The great CLE instructor Jim McElhaney, a Professor Emeritus at Case Western, used to tell the story of a “professional expert” testifying at trial on cross-examination. The guy was apparently a kindly old gentleman with an Irish brogue, and also an engineer, and indeed made most of his money in the litigation game.
“You’re a professional witness, aren’t you? You do this for a living!” sneered the examining attorney.
Without missing a beat, the old gentleman responded (in full Irish mode): “Son, this is no job for an amateur.”
Sometimes when I read judicial opinions in the area of insurance, that line comes to mind. This really is no job for an amateur. And I sympathize, because judges are required to be superhuman, and to master and apply many arcane areas of law, from antitrust to zoning. Meanwhile, those of us who focus on insurance law spend years trying to understand it (and usually don’t succeed).
With that preamble, let’s look at a troubling aspect of the New Jersey Appellate Division’s recent coverage decision in IMO Industries v. Transamerica, which you can read by clicking here.
For years, long-tail claims (such as asbestos and environmental claims) consumed buckets of money on fights over the meaning of such scintillating terms as “sudden and accidental.” Now that the meaning of many, if not most, coverage terms under general liability policies has been resolved, the main fight has turned to the issue of allocation – namely, what percentage of the loss does each party pay, and how is that decided?
In days of yore, when multiple insurance policies were triggered by asbestos or environmental claims, many courts (including those in New Jersey) would impose “joint and several” liability on the responsible carriers. The policyholder would then choose which policies it wanted to respond to the claim, and the carriers would later allocate loss among themselves. This had the virtue of simplicity, and of protecting the policyholder first, which, after all, is the purpose of insurance.
That all changed in New Jersey with the decisions in Owens-Illinois, Inc. v. United Ins. Co., 138 N.J. 437 (1994) and Carter-Wallace, Inc. v. Admiral Ins. Co., 154 N.J. 312 (1998). In New Jersey, allocation is now done by a “pro rata by limits” method. Basically, the total coverage limits under triggered policies (primary and excess) for the entire triggered period are added together and become the denominator in a fraction. To figure out the exposure in any triggered year, the limits in that year are added together and become the numerator. To use a very simple example, if you have 10 triggered years, each with $1 million in coverage, the denominator is $10 million, and the numerator for any one year is $1 million, meaning that 10% of the loss would be allocated to any one year.
The analysis becomes more complicated when dealing with defense costs. In many general liability policies, the payment of defense costs doesn’t erode the indemnity limit, and the carrier’s duty to defend continues until the indemnity limit is extinguished by payment of judgment or settlement. That, of course, is a significant benefit to the policyholder – and it’s the risk upon which the premium is based. I’ve seen allocations of defense costs in which special masters or economics experts have used statistical assumptions as to when indemnity limits would be wiped out, and have calculated assumed defense costs to that point to do a proper allocation. As you can imagine, some of these calculations become fairly involved.
IMO dispensed with the niceties. The case involved the allocation of loss for asbestos-related personal injury claims. The policyholder contended that the appropriate allocation should take into account the fact that the obligation to pay defense costs continued until the indemnity limit under a particular policy was exhausted. The insurance companies derided this as a “running spigot” theory of coverage, because, since indemnity limits might never be eroded, the primary carrier would have a never-ending obligation to pay defense.
The IMO Court ruled that Owens-Illinois and Carter-Wallace “superseded” the specific terms of insurance policies, and that defense costs should be allocated identically to indemnity expense. The structure of the opinion is itself a bit maddening, because while the Court recites the holdings of various Supreme Court decisions on allocation, the Court does not really explain its reasoning. The Court simply refers to the “undeniable implication of Owens-Illinois…that defense costs are also allocable, subject to policy terms, in the same manner as indemnity expenditures.”
So, the Appellate Division has basically converted commercial general liability policies, in which defense costs are unlimited, into eroding limits policies – that is, insurance policies in which the payment of defense costs “erodes” the indemnity limit. That may be a simplistic and straightforward solution to the allocation issue, but it is not the basis upon which premiums were calculated when the policies were sold.
I don’t know whether an appeal is planned, or what the Supreme Court might do with such a petition, but I do know that a lot of people (including me) are watching with great interest.