Understanding the Distinct Purpose and Meaning of First-Party Insurance

The distinct purposes served by these types of coverage give rise to at least two third-party concerns that do not apply to first-party insurance. First, when insureds purchase third-party insurance, their potential liability extends to the rest of the world, making it difficult to assess their probable and maximum exposures. Furthermore, liability depends on changing legal standards, which, as the asbestos experience demonstrates, can greatly expand insureds' exposure in unanticipated ways. This uncertainty does not apply to first-party insurance, where the insured knows at the time of placement the value of the property and other interests it intends to insure. Second, the interpretation of third-party insurance often is influenced by judicial concern with compensation for innocent third parties, a concept sometimes referred to as “public rights.” In contrast, this solicitousness has no place in the interpretation of first-party insurance because the injured insured is a party to the contract who made choices about what to insure and how to insure it. A further distinction stems from the undertaking in most third-party contracts to provide a defense or pay defense expenses. This third-party undertaking often makes the insured and insurer “allies” against the claimant, a relationship foreign to first-party insurance. See Port Auth. of N.Y. & N.J. v. Affiliated FM Ins. Co., 311 F.3d 226, 233 (3d Cir. 2002).

Three illustrations demonstrate how thoughtful courts recognize and enforce the distinction between first-party and third-party insurance.

Physical Loss or Damage

The U.S. Court of Appeals for the 3rd Circuit recently relied on the “time-honored distinction between the two types of insurance coverage” in declining to apply third-party precedent to determine whether first-party property had been damaged. Port Auth. of N.Y. & N.J. v. Affiliated FM Ins. Co., 311 F.3d 226 (3d Cir. 2002). There, the insured sought coverage under first-party policies for the removal of asbestos-containing products, which, it said, were releasing asbestos fibers that circulated throughout its buildings.

The Third Circuit held that there was no first-party physical loss or damage unless the condition rendered the building “uninhabitable and unusable.” The court rejected the insured's proposed standard, which relied on third-party precedent addressing the threat posed by the presence of asbestos. The Third Circuit expressly noted the absence in first-party insurance of any “public interest in compensation for injured third-parties” and the fact that the scope of first-party insurance depends on the insured's “own determination and judgment.” In short, first-party policies insure against physical impacts that materially alter occupancy. They are not “maintenance contracts” subject to interpretation under third-party standards.

Date Of Loss

Courts have applied the same line of reasoning in cases adopting a distinct date of loss for first-party contracts. In Prudential-LMI Commercial Insurance v. Superior Court, 798 P.2d 1230 (Cal. 1990), the California Supreme Court looked to the purposes of first-party insurance and concluded that, where a claim involved subsidence of a building over time, the policy responsible for covering the loss was the policy in effect when the insured discovered the damage. The court relied extensively on the “substantial analytical differences” between first-party and third-party insurance articulated in prior decisions and rejected arguments for the “continuous damage” concept found in third-party precedent. Appellate courts in other states have reached the same conclusion. See, e.g., Winding Hills Condominium Ass'n, Inc. v. North Am. Specialty Ins. Co., 332 N.J. Super. 85 (App. Div. 2000); Jackson v. State Farm Fire & Cas. Co., 835 P.2d 786 (Nev. 1992); Sentinel Mgmt. Co. v. Aetna Cas. & Sur. Co., 1999 WL 540466 (Minn. App. July 27, 1999), aff'd in relevant part, 615 N.W.2d 819 (Minn. 2000).

The discovery standard looks to the existence of material damage and provides a single date of loss at the time the insured knew or should have known of the insured physical loss or damage. This standard follows logically from the nature and purpose of first-party insurance. First, when placing first-party insurance, the insured can reasonably estimate the total value of its property and the exposure it is prepared to leave uninsured. Second, because first-party insurance applies only to the insured's property, the parties know during the policy period what losses have occurred and need to be accounted for in any renewal. The discovery standard thus best fits with this short-tail feature of first-party insurance. Third, compensation of injured third parties is not a concern relevant to this type of insurance.

Number Of Occurrences

The same first-party/third-party distinction applies when determining the number of occurrences ' and hence, the number of deductibles and limits ' presented by a claim. In Newmont Mines Ltd. v. Hanover Insurance Co., 784 F.2d 127 (2d Cir. 1986), the Second Circuit declined to follow third-party occurrence precedent because, “when construing a property damage policy … the business purpose sought to be achieved by the parties is considerably different.” Id. at 136. Insureds purchase third-party insurance to indemnify themselves for the financial consequences of the harm they cause others. It follows then that courts determine the number of occurrences under third-party insurance by looking to the “underlying” conduct that gave rise to the insureds' liability. Id.; Stonewall Ins. Co. v. Asbestos Claims Mgmt. Corp., 73 F.3d 1178, 1213 (2d Cir. 1995) (“[C]ourts should look to the event for which the insured is held liable.”).

This focus on insureds' liability-causing conduct is irrelevant to first-party insurance, which insures against the external peril causing damage to the insured's own property. The first-party occurrence determination therefore focuses on the parties' expectations regarding the circumstances of the loss. An occurrence takes place when insured physical loss or damage “occur[s] unexpectedly and without design, unless the damage occurring at one point in time was merely part of a single, continuous event that already had caused other damage.” Newmont Mines, 784 F.2d at 136.

This standard requires the court to examine the proximity and connection of damage by time, location and peril to determine whether a reasonable business insured would consider that the loss arose from a “continuous event or incident.” In Newmont Mines, for example, the Second Circuit affirmed a jury verdict that the collapses of two sections of a roof were not a continuous event or incident because: (i) the two collapses were at least three and potentially seventeen days apart; (ii) the collapses were not connected in any way; (iii) the sections of the roof were structurally independent; (iv) temperature change may have contributed to the second collapse, but not the first; and (v) additional snow may have fallen between the two collapses.

Conclusion

Principals, practitioners and courts deal most effectively with claims and controversies when they pause at the outset to consider the type of insurance at issue. While this factor will not likely affect the answer to some disputes, the outcome on many central issues ' insuring agreements, exclusions, date of loss, and number of occurrences ' will differ as a result of this distinction. Failure to recognize the underlying purpose of the insurance in question can produce outcomes that do not reflect the intentions of the parties and that disrupt the expectations of others entering into such contracts. Fortunately, as the long-standing and growing body of case law reflects, the vast majority of courts recognize, follow and enforce the dispositive differences between first-party and third-party insurance.

Like all contracts, insurance agreements are drafted and entered into in order to carry forward the intentions of the parties. Because parties negotiate first-party property insurance to protect interests that differ fundamentally from those covered by third-party liability insurance, third-party precedent is of limited ' if any ' relevance and utility in interpreting first-party insurance agreements.

Courts broadly recognize the distinct purpose and meaning of first-party insurance. See, e.g., Great Northern Ins. Co. v. Mount Vernon Fire Ins. Co., 708 N.E.2d 167, 170-71 (N.Y. 1999) (“[W]holly different interests are protected by first-party coverage and third-party coverage.”); Garvey v. State Farm Fire & Cas. Co., 770 P.2d 704 (Cal. 1989). At its core, first-party insurance protects insureds against physical loss or damage from external perils ' eg, fire, flood, windstorm, intentional acts ' to their own property. Many commercial first-party contracts also indemnify a business for the loss of profits directly resulting from this insured physical loss or damage. The coverage afforded by this and any similar endorsement or extension is based on the same fundamental first-party principles as underlie the core physical loss insurance. In each case, the first-party insured bears the impact and receives any indemnity that is due.

In contrast, third-party insurance protects insureds from the consequences of their own unintentional conduct damaging the property of others or causing injury to them. The third party bears the impact and receives any indemnity that is due. Most third-party contracts also provide that the insurer will defend or pay expenses incurred to defend the insured against a suit for damages.

The distinct purposes served by these types of coverage give rise to at least two third-party concerns that do not apply to first-party insurance. First, when insureds purchase third-party insurance, their potential liability extends to the rest of the world, making it difficult to assess their probable and maximum exposures. Furthermore, liability depends on changing legal standards, which, as the asbestos experience demonstrates, can greatly expand insureds' exposure in unanticipated ways. This uncertainty does not apply to first-party insurance, where the insured knows at the time of placement the value of the property and other interests it intends to insure. Second, the interpretation of third-party insurance often is influenced by judicial concern with compensation for innocent third parties, a concept sometimes referred to as “public rights.” In contrast, this solicitousness has no place in the interpretation of first-party insurance because the injured insured is a party to the contract who made choices about what to insure and how to insure it. A further distinction stems from the undertaking in most third-party contracts to provide a defense or pay defense expenses. This third-party undertaking often makes the insured and insurer “allies” against the claimant, a relationship foreign to first-party insurance. See Port Auth. of N.Y. & N.J. v. Affiliated FM Ins. Co., 311 F.3d 226, 233 (3d Cir. 2002).

Three illustrations demonstrate how thoughtful courts recognize and enforce the distinction between first-party and third-party insurance.

Physical Loss or Damage

The U.S. Court of Appeals for the 3rd Circuit recently relied on the “time-honored distinction between the two types of insurance coverage” in declining to apply third-party precedent to determine whether first-party property had been damaged. Port Auth. of N.Y. & N.J. v. Affiliated FM Ins. Co., 311 F.3d 226 (3d Cir. 2002). There, the insured sought coverage under first-party policies for the removal of asbestos-containing products, which, it said, were releasing asbestos fibers that circulated throughout its buildings.

The Third Circuit held that there was no first-party physical loss or damage unless the condition rendered the building “uninhabitable and unusable.” The court rejected the insured's proposed standard, which relied on third-party precedent addressing the threat posed by the presence of asbestos. The Third Circuit expressly noted the absence in first-party insurance of any “public interest in compensation for injured third-parties” and the fact that the scope of first-party insurance depends on the insured's “own determination and judgment.” In short, first-party policies insure against physical impacts that materially alter occupancy. They are not “maintenance contracts” subject to interpretation under third-party standards.

Date Of Loss

Courts have applied the same line of reasoning in cases adopting a distinct date of loss for first-party contracts. In Prudential-LMI Commercial Insurance v. Superior Court, 798 P.2d 1230 (Cal. 1990), the California Supreme Court looked to the purposes of first-party insurance and concluded that, where a claim involved subsidence of a building over time, the policy responsible for covering the loss was the policy in effect when the insured discovered the damage. The court relied extensively on the “substantial analytical differences” between first-party and third-party insurance articulated in prior decisions and rejected arguments for the “continuous damage” concept found in third-party precedent. Appellate courts in other states have reached the same conclusion. See, e.g., Winding Hills Condominium Ass'n, Inc. v. North Am. Specialty Ins. Co., 332 N.J. Super. 85 (App. Div. 2000); Jackson v. State Farm Fire & Cas. Co., 835 P.2d 786 (Nev. 1992); Sentinel Mgmt. Co. v. Aetna Cas. & Sur. Co., 1999 WL 540466 (Minn. App. July 27, 1999), aff'd in relevant part , 615 N.W.2d 819 (Minn. 2000).

The discovery standard looks to the existence of material damage and provides a single date of loss at the time the insured knew or should have known of the insured physical loss or damage. This standard follows logically from the nature and purpose of first-party insurance. First, when placing first-party insurance, the insured can reasonably estimate the total value of its property and the exposure it is prepared to leave uninsured. Second, because first-party insurance applies only to the insured's property, the parties know during the policy period what losses have occurred and need to be accounted for in any renewal. The discovery standard thus best fits with this short-tail feature of first-party insurance. Third, compensation of injured third parties is not a concern relevant to this type of insurance.

Number Of Occurrences

The same first-party/third-party distinction applies when determining the number of occurrences ' and hence, the number of deductibles and limits ' presented by a claim. In Newmont Mines Ltd. v. Hanover Insurance Co., 784 F.2d 127 (2d Cir. 1986), the Second Circuit declined to follow third-party occurrence precedent because, “when construing a property damage policy … the business purpose sought to be achieved by the parties is considerably different.” Id. at 136. Insureds purchase third-party insurance to indemnify themselves for the financial consequences of the harm they cause others. It follows then that courts determine the number of occurrences under third-party insurance by looking to the “underlying” conduct that gave rise to the insureds' liability. Id.; Stonewall Ins. Co. v. Asbestos Claims Mgmt. Corp., 73 F.3d 1178, 1213 (2d Cir. 1995) (“[C]ourts should look to the event for which the insured is held liable.”).

This focus on insureds' liability-causing conduct is irrelevant to first-party insurance, which insures against the external peril causing damage to the insured's own property. The first-party occurrence determination therefore focuses on the parties' expectations regarding the circumstances of the loss. An occurrence takes place when insured physical loss or damage “occur[s] unexpectedly and without design, unless the damage occurring at one point in time was merely part of a single, continuous event that already had caused other damage.” Newmont Mines, 784 F.2d at 136.

This standard requires the court to examine the proximity and connection of damage by time, location and peril to determine whether a reasonable business insured would consider that the loss arose from a “continuous event or incident.” In Newmont Mines, for example, the Second Circuit affirmed a jury verdict that the collapses of two sections of a roof were not a continuous event or incident because: (i) the two collapses were at least three and potentially seventeen days apart; (ii) the collapses were not connected in any way; (iii) the sections of the roof were structurally independent; (iv) temperature change may have contributed to the second collapse, but not the first; and (v) additional snow may have fallen between the two collapses.

Conclusion

Principals, practitioners and courts deal most effectively with claims and controversies when they pause at the outset to consider the type of insurance at issue. While this factor will not likely affect the answer to some disputes, the outcome on many central issues ' insuring agreements, exclusions, date of loss, and number of occurrences ' will differ as a result of this distinction. Failure to recognize the underlying purpose of the insurance in question can produce outcomes that do not reflect the intentions of the parties and that disrupt the expectations of others entering into such contracts. Fortunately, as the long-standing and growing body of case law reflects, the vast majority of courts recognize, follow and enforce the dispositive differences between first-party and third-party insurance.