The American Law Institute (ALI) is the preeminent independent legal organization in the United States producing scholarly work in the legal field, including the Restatements of Law. The ALI entered the field of insurance law for the first time in 2010, initiating its Insurance Law project, which ultimately led to the development of the Restatement of the Law of Liability Insurance. After nearly a decade of debate and controversy, the ALI voted to approve the much-anticipated Restatement of the Law of Liability Insurance at its annual meeting on May 22, 2018.

The significance of the Restatement of the Law of Liability Insurance on the insurance industry cannot be overstated, given the enormous influence of the ALI on binding legal decisions. According to ALI statistics, the U.S. Supreme Court cited ALI publications 71 times during the 2013 to 2015 terms of court, and state and federal courts have cited ALI publications over 200,000 times since the ALI was founded in 1923. In fact, several courts began citing the Restatement of the Law of Liability Insurance as persuasive authority even before the ALI formally voted to adopt the Restatement this past month, and courts’ reliance on the Restatement will certainly accelerate now that it has been formally adopted by the ALI.

A Brief History

The ALI’s Insurance Law project was first introduced in 2010 as the “Principles of the Law of Liability Insurance” project. According to the ALI, its Principles projects “express the law as it should be, which may or may not reflect the law as it is.”

In October 2014, the ALI converted the Principles project into a Restatement project—a move that substantially magnified the project’s significance and influence because the Restatements of Law are generally regarded as clear formulations of common law and are often cited by courts and attorneys as support for their positions.

As stated in the ALI Style Manual, the Restatements seek to set forth “clear formulations of common law…as it presently stands or might appropriately be stated by a court.” However, given the unsettled nature of various insurance law issues in many jurisdictions, as well as competing rules adopted by different jurisdictions, the goal of setting forth “clear formulations of common law” is often more easily stated than accomplished. As such, in a few areas, the Restatement of the Law of Liability Insurance misses the mark, with the ALI adopting a rule of law that it considers to be the “better rule” rather than the majority rule.

The breadth and scope of the Restatement of the Law of Liability Insurance is substantial, touching upon nearly every legal issue frequently faced by insurance professionals in four chapters:

• Chapter 1, “Basic Liability Insurance Contract Rules,” addresses basic contract-law doctrines that have special application in the insurance-law context, such as interpretation, waiver, estoppel and misrepresentation.

• Chapter 2, “Management of Potentially Insured Liability Claims,” explores the duties of insurers and insureds in the management of potentially insured liability actions, including the duty to defend, settle and cooperate.

• Chapter 3, “General Principles Regarding the Risks Insured,” examines general principles relating to most forms of liability insurance, including coverage provisions (i.e., insuring clauses and exclusions); conditions; and the application of limits, deductibles and retentions (including number of occurrences and allocation).

• Chapter 4, “Enforceability and Remedies,” addresses enforcement of policy provisions and remedies, including claims for bad faith.

Given its scope, a comprehensive discussion of the substance of every provision of the Restatement is beyond the reach of this article. But understanding a few of the more significant insurance law principles and positions adopted by the ALI in the Restatement will help insurers and risk managers anticipate coverage dispute complications and manage their risks accordingly.

The ‘Plain Meaning Presumption Rule’ to Policy Interpretation

With regard to the most fundamental insurance law issue—the interpretation of the policy itself—Section 3 of the Restatement at first adopts the majority rule that “[a]n insurance policy term is interpreted according to its plain meaning.” However, the Restatement includes a significant exception to the “plain meaning” rule where “extrinsic evidence shows that a reasonable person in the policyholder’s position would give the term a different meaning.” As a result, the Restatement provides that even where a policy term “is unambiguous on its face…extrinsic evidence may be used to show that the term has a different meaning in context.” In making this determination, the Restatement provides that “the court necessarily expands its view to consider the circumstances,” including the policyholder’s experience and expertise in the insurance market.

The “plain meaning presumption rule” adopted by the Restatement is significant because such a rule is at odds with the majority rule in most jurisdictions that an insurance policy is subject to general rules of contract construction and must be construed according to its plain terms when the policy language is unambiguous. In fact, during the drafting of the Restatement, Section 3 was the target of several motions brought by an ALI member to replace the “plain meaning presumption rule” with the traditional “plain meaning rule.” However, such motions were defeated despite concerns raised by ALI members (including several judges) that the “plain meaning presumption rule” adopted by the ALI would cause confusion.

The ALI’s approach to policy interpretation (if adopted by courts) may lead to greater uncertainty in the interpretation of policy forms and higher costs in resolving insurance coverage disputes, because courts will be called upon to interpret insurance forms in light of extrinsic evidence rather than pursuant to the plain language of the forms at issue.

Trigger of Coverage and Allocation of Long-Tail Claims

Courts across the country have long been vexed with the problem of determining which policy or policies should be triggered for long-tail claims—such as environmental losses or asbestos claims—where the damage at issue continues or progresses over time and/or does not manifest itself for a lengthy period, as well as how to allocate such damage among multiple triggered policies.

Addressing the trigger issue, courts have generally applied one of the following trigger of coverage theories:

• Manifestation theory—coverage is triggered in the first year in which the injury of damage becomes manifest or known, even though the exposure occurs over many years.
• Exposure theory—coverage is triggered during the years in which the claimant was exposed to harm-causing circumstances regardless of when the harm is made manifest.
• Injury-in-fact theory—coverage is triggered when actual injury or damage occurs, regardless of whether the injury or damage is ascertainable.
• Continuous trigger theory—coverage is triggered throughout the entire period of exposure and manifestation.

As to the allocation of long-tail claims, courts have generally adopted either the “all sums” rule or the “pro rata” rule. Under the “all sums” rule, the insured is permitted to allocate its entire indemnity liability (up to the policy limits) to any of the triggered policies. Under the “pro rata” rule, the insured’s indemnity liability is allocated across all triggered years, including those years in which the insured may have been uninsured, with each insurer only owing its pro-rata share.

The ALI’s Restatement of the Law of Liability Insurance tackles these issues in Sections 33 and 42. In Section 33, the ALI ostensibly adopts the “injury-in-fact” theory, triggering coverage only during those policy periods when actual injury or damage occurs. However, in the context of long-tail claims, the ALI’s “injury-in-fact” approach produces results that will often be indistinguishable from the “continuous-trigger” theory by triggering coverage during all policy periods after the potential claimant’s first exposure to the risk unless the insurer can “prove that there was no injury during its policy period.”

After adopting a trigger of coverage theory that will likely result in multiple policies being triggered for long-tail claims, the ALI rejects the “all sums” allocation rule in favor of the “pro rata” rule known as “time on the risk” allocation in Section 42. In adopting the “pro rata” rule over the objections of policyholder representatives, the ALI recognized that there is split of authority between the “all sums” rule and the “pro rata” rule as well as “some disagreement over the precise number of jurisdictions that have adopted each position.”

Ultimately, the ALI took the position that “[w]hile the all-sums approach has been adopted by a significant number of courts…a clear majority of the jurisdictions that have addressed the question have adopted the pro rata approach.” Furthermore, the ALI stated that the “pro rata” rule adopted is the most consistent, simplest and fairest solution to the difficulties presented by long-tail claims. Specifically, the “pro-rata” rule is “fair” because all triggered years, including those in which the insured did not purchase insurance, share equally in indivisible losses.

Consequences of Breach of Duty to Defend

The majority of jurisdictions to have addressed the effect of an insurer’s breach of its duty to defend have held that an insurer does not automatically forfeit its coverage defenses if it is found to have wrongfully breached its defense obligation. This majority of courts have declined to impose an automatic indemnity penalty because such a rule would be overbroad, unfairly punitive and interfere with the parties’ contractual rights. A minority of courts have held that if an insurer wrongfully breaches its duty to defend, it automatically forfeits its coverage defenses on indemnity on the theory that any other rule would allow insurers to convert a “duty-to-defend” policy into an “after-the-fact defense-cost-reimbursement” policy.

The Restatement rejects both the majority rule and the minority rule in favor of a “middle ground” approach. Section 19 provides that an insurer that breaches the duty to defend a legal action loses the right to contest coverage for the action, but only if the insurer breaches the duty to defend “without a reasonable basis.” The Comments to the Restatement indicate that the “reasonable basis” standard is satisfied “when there is a sufficient basis in the law for taking that legal position” such that “a reasonable insurer would take [the legal position] under the circumstances.”

What to Expect

The Restatements are highly regarded by judges, who will often turn to the Restatements for guidance when their state appellate courts have not yet addressed a particular legal issue. Now that the Restatement of the Law of Liability Insurance has been approved by the ALI, we can certainly expect parties to cite the Restatement in coverage litigation in an attempt to persuade courts to their side. And, if history is any indicator, it is likely that the Restatement will be given weight by courts, particularly when addressing areas of law in which the court does not have binding precedent to follow.