Insurance Companies and Advice

Along with many others who know the industry, David Rossmiller is upset about a Bloomberg story. He protests:

It's not up to your insurance company to make sure you have enough liability insurance to protect your assets if you hit someone with your car, or to make sure you buy enough property coverage to replace your jewelry, or to sit down at your table and make sure you understand you are not covered for earthquakes or floods. First, the law presumes that you the consumer know how much insurance you need, and if you don't get it, that responsibility is yours. Second, this is the theory of a standard-form contract -- the market eliminates the transaction costs of having to negotiate with every person in the world. In return for these savings, it is legally presumed you have read and understood the contract, whether you did or not.... So what's the problem ? The contract said what they would get, they just didn't read it.

Well, I can think of a number of problems with those protests:

• The process of dis-intermediation is now so advanced that, arguably, insurers cannot pretend that the policyholder is not in fact relying on them to do what the broker used to do i.e. advise on levels of cover;
• The insurer's duty of good faith arguably bolsters the latter argument;
• As lawyers, we often forget how arcane is even the simplest standard-form contract of insurance. Interpretation by an expert is the only reliable one;
• In theory, standard-form contracts and dis-intermediation benefit the consumer as well as the provider. In practice, the distribution of the benefits is very uneven, and the only casualties are found among consumers.

Earthquake Cover

Last year, I wrote, more than semi-humourously, about my lack of earthquake cover. (In the meantime, my insurer has told me that I *do* have it - but that's not what the policy document says).

Per David Rossmiller , I now learn of another effort to justify the position:

... J. David Cummins and Neil A. Doherty of the Wharton School, University of Pennsylvania, explained this stuff a while back in a scholarly paper much better than I could, so I'll let them do the talking. Here's their explanation ...:

1) High-frequency, low-severity losses. These are losses that are numerous and small relative to industry resources. A good example is automobile collision losses. Although such losses may be considered a serious financial hardship to the individual insured, they are very small relative to the resources of the industry. Moreover, there are large numbers of such losses, most of which are statistically independent, meaning that the occurrence of any one accident is not usually associated with other, related accidents. For types of insurance where there are many statistically independent losses, insurers can exploit the statistical property known as the "law of large numbers.” The law of large numbers essentially says that when large numbers of statistically independent events are observed, the average loss becomes highly predictable. Or, in other words, the chances become small that the actual observed losses will deviate from expected losses by an amount which is large relative to the overall expected value of loss. This is the type of loss the insurance industry handles most effectively. By pooling together the losses of many individuals with statistically independent risk exposures, the industry is able to charge premiums which reflect the expected or average loss plus expenses and a relatively modest charge for risk bearing. The industry’s equity capital is more than adequate to absorb any adverse fluctuations in losses of this type.

(2) Low-frequency, high-severity losses. The second major type of loss is the type represented by large catastrophes, i.e., events that occur infrequently and are large relative to the resources of the insurance industry. This type of loss is much more difficult for the insurance industry to handle because the usual pooling mechanisms do not apply. The events are simply not sufficiently frequent for the law of large numbers to operate. For this type of loss, the insurer is essentially in the same position as the policyholder in the usual insurance transaction, i.e., the insurer faces a loss that amounts to a high proportion of its resources and that is highly uncertain or unpredictable. Low-frequency, high-severity losses cannot be handled effectively by the insurance industry acting alone. However, these losses can be diversified by pooling them with other economic events that are not usually the subject of insurance . . . .

I think that that confirms that it is most unlikely that I really have earthquake cover.

Deliberate or wilful acts: the case of Patrick v. Royal London

Policyholders are occasionally agreeably surprised to learn that they are in fact protected by their insurance, when something goes wrong expensively and "it was your own fault".

In fact, of course, one purpose of insurance contracts is precisely to offer protection against the unwanted and unexpected consequences of things that we do, even negligently: think of road traffic accidents. Experts, including lawyers, almost always carry insurance against their own negligence.

Insurers constantly worry, however, about what is quaintly referred to as "moral hazard" in connection with cover of this kind. Life is full of moral hazards, but the only one insurers have in mind is the risk that policyholders might be influenced by the fact of cover to do things they would not otherwise do and which might end up costing the insurers money.

For this reason, contracts often exclude from their scope the result of "deliberate" or "wilful"acts. The declared intention is to discourage policyholders from doing things which are purposefully harmful rather than accidental or a result of error. An example of the former might be a builder who, while erecting a building, deliberately damages the house next door because the owner is, say, a love-rival. When sued, he asks the insurance company to pay.

In practice, these situations are usually less clear-cut. It is surprising that there are so few reported cases on this aspect of the interpretation of insurance contracts. I suspect that this may be because, either on their own or with the encouragement of the insurer, policyholders decide not to claim when this exclusion is invoked.

 My favourite case is the Canadian one of the medical doctor who died after taking a drug over-dose.  The life insurance company tried to escape paying on the grounds that he had deliberately caused his own death, but were ordered to pay the claim by the court because the evidence was that it was likely that the overdose was accidental ! Read it here: http://scc.lexum.umontreal.ca/en/2003/2003scc16/2003scc16.html

The most recent case has been drawn to my attention by David Martin Clark (whose website http://www.onlinedmc.co.uk/insurance.htm I recommend to all those interested in insurance law).

The case is that of Patrick v. Royal London Mutual [2006] EWCA Civ. 421.  Mrs Patrick had a household insurance policy which included cover for accidental damage caused by her or any member of her family.  Her son lit a fire on a derelict premises which unfortunately consumed not only that premises but also a non-derelict property next to it.  The son, aged 11, testified that it had not been his intention to burn any building down, but simply to destroy the wooden structure he had built himself.  He claimed that he did not realise this could lead to the consequences that it did, and his testimony was accepted by the court.  On that basis, the English Court of Appeal held that the exclusion on Mrs Patrick's policy to the effect that the policy would not cover damage "wilfully" caused did not apply and the claim had to be paid.

Read the full judgment here: http://www.hmcourts-service.gov.uk/judgmentsfiles/j4172/patrick_v_rlmis_0306.htm