Recently I was reading an article from the University of Pennsylvania Law Review titled “The Illusory Coverage Doctrine: A Critical Review.” According to the article, the Illusory Coverage Doctrine “is a doctrine of insurance contract enforceability, as opposed to interpretation, that serves to protect policyholders from procedurally unconscionable exclusions that almost completely wipe out the coverage purportedly available under their policies.”

In other words, if a commercial lines insured is sold a policy that doesn’t cover a business activity that resulted in a claim, the coverage under the policy might be considered illusory, depending on the scope and degree of the exclusion. If the exclusion is broad and deep, a court might find the insurance contract to be unenforceable.

I first spoke about this in seminars I did in the ’90s and wrote about it in my book, “When Words Collide: Resolving Insurance Coverage and Claims Disputes.” The problem is, many courts have found that coverage is not illusory if there is any coverage at all for which a premium was paid.

In my book, I give a personal example of when my residence was hit by a tornado in 2013. In addition to about $40,000 in damage to property, we lost 19 trees that had to be cut down and removed from the premises. These were largely 40- to 80-foot cedar trees in various states of damage. We received at least four quotes from tree service companies vying for the job. Of course, I asked for documentation of insurance coverage.

One of the companies had only been in business for a few months. I’m sure getting coverage was difficult for them, as attested by the fact that the owner proudly presented me with a portfolio of insurance documents that included a certificate of insurance, a CGL policy declarations page and assorted policy forms.

The CGL policy was the 2004 ISO edition and attached to it were 42 endorsements, many of them exclusionary in nature. One in particular excluded “ongoing operations” and “your work,” the latter term effectively meaning completed operations. In other words, this business owner, tasked with bringing down very large trees, some immediately adjacent to a neighbor’s home, essentially had what was referred to in the old days as an OL&T policy—owners, landlords and tenants. That is, his policy covered him on his premises but not on a job site.

Was his CGL coverage illusory given the nature of his business? I would argue that it absolutely was. However, many courts would opine otherwise. The law review article above cited an Indiana Supreme Court decision that reiterated an established rule that “Coverage under an insurance policy is not illusory unless the policy would not pay benefits under any reasonably expected set of circumstances.”

As stated earlier, many courts have found that coverage is not illusory if there is any coverage at all for which a premium was paid. Translated, this means that, if your insurance premium deal was too good to be true, there is likely little coverage to be found. In the case of this tree service company, I suspected as much when I saw on the declarations page that the CGL coverage was priced at $707, a ridiculously low premium for such a hazardous business.

Obviously, the reason the premium was so low was that it was essentially a premises-only policy. Therefore, the premium being commensurate with a premises exposure, the coverage might not be considered illusory. You get what you pay for. Again, guessing that this new tree service business had a very difficult time procuring coverage, you would think that the owner would question what he was buying at such a discounted price after likely being turned down by other insurers or offered coverage at an outrageous price.

The problem is that most consumers and small business owners don’t understand this. After all, especially from the standpoint of home and auto insurance, industry marketing is dominated by price-focused advertising. The implication is that insurance, by and large, is a commodity differentiated only by price. A homeowners policy is a homeowners policy. An auto policy is an auto policy. A CGL policy is a CGL policy. The law review article addresses this by invoking the “reasonable expectations” doctrine, something I also address in my book.

I’m sure there are business owners who would be suspicious of the extent of coverage, but if it helps them get work, ignorance is bliss. Unfortunately, that doesn’t protect the public who could be harmed by someone who is effectively uninsured. The law review article addresses this by questioning whether coverage should be granted as a matter of public policy, another concept I explore in my book.

So, can a policy provide illusory coverage? Legally, it probably can as some courts have found, but realistically, making a case for illusory coverage can be very difficult. But that’s not the point.

March is recognized as “Ethics Awareness Month” in the insurance and risk management industry. From that perspective, let’s forget about the legality of an insurance policy like the CGL package discussed in this article. Is it ethical to sell such a policy, knowing how limited the coverage is relative to business operations?

I don’t believe it is. It might possibly violate fraud or unfair trade practices laws, but even that is debatable given how most state laws are written.

Is it an ethical practice? I don’t believe it is, and I said that to the tree service business owner, explained his coverage deficiencies, and gave him my business card if he wanted to present it to his insurance representatives. I never heard any more about this, so my guess is that the business owner pretended our conversation never happened. We have enough people in the industry who unknowingly sell deficient coverage—we don’t need people knowingly doing that.

What do you think? Is knowingly selling an insurance package that is grossly deficient in providing coverage for a business’s usual and customary operations unethical? Feel free to respond in the Comments section of this article, if reading online, or send me an email.

This article is republished from Insurance Journal magazine.