The American Law Institute (ALI) - the preeminent independent legal organization in the United States producing scholarly work in the legal field, including the Restatements of Law - voted to adopt significant portions of the first two chapters of the ALI’s “Principles of the Law of Liability Insurance” (Insurance Law Principles) at its Annual Meeting on May 20, 2013. Since the Insurance Law Principles project was announced in 2010, the ALI’s adoption and publication of the project’s initial chapters has been eagerly anticipated. When complete, the ALI’s Insurance Law Principles will likely be seen as persuasive authority by courts, particularly in addressing novel or contemporary issues where there is no controlling case law.
This past week, the ALI took a major step in the progress of the Insurance Law Principles project when its membership voted to approve the entirety of Chapter 1 - “Basic Liability Insurance Contract Principles” and significant portions of Chapter 2 - “Management of Potentially Insured Liability Claims” of the proposed Insurance Law Principles. While the principles that the ALI has adopted to date touch upon several areas of insurance law, two particularly significant principles relate to the rescission of insurance policies based upon misrepresentations on insurance applications and the insurer’s duty to defend.
The most contentious principle adopted at the ALI’s Annual Meeting would limit the circumstances under which an insurer may rescind an insurance policy based upon misrepresentations on insurance applications. Under the approved principle, an insurer would be permitted to rescind a policy based upon material misrepresentations on the insurance application only if the insurer can prove that the misrepresentations were intentional or reckless. Such a standard is clearly more restrictive and contrary to the current law in most states, which permit an insurer to rescind a policy based upon a material misrepresentation - even if made innocently by the insured - on the insurance application. The Insurance Law Principles commentary attempts to justify this standard on the grounds that (1) an innocent misrepresentation is the type of risk for which the insured has purchased liability insurance, and (2) shifting the risk of innocent misrepresentations to the insurer will encourage best practices on the part of insurers in gathering information about their prospective insureds. Still, under the principle adopted by the ALI, it would be virtually impossible for an insurer to rescind or void a policy ab initio based upon misrepresentations on the insurance application because an insurer will rarely be able to prove that an insured acted intentionally or recklessly in making such misrepresentations.
With regard to the duty to defend, one of the principles approved by the ALI addresses a dilemma frequently faced by insurers when facts known by the insurer, but not within the four corners of the complaint, would justify a denial of coverage. In addressing this issue, the principle adopted by the ALI provides that the allegations in the pleadings should generally govern an insurer’s duty to defend. However, the principle carves out two important exceptions to this general rule and permits an insurer to rely upon all facts and circumstances reasonably available to it in determining whether: (1) a person or entity is insured under a liability insurance policy, and (2) the events required for the claim to trigger the policy took place within the policy period. This principle is particularly significant for insurers faced with long-tail exposure claims where triggering dates are rarely included in the pleadings, and are often omitted intentionally by plaintiff’s counsel in an effort to trigger as many policies as possible.
As the ALI continues to work on the Insurance Law Principles project, it will be important to monitor its progress and the potential impact of the principles as they are adopted in unsettled or novel areas of insurance law. The advisers and members consultative group for the project are slated to meet again in November 2013 to continue their debate and work.