INNOCENT INSUREDS (Definitions and Interpretations)

INNOCENT INSUREDS (Definitions and Interpretations)

(July 2019)

No matter its level of complexity or the line of business involved, an insurance policy is meant to protect the policyholder against fortuitous (accidental) events. Further, such incidents usually must take place quickly, as a surprise rather than be the result of a gradual process. When these elements are met, it is likely that any resulting damage will qualify for an insurance payment. With few exceptions (i.e., mitigating facts), intentional or deliberate actions that cause damage or injury are excluded from coverage. Nor is there usually coverage when there is prior knowledge of an occurrence. The rationale? Insurance is not designed to protect a party for damage or injury over which that party had significant control in causing or which the insured knew about before securing coverage.

Examples:
Line of Business	Loss Description	Covered?
Personal Auto	Driver attempts turn on icy road, car slides across street and slams into a light pole.	Yes
Commercial Auto	Driver is angered by supervisor on a job site, so he backs over a stack of construction materials.	No
General Liability	A restaurant owner confronts a visiting food critic and smashes a bowl over his head.	No
Homeowners	Resident drops a can of lighter fluid while barbecuing, the can ignites and then explodes, severely damaging home’s rear wall, porch ceiling and floor.	Yes
Professional Liability	Lawyer gives approval on a building plan that she knows violates several land use ordinances. Contractor sues for delay costs caused when plan is rejected by city officials.	No

Coverage for Intentional Acts

While an insured having control over an act that causes loss or injury usually is grounds for exclusion, there are exceptions such as:

Actions of a minor or other legal incompetent
Damage or injury involving self-defense or protecting another party or property
The existence of innocent insureds

The reason for exceptions is to make fair allowances for permitting an insurance policy to respond to losses when justified by circumstances. Therefore, coverage still applies to loss that arises out of deliberate acts by persons who are legally incompetent (includes minors) because they are considered as lacking the ability to form intent. Coverage often applies to acts of preservation or self-defense because the possibility of injury or damage is typically unavoidable when repelling the actions of an attacker or reacting to other dangerous situations. However, there is a critical difference when considering allowing coverage for innocent insureds.

Innocent Insureds

The exceptions involving the inability to form intent or unavoidability related to self-preservation do not apply to instances involving innocent insureds. Unlike the other exceptions, the latter situation does involve an unjustified loss deliberately caused by an informed party. The difference is that coverage may be allowed because the guilty party is accompanied by at least one other party who is free of involvement with the injury or damage.

Example: Insured reports a fire that destroys the home. The insurer denies the claim after discovering it was arson and the husband set the fire in the hopes of getting money to cover gambling debts. A court rules that the insurer has to pay the wife for half the value of the home as she had no knowledge of the spouse’s financial problems or of his arson plans.

Innocent insureds are usually spouses, resident relatives, co-owners, partners, employees and/or other parties who have an insurable interest in some covered property or share a legal responsibility with a guilty party. The relationship between the guilty and innocent parties tends to be very close. One common exception are parties that hold a large insurable interest in covered property because they have lent funds to an insured, such as mortgage holders, banks, credit unions and similar parties. However, when payment is typically made to a third party, financial interest, an insurer often subrogates against an insured to recover the payment.

One issue that is vitally important regarding innocent insureds is that, generally, any compensation tends to result from judicial decisions rather than contractual considerations. Typically, an insurance contract does not make a distinction among the different parties who share an insurable interest in instances of breach, material misrepresentation or intentional acts.

Imputing

The result is that, without outside (usually judicial) intervention, no consideration is provided to uninvolved parties with their own insurable interests because of imputing. In other words, the act (or failure to act) by any insured is attributed to all other insureds. This removes any question of innocence. However, court review does not mean that an innocent party’s position will be ruled as enforceable. It often depends upon the applicable circumstances.

The question of attributing the actions of one insured to all insureds is a particularly controversial issue in Directors and Officers (D&O) Coverage. D&O is designed to protect all of an operation’s directors and chief officers against their liability related to performing their jobs. D&O coverage often responds to lawsuits filed by different third parties such as shareholders alleging the directors of a negligent decision that devalued stocks or by former employees charging wrongful termination.

As is the case with other lines of business, insurance companies depend upon acquiring accurate information from clients seeking coverage. The typical D&O application carries wording that is shared by other lines. Specifically, such applications state that the application may be declined or subsequent coverage or policy may be voided if the applicant is guilty of misrepresentation.

Example: The Acme Corporation has a D&O policy from Crankland Insurance. Shareholders sued Acme’s directors because a highly publicized merger fell through. The other company in the proposed merger discovered that Acme’s accounting practices substantially inflated earnings in several crucial aspects of their operations, so the company terminated the merger talks. Crankland investigates the claim and denies coverage. It turns out that Acme’s CEO authorized the bogus practices and hid this fact when he completed the application for D&O coverage. Acme’s directors, who knew nothing of the CEO’s action, argue that they should still be covered. Crankland counters that, whatever knowledge held by Acme’s CEO is knowledge held by its board (imputed), so no coverage applies.

The question of innocent insureds continues to be clarified by lawsuits and by changes in policy wording. Typically, both applications and policies use language that imputes one insured’s knowledge to all.

Related Court Case: Misappropriation Not Covered

In rarer circumstances, some forms still contain policy language that includes consideration of maintaining coverage for innocent parties. Different jurisdictions will further affect what happens in the future as they make decisions regarding the fair application of coverage as well as address reasonable coverage expectations.