Academic journal article Law and Contemporary Problems

The Butterfly Effect in Interpreting Insurance Policies

Academic journal article Law and Contemporary Problems

The Butterfly Effect in Interpreting Insurance Policies

Article excerpt

I

INTRODUCTION

In resolving contract disputes, one might think a court's interpretation of the contract at issue would impact only the parties in the case. In the vast majority of contract cases today, however, that is not true because more than ninety-nine percent of the contracts entered today are standard form contracts. (1) When a court interprets a standard form contract, the court's interpretation of the language impacts all of the entities who are using, or will be using, the contractual language at issue, not just the parties in the case. (2) The court's interpretation also impacts how other courts will interpret the same language even if the courts are in different jurisdictions. Because the drafters of standardized contract language often understand the far-reaching impact of courts' interpretations, they respond to the courts' interpretations of their language when drafting or redrafting standardized contracts. Courts' interpretations of standardized contract language also impact the behavior of repeat users of such language in seeking or avoiding judicial interpretation of the contract language. These ripple effects of courts' interpretations of standardized contract language are commonly referred to as the "butterfly effect." (3)

As the first type of standardized contract described as a contract of adhesion one hundred years ago, one can intuit that courts' interpretations of insurance policies would have a butterfly effect on parties not involved in the litigation. (4) Indeed, much of the language found in insurance policies today has been recycled in policies decade after decade. (5) And, for some lines of insurance, many insurers use identical or nearly identical policy forms. (6) Consequently, the courts' interpretations of the standardized policy language in insurance policies is fertile ground for the butterfly effect.

One pronounced butterfly effect occurs as a result of the first court's interpretation of the policy language because the interpretation impacts all users of the policy language. (7) The initial interpretation also impacts how other courts will interpret the same language. Indeed, the mere prospect of a court interpreting policy language impacts insurers' litigation conduct because they, unlike most policyholders, are repeat players in litigation regarding the meaning and application of policy language. The butterfly effect from the initial court's interpretation of policy language incentivizes insurers, as repeat players, to seek or avoid judicial interpretation of policy language in order to generate or avoid the creation of such precedent. (8)

Insurers also seek to counteract the butterfly effect of courts' adverse interpretations of policy language when drafting the policy language. Insurers are aware that a court's interpretation of a single word or the placement of a comma or semicolon in a sentence in a policy can result in the creation of billions of dollars of insurer liabilities to policyholders in the event of a significant coverage event. Consequently, to minimize the butterfly effect of adverse court interpretations of policy language, a drafting feedback loop can result. Insurers react to judicial interpretations by creating exclusions and/or redrafting existing policy language to avoid the application of courts' interpretations with which insurers disagree.

To examine the butterfly effect in the interpretation of insurance policies, this Article proceeds in five parts. Part II explains how insurance policies became prototypical standardized contracts. Part III addresses how courts' interpretations of policy language impact insurers' decisions whether to settle or litigate in order to obtain or avoid creating precedent regarding the meaning of standardized policy language due to the interpretation's butterfly effect. Part IV addresses insurers' efforts to counteract the butterfly effect by redrafting policy language or creating exclusions to nullify adverse court interpretations of policy language. …

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