A Products Liability Theory for the Judicial Regulation of Insurance Policies

Article excerpt

ABSTRACT

Many insurance law commentators believe that judges should regulate the substance of insurance policies by refusing to enforce insurance policy terms that are exploitive or otherwise unfair. The most common guide for the judicial regulation of insurance policies is the "reasonable expectations doctrine," which requires courts to disregard coverage restrictions that are beyond insureds' reasonable expectations unless the insurer specifically informed the insured about the restriction at the time of purchase. This Article argues that although the judiciary has a potential role to play in policing insurance policy terms, that role should not be defined by reference to consumers' reasonable expectations. Instead, by drawing on the parallels between insurance policies and ordinary consumer products, this Article advances a products liability framework for understanding how and why courts should regulate insurance policies. It proposes that, just as firms that make defective products must pay for the resulting injuries, insurers that issue "defective" insurance policies should have to provide coverage to insureds. The Article argues that the usefulness of the analogy to products liability law goes well beyond understanding the normative basis for the judicial regulation of insurance policies. Products liability law offers important insights into how courts can efficiently correct failures in insurance markets by encouraging effective disclosure to consumers and appropriately setting penalties so that insurers take an optimal amount of care in drafting policy terms.

TABLE OF CONTENTS

INTRODUCTION
I. THE NEED FOR JUDICIAL REGULATION OF
   PROPERTY/CASUALTY INSURANCE
   A. Insurance Policies and the Efficiency of
      Standard-form Contracts
   B. Consumer Information and Rationality in
      Property / Casualty Insurance Markets
      1. The Assumption of Consumer Knowledge
         a. Reputation
         b. Insurance Information Intermediaries
         c. Secondary Literature
      2. The Assumption of Consumer Rationality
   C. A Role for Judicial Intervention
      1. The Social Welfare Consequences of
         Inefficient Coverage
      2. The Limitations of State
         Administrative Regulation
II. REASONABLE EXPECTATIONS AS A FLAWED
    DOCTRINE FOR THE JUDICIAL REGULATION OF
    INSURANCE
    A. The Stunted Evolution of the Reasonable
       Expectations Doctrine
    B. Reasonable Expectations as a Corrective for
       Market Failure?
       1. Reasonable Expectations and Inefficient
          Coverage Exclusions
       2. Reasonable Expectations and
          Informing Consumers
III. PRODUCTS LIABILITY LAW AND THE JUDICIAL
     REGULATION OF INSURANCE POLICIES
     A. Justifying a Products Liability Model
     B. Constructing a Products Liability Model
        1. Defective Warnings
        2. Insurance Harms and Design Defects
           a. Deviations for a Clause's Purpose as an
              Insurance Harm
           b. Defective Insurance Designs
           c. Damages
        3. The Interaction of Design Defects and
           Defective Warnings
     C. The Costs of a Products Liability Model
CONCLUSION

INTRODUCTION

In the wake of Hurricanes Katrina, Rita, and Wilma, insurers feared no one more than Trent Lott. Not only did the Mississippi senator have an obvious political incentive to insist that insurers pay for as much of the unprecedented hurricane damage as possible, he had a strong personal incentive as well: his house lay in ruins, and his insurer insisted that it was not liable for the damage as Lott's policy excluded coverage for all losses caused by flooding. (1) Lott--like thousands of other hurricane victims along the Gulf Coast facing similar resistance from their insurers (2)--quickly filed suit, claiming that his insurer's reliance on the flood exclusion violated his "reasonable expectation" of coverage. …