Chapter 3

• Jurisdiction: United States

Chapter 3

The Insurance Policy as a Contract

§ 3.01 Overview

An insurance policy is nothing more than a commercial agreement, albeit extremely specialized, between two parties: (1) an insurance company and (2) its policyholder. The essential feature of the insurance policy is the transfer of certain risks by the policyholder to the insurance company in exchange for the policyholder’s payment of a sum of money or premium to the insurance company. That risk transfer is limited in scope and subject to the terms and conditions set forth in the insurance contract.

As discussed previously, there are generally two categories of insurance policies—first-party and third-party. For and within each of these categories, there are two lines—personal and commercial, applicable to individuals and commercial enterprises, respectively. Within each category and line, there are a number of different types and kinds of insurance policies.¹

Remarkably, despite this great variety of insurance available and in use in the market, many of the principles uniformly apply across all categories, lines, and types of insurance policies. This chapter is intended to discuss many of these common elements, aspects, and provisions applicable to all categories, lines, and types of insurance policies.

First, the chapter discusses rules of construction that are generally used by courts when interpreting insurance policies, irrespective of the kind of insurance at issue.² The chapter then covers the regulatory landscape in the sense of the approvals generally necessary to authorize the use of certain insurance policy language for many of the types of policies.³ A further discussion addresses the mechanism for establishing the terms of coverage when the actual policies, regardless of the type, are misplaced, stolen, destroyed, or lost.⁴ Finally, there is coverage of miscellaneous provisions generally seen in all types of policies, including provisions dealing with arbitration,⁵ choice of law and choice of forum,⁶ contractual limitations,⁷ allocation,⁸ and subrogation.⁹

§ 3.02 Insurance Policies as Ordinary Contracts

The most important rule in the interpretation and construction of an insurance policy is that an insurance policy is essentially no different than any other commercial contract, although it is a specialized contract that is usually not negotiable unless the policyholder is a large corporation. Accordingly, the same rules for interpretation and construction for contracts in general apply to insurance policies.¹⁰

[1]—Freedom to Contract

To arrive at the proper construction of contracts in general and of insurance policies in particular, the plain meaning of the document controls unless there is some law, statute, regulation, constitutional provision, or public policy preventing application or enforcement of such construction.¹¹ To wit, the parties generally enjoy the freedom to contract. They are free to contract about anything, and whatever they contract and how they draft it are generally enforceable as written unless a constitution, statute, law, regulation, or public policy would prevent such an interpretation, application, or enforcement.¹²

This freedom to contract rule has significance in two material respects. First, the language used generally will ultimately control, making insurance policies governed by the language contained in the policies themselves.¹³ Dictionaries can help explain the plain meaning of the language used in the policies.¹⁴ Other sources that are useful in arriving at the plain meaning of words in an insurance policy include, among other things: (a) the definitions set forth in the insurance policy (which should be consulted first);¹⁵ and (b) common everyday usage and understanding of the words utilized.¹⁶ Additionally, case law may be relevant, helpful, and potentially precedential or persuasive where identical or substantially similar language has been construed or interpreted by other courts in similar factual circumstances. However, cases construing the same provisions under materially different facts and/or provisions that differ in material respects should have no influence on the meaning of the particular language at issue. Accordingly, when interpreting and applying an insurance policy to a given set of facts, the language contained in the policy is generally the best starting point. This principle is reflected throughout this treatise.

Of equal or greater significance is the second material effect of contractual freedom—namely, the language itself can be used to override common-law interpretations. Insurance companies can change language in their policies in an attempt to mitigate or alleviate themselves from precedential decisions regarding construction of particular terms or phrases, which they view as harmful or otherwise detrimental to their business.¹⁷ This theme is also often repeated in this treatise.

Of course, the freedom to contract is not without its limitations. For instance, any language change might need to be pre-approved for use by state insurance regulators.¹⁸ However, such regulatory hurdles do not negate the ultimate freedom to contract.

In addition, even after regulatory approval is obtained, changes to the terms of current insurance policies can usually not be made until the renewal of those policies. And with respect to such changes in terms at renewal, an insurance company may be required to do more than send a policy with the revised terms included. Often, at the time of renewal, the insurance company is required to notify its policyholder of the changes in coverage and the significance of the changes, and in the absence of its strict compliance with these rules, may be unable to rely upon the revised terms as part of the renewed policy.¹⁹

[2]—Interpretation and Construction of Insurance Policies

Interpretation of insurance policies is a question of law within the province of the court.²⁰ In construing or interpreting insurance policies, courts should first determine whether the policy is ambiguous.²¹ Courts will find a policy to be ambiguous where its meaning is unclear or where there is more than one reasonable interpretation as to its meaning.²²

If it is not ambiguous, courts should construe the unambiguous policy in accordance with its plain meaning.²³ On the other hand, ambiguous policies are generally construed in favor of coverage and the policyholder, and they are generally construed against the insurance company as the drafter of the incomprehensible or ambiguous contract.²⁴

[a]—Parties’ Mutual Intentions

The paramount goal, and indeed the governing rule, in insurance policy construction is to ascertain and enforce the mutual intentions of the parties based on the policy’s terms and conditions.²⁵ In interpreting an insurance policy in accordance with the parties’ mutual intentions, the court first looks to the insurance policy itself, including review of the entire policy as a whole, the language used, any definitions set forth therein, and the attendant circumstances surrounding the contract formation, such as the type of insurance, the nature of risks involved, and the purpose of the transaction.²⁶ If the policy does not define a significant term, the court will apply the term’s plain meaning taken from the viewpoint of the ordinary purchaser of insurance, often, but not always, with resort to the policy’s definitions and/or a dictionary.²⁷

[b]—Rules of Construction

In attempting to arrive at the meaning of a policy, where the language of the policy is not otherwise clear,²⁸ courts may, and often do, utilize various rules of construction, such as:

(1) Construing a policy as a whole to harmonize its provisions and avoid an interpretation that creates an internal conflict. ²⁹

(2) Construing a policy as a whole to effectuate each provision and to avoid redundancy, superfluousness, and surplusage. ³⁰

(3) Construing the policy as a whole to ensure that the interpretation of it comports with the purposes the parties had contemplated in entering into the transaction. ³¹

(4) Construing a policy to comport with the policyholder’s reasonable expectations. ³²

(5) Construing a policy to avoid a construction providing what appears to be illusory coverage—namely, the payment of premiums for effectively no insurance coverage. ³³

(6) When two parts of a policy appear to conflict irreconcilably and conflict cannot be harmonized, construing the policy such that the irreconcilably conflicting specific provisions control over the general ones. ³⁴

(7) Utilizing the doctrine of expression unius est exclusion alterius, meaning interpreting a policy in such a way that the expression of one thing implies the exclusion of anything not mentioned. ³⁵

(8) Construing a policy in a fair, reasonable, practical, sensible, just, logical, and unstrained manner to avoid absurd results. ³⁶

(9) Construing an ambiguous policy in favor of coverage and the policyholder and against the insurance company as the drafter of the incomprehensible or ambiguous contract. ³⁷

§ 3.03 State Insurance Regulation

The insurance industry has traditionally been regulated by states, with the relevant statutory and regulatory law administered by the insurance departments of the various states.³⁸ Among other things, states often require that the insurance departments approve new policy language forms and/or changes in premium rates before they may be employed or applied in insurance sold in the state.³⁹

[1]—Regulatory Filings

[a]—Required Regulatory Approval

Except with respect to surplus lines insurance,⁴⁰ and often with respect to self-insurers and uninsured entities or persons,⁴¹ most jurisdictions make it unlawful to issue or sell any kind of insurance policy, including endorsements, until the language in the policy has been submitted and formally approved by the state’s Insurance Commissioner. For example, in Pennsylvania, a statute provides:

“It shall be unlawful for any insurance company, association or...