Kozak: What you don’t know shouldn’t hurt your coverage rights

Kozak

By Chris Kozak

Insurance exists because life is full of risk. We pay an insurer a small amount of money (the premium) on the off chance we might need a much larger amount of money promised by the policy (the benefit). This trade-off only works because the insurer knows it won’t pay a benefit to everyone who pays a premium or else it would go out of business.

The courts protect this expectation with the “known-loss doctrine.” The rule, in short, says this: You can’t buy insurance after you know something bad has already happened. Gen. Housewares Corp. v. Nat’l Sur. Corp., 741 N.E.2d 408, 413-14 (Ind. Ct. App. 2000). For example, a homeowner shouldn’t be allowed to buy property insurance while a tree lays, horizontal, in his living room. A person can’t run from the courthouse and buy liability insurance only after her business has been sued. Insurers don’t need to write this rule into policies to be protected by it. It exists as a matter of law to protect the insurance company from fraud and to protect the public from insolvent insurers.

But as in most areas of insurance law, Indiana guards policyholder rights carefully. Knowing that a tree’s core is rotten, or that someone has slipped and fallen in your store, isn’t enough to void your policy. That’s because you still don’t know the tree will fall; you aren’t sure the customer will sue you. Indiana courts won’t void your coverage rights unless the loss was “virtually inevitable” before you bought the insurance. Gen. Housewares, 741 N.E.2d at 414.

In recent years, insurers have tried to broaden this concept. Many policies now include language stating there is no coverage if, “prior to the policy period,” specified policyholders or employees “knew that the ‘bodily injury’ or ‘property damage’ had occurred, in whole or in part.” In theory, this language protects multistate insurers against varying formulations of known-loss rules. See Travelers Cas. & Sur. Co. v. Neth. Ins. Co., 95 A.3d 1031, 1054 (Conn. 2014). But what’s not clear is how much work this language actually does. The Indiana courts have only looked at this language once. Ind. Ins. Co. v. Kopetsky, 14 N.E.3d 850 (Ind. Ct. App. 2014). But the sum total of their advice has been “enforce the policy language.”

This, of course, helps nobody. Insurance policies are cryptic and often do not easily apply to the strange world we live in. What should a court do with a mom-and-pop gas station with chronic underground storage tank leakage issues? The owners may know about the leaks and may be trying to fix the issue, but is that knowledge enough to destroy coverage for any liability that might arise from each “spill?” Can the insurer refuse a defense when the Indiana Department of Environmental Management shows up 10 years later with evidence that the spills penetrated the neighboring town’s drinking water?

Or consider a different angle. A human resources official in a company’s Miami branch receives a complaint of sexual harassment. He investigates, confirms the underlying facts and emails his supervisor in Indianapolis. While the HR process unfolds, however, the company’s risk manager in New York renews the company’s employment practices liability insurance policy. A week later, 10 women from the Miami branch (including the complainant) sue the company, alleging negligent supervision of the manager. Can the EPL insurer avoid a pricey duty to defend because the “company” knew about the “injury” before renewing its insurance policy?

These are questions for which Indiana’s policyholders don’t have an answer. And Kopetsky’s admonition — “enforce the policy language” — doesn’t cut it. The known-loss doctrine and the known-injury exclusion overlap in some cases. And Kopetsky dealt specifically with whether the insurer’s knowledge of the loss was relevant to the known-injury issue, as it would be in the known-loss analysis. But as more insurers place these clauses in their policies, the Indiana courts need to tell policyholders what they mean. Several issues loom large in this discussion:

What does “injury” mean? The known-loss rules require the policyholder to know about the loss itself (e.g., a lawsuit) before an insurer can void coverage. Knowledge of the thing leading to the loss is generally not enough. But losses are discrete and unitary — a policyholder seeks coverage for a distinct lawsuit or particular property damage. The injury causing a loss is nearly always more diffuse. Pollution cases provide a good example: If the “loss” is an IDEM cleanup action or a private suit, then what’s the “injury?” Is it the spill? Or is it the entry of the chemical into someone else’s property? There is virtually no case law addressing this question. But an answer is critical for many businesses, which could lose coverage under these exclusions if the courts interpret “injury” to mean every splash of petroleum or every unwanted sexual innuendo.

How much knowledge is required? Courts outside Indiana have held — over insurers’ objections — that “an insured’s knowledge of one type of damage … doesn’t automatically constitute knowledge of any and all damage to property.” Kaady v. Mid-Continent Cas. Co., 790 F.3d 995 (9th Cir. 2015); Alkemade v. Quanta Indem. Co., 687 F. App’x 649 (9th Cir. 2017). Instead, the policyholder must have actual knowledge of the specific injury or loss claimed to be within the exception, not just knowledge of a similar defect, and not just knowledge of a risk of the specific defect. Thus, a building owner who raised concerns about cracks in the surface masonry of a building did not lose coverage for the underlying structural damage.

This rule, articulated by the 9th Circuit in Kaady, is a sensible one, “considering that a commercial general liability insurance policy covers (as its name implies) many different types of hazards that have no relationship to one another.” Kaady, 790 F.3d at 999. Moreover, it is consistent with the strict construction Indiana places on exclusions, requiring them to clearly apply to a case before they are enforceable.

What are the consequences of repair? One final issue that has arisen outside Indiana is the consequences of repair. When a minor problem arises, the policyholder’s first impulse is usually to fix it. If she does so, but later discovers the problem was worse than it originally appeared, does she lose coverage? The courts have generally rejected insurers’ attempts to deny coverage on these grounds. Following the logic in Kaady, they have held that known-injury arguments are cut off when, at the time, the repairs satisfy everyone concerned. Alkamade, 687 F. App’x at 689; Desert Mt. Props. Ltd. P’ship v. Liberty Mut. Fire Ins. Co., 236 P.3d 421, 434-35 (Ariz. Ct. App. 2010); AGLIC v. U.S. Fire Ins. Co., 255 F. Supp. 3d 677, 692-93 (S.D. Tex. 2017). The policyholder’s knowledge of the “injury” is extinguished by the repair, and new knowledge of the specific injury is required to revive it.

These three issues are unanswered under Indiana law. But as more insurers write known-injury exclusions into their policies, customers in Indiana need to know what their rights are. The out-of-state cases provide helpful guidance, but they are no substitute for an authoritative ruling by the Indiana courts.•

• Chris Kozak is an associate at Plews Shadley Racher & Braun LLP. Opinions expressed are those of the author.