do interpret these phrases differently and courts generally interpret the phrase “because of bodily injury” more broadly. The logic of this difference in interpretation can be illustrated by considering the following example: an individual has automobile insurance; the insured individual caused an accident in which another individual became paralyzed; the paralyzed individual sues the insured driver only for the cost of making his house wheelchair accessible, not for his physical injuries. If the insured driver had a policy that only covered damages “for bodily injury” it would be reasonable to conclude that the damages sought in the example do not fall within the insurer’s duty. However, if the insurance contract provides for damages “because of bodily injury” then the insurer would have a duty to defend and indemnify in this situation.

Medmarc Slip Op. at 19 (citations omitted).

Nevertheless, the court focused on the relief claimed in rejecting coverage notwithstanding the references in the complaint to the allegedly harmful nature of products containing BPA:

Even considering the broader duty to defend created by the phrase “because of bodily injury,” the complaints in the underlying suits do not reach the level of asserting claims “because of bodily injury.” Implicit in Avent’s argument is that the damages claimed are somehow, at least tangentially, tied to a bodily injury caused by BPA. As discussed above, that simply is not the case here. The theory of relief in the underlying complaint is that the plaintiffs would not have purchased the products had Avent made certain information known to the consumers and therefore the plaintiffs have been economically injured. The theory of the relief is not that a bodily injury occurred and the damages sought flow from that bodily injury.

Id. at 19-20.

Thus, while duty to defend coverage should not be determined by the “whim” of the pleadings in the underlying claim, insureds don’t have a “prayer” if the prayer for relief doesn’t seek damages “because of bodily injury.” While the court’s analysis never mentions “reasonable expectations” and does not address the business risk exclusions, the decision reflects a common sense consideration of which risks ought to be the subject of liability insurance (bodily injury and property damages resulting from the insured’s products) , and which risks are inherently uninsurable business risks (economic losses resulting from the non-utility of the insured’s products).

It happens after nearly every tragedy. Initially, some spokesperson, or government official, or pundit says the event was “unprecedented,” “unforeseeable,” or “could not have been anticipated.” Some time later, society adopts protective measures that, in a word, are “obvious.” At times, we seem to be completely reactive, unable to identify and avoid non-routine risks, until calamity strikes, and then we implement common sense protective measures. Must we suffer every disaster at least once? From a risk management perspective the answer should be a resounding no. All too often, however, enterprises limit their assessment of risks to the known or obvious risks, without a dedicated effort to look beyond. We can and should do better.

For starters, lets challenge every explanation that an event was an unforeseeable calamity. And by challenge, I don’t mean adopting conspiracy theory as a belief system. Instead, we should ask ourselves whether the claim of unforeseeability is consistent with our own knowledge of the world.

Let’s think about one such event from this perspective. In the immediate aftermath of 9-11, the attacks were described as unforeseeable, but does that statement hold up? Using planes as weapons in coordinated suicide attacks goes back at least to World War II (kamikazes). Jihadists had already tried to take down the World Trade Center, so the target could hardly be described as new. So what was new and unknowable about that tragedy- the use of commercial airliners as weapons of mass destruction? While that point is debatable, the debatability of a risk is not an excuse for failure to anticipate the risk and adopt reasonable avoidance measures.

Ask yourself this question about all such “unforeseen” events: If it was my life’s work to think about possible risks in this area, in this instance, risks associated with air travel, should I have foreseen this risk, and recommended common sense measures against it, e.g., fortifying cockpit doors. Maybe this is just a case of hindsight being 20/20, but then again, maybe not. I tend to think that the risk that an airline hijacker would do something other than simply ask to be flown to a destination, and would instead try to use the plane as a weapon to make a political statement, indeed, flying the plane into an iconic building, was readily foreseeable, at least if any smart person was charged with thinking about such risks.

Run this same analysis for any number of reportedly unanticipated events, (the uncontrolled release of oil from a deep ocean well in the Gulf of Mexico, the Challenger explosion, etc., etc.) and in most instances the results would be the same, in hindsight, the events seem entirely knowable from the perspective of someone specifically charged with anticipating risks.

Given the consequences of major catastrophes, why don’t we, at the enterprise level, pay more people to creatively anticipate the unknown? There are several reasons for this. For public companies, the drive to meet or beat short term (quarterly or annual) expectations certainly works against maintaining a dedicated cost center charged with thinking about and avoiding (usually by incurring more costs) calamitous events to the enterprise. Given the American penchant for eternal optimism, the role of Chief Risk Officer, (a/k/a Chief Naysayer) is not likely to be a popular one, and will clash with other officers who may see themselves in the role of Cheerleader in Chief.

What we need is a culture shift, in which the timely identification and prudent avoidance of risk is valued and rewarded, at least as much as fortitude in crisis response. Fortunately, there are some inklings of change. According to a recent press release,here, one of the ratings agencies has highlighted the identification of “emerging risks” as an integral part of its “enterprise risk management” (ERM) reviews which are incorporated into overall credit opinions for the property and casualty insurers it rates:

The assessment of emerging risks is a critical and forward-looking
component of our ERM and credit analysis for property/casualty insurers. …Our
world is increasingly dynamic, and to the extent an insurer can demonstrate a
meaningful degree of preparedness in handling emerging risks, the more likely, in our view, it will be able to maintain its creditworthiness when a risk emerges.

Indeed, while the press release describes the benefits of controlling emerging risks (“risks that so far have not resulted in significant losses for … but have the potential to cause problems”) for insurers, the point could be applied more universally to all enterprises. Those companies that actively try to anticipate and reasonably avoid catastrophe, should be recognized and rewarded for their effort.

To be fair, there will always be something beyond our ken, and mistakes will be made, but we should view these facts as motivation for planned forethought and action, not as an excuse to be uttered from the ruins of a preventable disaster.

On May 3, 2010, the Georgia Supreme court in World Harvest Church, Inc. v. GuideOne Mutual Insurance Company here held that an insurer who defends an insured in the absence of an express and specific reservation of rights to deny coverage is effectively estopped from later denying coverage, even where the absence of coverage for the underlying claim is beyond dispute. The principal rationale for the decision is the “conclusive presumption of prejudice” resulting from the insured’s inability to completely control its own defense in the face of a potential denial of coverage. Id. p. 2. As harsh as this result seems, it is consistent with Georgia’s pro-insurer rejection of the late-notice prejudice rule adopted by common law or statute in many other jurisdictions. Nevertheless, for insurers doing business in Georgia, an express and specific reservation of rights, prior to any meaningful assumption of the insured’s defense, is now an imperative.

The underlying facts involved a “Ponzi scheme” and alleged contributions by the schemers to World Harvest Church, followed by two suits by an SEC appointed receiver against the church to recover the contributions. The first suit was the subject of a written reservation of rights and subsequent denial, by a sister company of GuideOne. That suit was later dismissed for lack of personal jurisdiction. When a second suit was filed, GuideOne told the church it was assigning two adjusters, one of whom was to address coverage. The coverage adjuster stated “We didn’t see coverage but we would have to evaluate what we have currently to see if there would be coverage issues.” No written reservation regarding the second suit was ever issued and after assuming the defense and defending for 10 months, GuideOne informed the Church that it would stop defending in 30 days because there was no coverage. Thereafter, the insured assumed its own defense. Following the receiver’s successful summary judgment motion, the court awarded damages against the church in the amount of $1.8 million. A few months later, the church sued GuideOne in the district court for breach of the duty to defend and indemnify it from the receiver’s suit. After a lower court ruling in GuideOne’s favor, the case was appealed to the 11th Circuit which certified three questions:

(1) Does an insurer effectively reserve its right to deny coverage if it informs the insured that it does “not see coverage,” after the insured had received a written reservation of rights from the insurer’s sister company in a similar lawsuit in another jurisdiction, or is a written or more unequivocal reservation of rights required?

(2) When an insurer assumes and conducts an initial defense without notifying the insured that it is doing so with a reservation of rights, is the insurer estopped from asserting the defense of noncoverage only if the insured can show prejudice, or is prejudice conclusively presumed?

(3) If the insured must show prejudice, do the facts and circumstances of this case show it?

See World Harvest Church v. GuideOne Mut. Ins. Co., 586 F3d 950, 961 (11th Cir. 2009).

The Georgia Supreme Court, in responding to the first question noted that a reservation of rights need not be written to be effective, however, the notice must reflect a present (not future) intent to avoid coverage (disclaim liability) on specified grounds and state that the insurer does not waive the defenses available to it against the insured. Id. at 5. The oral statements of GuideOne’s adjuster did not meet this standard, and the prior reservation by GuideOne’s sister company to a different (if similar) suit did not cure the defect and thus there was no adequate reservation.

On the second question, the Georgia Supreme Court found that the insurer, by failing to issue an adequate reservation was estopped to later deny coverage, even if the insured had actual knowledge of the likelihood that the insurer would ultimately deny coverage, and even if there was no affirmative showing of prejudice by the insured. According to the court, in this context-where the insurer assumes and actively conducts the defense, prejudice is conclusively presumed. The court distinquished its decision in Prescott’s Altama Datsun v. Monarch Ins. Co. of Ohio, 253 Ga. 317, 318, 319 SE2d 445 (1984), which precluded an automatic estoppel where the insurer merely filed an appearance but then immediately abandoned the defense. According to the court, the rationale for the estoppell is the insureds “surrende[r of] innumerable right associated with the control of the defense.” Id. p. 13.

Having found an estoppel as a matter of law, there was no need to respond to the third certified question regarding the existence of prejudice under the circumstances.

A rule which purports to apply a “conclusive presumption of prejudice” is one which, using the gloss of a purported evidentiary issue, is in fact a foregone conclusion. Why not just call it an anti-insurer estoppel, and leave it at that? Well, one reason may be that the rule in this context is really the necessary converse of Georgia’s pro-insurer rule of law, that an insurer who receives late notice may disclaim coverage even in the absence of prejudice. See Granite State Ins. Co. v. Nord Bitumi U.S., Inc., 262 Ga. 502, 504, 422 S.E.2d 191, 194 (1992) (”breach [of notice provision] relieved [insurer] of its obligation to defend [,] and of … liability for any judgment[.]”) This is contrary to the late notice/prejudice rule applied by common law or statute in many jurisdictions. In both cases, prejudice is presumed when the party at risk is denied the control of that risk which a defense right necessarily entails. All the more reason to “Consider the Risk.”