Products liability for financial products: judicial insurance for the insured.

• Author: Phillippi, William R., III

1. INTRODUCTION

   The twentieth and twenty-first centuries have seen the insurance industry reach an unprecedented level in American society in terms of the influence it has on American families. Virtually every aspect of an American's life is touched or affected by the presence of an insurance policy, whether it is Liability Insurance, Property Insurance, or Casualty Insurance. This presence exists because participation in modern America requires a citizen to acquire insurance in order to protect themselves, their families, and their property. This existence and influence has not gone unnoticed by American courts, as stated by Supreme Court Justice Hugo Black, "Perhaps no modern commercial enterprise directly affects so many persons in all walks of life as does the insurance business. Insurance touches the home, the family, and the occupation or the business of almost every person in the United States." (1)

   Unfortunately, as insurance companies have grown in size and prominence over the last 200 years, the consumer market, as well as the legislative and judicial regulation of insurer-consumer relationships, has struggled and failed to keep pace. The slick advertisements that present the self-proclaimed ironclad policy to the consumer actually leave them purchasing a policy containing massive loopholes and hidden defects, rather than the protection they thought they purchased. The results of such policies are often consequence-free denials of coverage by the insurer, leaving the insured without the very policy protection he believed he purchased.

   The purpose of this article is to recognize the important role our judiciary must play in protecting consumers of insurance but has yet to fill due to the deficiencies in the current judicial regulatory schemes available for first-party insurance actions (hereafter called "casualty insurance), which involve disputes centered on property and casualty insurance policies. After highlighting the current judicial shortcomings, this article will propose and advocate for the application of products liability principles to casualty insurance actions due to the unique nature of property and casualty insurance policies, and the attractiveness of a products liability framework for solving the myriad of issues present in casualty insurance actions.

   The idea of applying a products liability framework to the field of insurance policies is not a novel one, although the analysis of the variety of products liability principles was not carried through in-depth by the author. (2) The same author has also recognized the need for creation of a "post-sale" regulatory scheme to protect consumers from defective financial products ("financial products" being the current buzzword for insurance policies in the industry). (3) However, this article will delve into the problems faced by the insured and the courts with enforcing the current law regulating insurance companies and will then propose the use of several principles currently existing in the field of products liability, to give real protection to the buyers of insurance.

   This article consists of five parts. Part I is this introduction. Part II explains and discusses why the insurance industry has not been, and cannot be, regulated through consumer market behaviors (or market self-regulation) and legislatively created administrative regulations. Both failures are due to the unique nature of the insurance market and the enormous size and buying power created by its financial gains.

   Part III of this article examines the current regulatory principles the judiciary has at its disposal for the adjudication of casualty insurance actions. This examination starts by explaining what a casualty insurance action is, as differentiated from a third-party insurance (hereafter called "lawsuit insurance") action, and why judicial regulation is needed. Next, Part III goes over the history of casualty insurance actions before the courts, starting with the application of contract principles, but changing over time to actions grounded in tort, as courts gradually realized the inability of contract law to regulate the insurers' behaviors. Finally, Part III examines the shortcomings and inefficiencies of the judicial regulation of casualty insurance actions as they have played out in courtrooms.

   Part IV of this article shows how the uniqueness of property and casualty insurance policies and their marketing warrant the imposition of products liability principles, especially when coupled with the problems most often seen in casualty insurance actions. First, doing so will lead to the improvement of consumer information through judicial regulation of defective policy warnings, and, secondly, the judicial regulation of defective policy design will reduce the harm to consumers. Next, Part IV discusses the three products liability theories which are especially pertinent to solving current problems in casualty insurance actions: breach of warranty liability (4), strict tort liability under section 402A (5), and strict tort liability for misrepresentation by seller under section 402B. (6)

   Finally, Part V of this article ties together the various threads laid out in the preceding parts and will leave the reader with a new understanding of the challenges courts have today of deciding casualty insurance actions and an appreciation of just how attractive products liability principles are for deciding such actions. In sum, the courts need stronger tools to stop the insurance industry's abuse of its customers.

2. THE FAILURE OF REGULATION THROUGH MARKET CONSUMER BEHAVIOR AND THE FAILURE OF REGULATION THROUGH LEGISLATIVELY CREATED ADMINISTRATIVE REGULATION

   Before beginning a discussion on the necessity of judicial regulation of insurance companies, it is important to discuss the availability and the ultimate deficiency of the other two means of regulation: market self-regulation through consumer behavior and administrative regulation through the legislative branch of government.

   1. Buying an Insurance Policy Is Not Like Buying an Apple, So Why Would the Same Rules Apply to Both?

      Although the title of this section sounds a bit oversimplified, it is an adequate description of why the insurance market has failed to regulate itself through insurance consumer behavior. Market self-regulation occurs when consumers, as a group, become aware of bad goods or bad practices by the seller of those goods. Once the consumer group as a whole has been made aware, they regulate how the market itself conducts business by shifting their buying power to another market or seller, thereby forcing the shunned seller to change the way he does business. The key to this type of regulation is informed and aware consumers who are able to disseminate information to fellow consumers, thereby informing the group as a whole and allowing them to dictate how sellers act. The simpler a product or good is, the more effective market self-regulation becomes for a larger number of consumers. This is where the apple analogy becomes effective. (7) However, as modern society has become increasingly sophisticated, so have the products that are available to consumers through the open market. This did not go unnoticed by California Supreme Court Justice Traynor, who realized that these new complexities leave consumers unable to protect themselves. (8)

      The same analysis also works for regulating State Farm's behavior in marketing its apples. Every potential buyer of State Farm's apples hears the same sales pitch of how, like a good neighbor, State Farm's friendly and folksy sales people and farm workers strive to give you the best product on the market. However, once the product or good is seen, the potential buyers of these apples know they have been hoodwinked, and that State Farm only cares about making money instead of providing the best apples on the market. Word of mouth between buyers, as each one is immediately disappointed with the same bad apple upon delivery, would also lead to a consumer group decision to abandon State Farm's apples and seek out other vendors.

      As suggested in the heading of this section, insurance policies are not apples. They are highly sophisticated boilerplate, standard-form objects that are extremely difficult to inspect because the generalized and abstract language used encompasses a wide range of potential occurrences, which creates ambiguous interpretations during the claims process following an occurrence. (9) Also, any problems or failures of the insurance purchased do not become evident until following a catastrophic occurrence, which will usually happen long after the sale and to a smaller number of people. Therefore, an insurer's reputation held by a large number of consumers concerning their claims' handling does not truthfully represent how they act. (10) Furthermore, even though there may exist buyers in the market place who have the knowledge and ability to "sniff out" the bad apple, the insurance industry is unique in that it has an ability to modify its behavior and products to satisfy informed and intelligent customers. This is accomplished through the buyer-agent relationship. The sellers of insurance, or the agents, must discuss buyers' personal situations in order to assess coverage needs. The interaction allows agents to screen the sophistication of buyers, and adjust their behavior accordingly. (11)

      Therefore, buying insurance is not like buying an apple. Due to its complex and sophisticated nature, the market consumer group as a whole does not have the ability to inform itself as to the quality of insurance and the adequacy of the insurance seller's behavior prior to the sale, leading to the failure of re-directing the purchase. Furthermore, the occurrences of insurance failures and reprehensible seller practices only affect a small percentage of the market: the informed minority becomes informed only after buying a "bad apple from State Farm." This means...