Allocating Costs to Policyholders for Periods of No Insurance

In cases involving insurance coverage for injury or damage that has been held to have taken place over an extended time period, a majority of courts today allocate costs using the pro rata method, which assigns to each policy in effect during the applicable time period the share of costs proportionate to the amount of injury or damage that took place while the policy was in effect.

Pro rata allocation is often predicated on language contained in most general liability policies that limits coverage to injury or damage that takes place during the policy period. As is also consistent with that policy language, courts applying pro rata allocation generally require the policyholder to pay the costs attributable to periods for which it has no insurance coverage, either because it did not purchase any (or not enough), it claims to have purchased insurance but lost the policies, or it purchased insurance from an insurer which subsequently became insolvent.

A few courts, however, do not require the policyholder to pay the costs attributable to periods of injury when coverage for the risk at issue was not available in the insurance market, instead excluding those periods from the total number of years over which costs are allocated. That approach, sometimes called the “unavailability exception,” forces insurers for other policy periods to bear the costs of the periods when no insurance was found to have been available.

The 'Unavailability Exception'

The “unavailability exception” originated with Owens-Illinois, Inc. v. United Insurance Co., 650 A.2d 974 (N.J. 1994), one of the first state supreme court decisions to adopt pro rata allocation. Following a lengthy analysis, the New Jersey Supreme Court concluded that “[a] fair method of allocation appears to be one that is related to both the time on the risk and the degree of risk assumed,” and that “[w]hen periods of no insurance reflect a decision by an actor to assume or retain a risk, as opposed to periods when coverage for a risk is not available, to expect the risk-bearer to share in the allocation is reasonable.” Id. at 995.

The next year, in Stonewall Insurance Co. v. Asbestos Claims Management Corp., 73 F.3d 1178 (2d Cir. 1995), the Second Circuit, citing the latter sentence, agreed that proration to the insured was appropriate “only to oblige a manufacturer to accept a proportionate share of a risk that it elected to assume, either by declining to purchase available insurance or by purchasing what turned out to be an insufficient amount of insurance.” Id. at 1203-04. Over the two decades that have passed since Owens-Illinois and Stonewall were decided, one other state supreme court ' Minnesota's ' has adopted the unavailability exception. Wooddale Builders, Inc. v. Maryland Casualty Co., 722 N.W.2d 283, 297 (Minn. 2006).

The unavailability exception is not tied to policy language. Indeed, it contravenes the very policy language upon which most courts rely to apply pro rata allocation ' i.e., the language that limits coverage to injury or damage that takes place during the policy period ' because it results in the allocation of the costs incurred during the “unavailability” periods to the policies that provide coverage for different time periods, thereby requiring those policies to pay for injury or damage they do not cover. That disconnect between the unavailability exception and the basic principles of contract law underlying pro rata allocation was pointed out by the Seventh Circuit in Sybron Transition Corp. v. Security Insurance of Hartford, 258 F.3d 595 (7th Cir. 2001):

' instead of asking whether Sybron had some kind of insurance, we prefer to ask why it should matter whether Sybron was insured. ' Why would this affect the legal obligations of a firm whose last policy expired in 1971? The whole idea of a time-on-the-risk calculation is that any given insurer's share reflects the ratio of its coverage (and thus the premiums it collected) to the total risk. The full risk is not affected by whether insurance is available later.

* * * *

To require Security to pay extra because Sybron did not find it cost-effective to purchase coverage during 1986 to 1988 would be the economic equivalent of requiring Security to furnish free coverage during 1986-88 ' . Why an underwriter who furnishes low-price coverage during a period before the magnitude of the risk became apparent should be required to furnish, for nothing, an additional period of high-price coverage escapes us.

Id. at 600 (emphasis in original). See also AAA Disposal Systems, Inc. v. Aetna Casualty and Surety Co. , 821 N.E.2d 1278, 1290 (Ill. App. 2005) (noting that “fundamental principles of contract law” preclude “allocat[ing] the damages occurring during the uninsured period to an insurer that did not agree to provide coverage during that time”).

In the States

Recent years have seen a growing number of state supreme courts coming to the same conclusion, and refusing to adopt an unavailability exception. For example, in Boston Gas Co. v. Century Indemnity Co., 910 N.E.2d 290, 315 (Mass. 2009), the Massachusetts Supreme Court explained that to adopt such an exception “would contravene the limitation of coverage in the [defendant insurer's] policies to liability attributable to property damage during the policy periods.” The court agreed with the insurer that “the unavailability exception 'effectively provides insurance where insurers made the calculated decision not to assume risk and not to accept premiums.'” Thereafter, the South Carolina Supreme Court, agreeing with Boston Gas, similarly noted that “the effect” of the unavailability exception “is to shift losses from one policy period to another in order to create coverage where none was purchased.” Crossmann Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Co., 717 S.E.2d 589, 602 n.16 (S.C. 2011).

And in Bradford Oil Co., Inc. v. Stonington Insurance Co., 54 A.3d 983, 991 (Vermont 2011), the Vermont Supreme Court concluded that “the reason for the absence of effective insurance is not determinative” in allocating uninsured periods to the policyholder. Elsewhere, the unavailability exception has been rejected at the trial court level. See Midamerican Energy Co. v. Certain Underwriters at Lloyd's London, 2011 WL 2011374 (Iowa Dist. April 13, 2011) (policyholder was responsible for periods of damage “in which there is no insurance coverage, regardless of the reason that no coverage was obtained or available”; court found that approach to be “most consistent with the contractual genesis” for pro rata allocation).

Nevertheless, there are jurisdictions ' i.e., New Jersey and Minnesota ' where the unavailability exception arguably remains the controlling rule; Stonewall arguably remains authority for the exception under New York law; and the exception was recently applied anew by a Connecticut state trial court (even as that court acknowledged that the state supreme court's decision adopting pro rata allocation did not “specifically reference an 'unavailability of insurance' rule by name”). R.T. Vanderbilt Co., Inc. v. Hartford Accident & Indemnity Co., 2014 WL 1647135 at *7 (Conn. Super. March 28, 2014). Thus, the exception continues to be a factor in allocation disputes ' despite the fact that, as Sybron, Boston Gas, and Crossman collectively explain, the exception forces an insurer to cover a risk it not only did not assume, but “made the calculated decision” not to assume; forces the insurer to do so for free, when it “made the calculated decision” not to accept premiums; and, in short, “create[s] coverage where none was purchased.”

Public Policy

The stated rationale for the unavailability exception focuses on public policy considerations. The New Jersey Supreme Court in Owens-Illinois, “unable to find the answer to allocation in the language of the policies” and finding “the usual rules of interpretation” to be “less helpful in this context,” expressly turned to “public interest factors” for guidance in determining an allocation methodology. One such factor that the court identified was “the extent to which our decision will make the most efficient use of the resources available to cope with environmental disease or damage.” 650 A.2d 990, 992. The court felt that its decision should “provide incentives that parties should engage in responsible conduct that will increase, not decrease, available resources,” id. at 472, and one such course of “responsible conduct” that the court felt it should incentivize was the purchase of insurance: Because insurance companies can spread costs throughout an industry and thus achieve cost efficiency, the law should, at a minimum, not provide disincentives to parties to acquire insurance when available to cover their risks. Spreading the risk is conceptually more efficient.” Id.' at 992 (emphasis added).

That was the context in which New Jersey Supreme Court concluded that, “[w]hen periods of no insurance reflect a decision by an actor to assume or retain a risk, as opposed to periods when coverage for a risk is not available, to expect the risk-bearer to share in the allocation is reasonable.” Id. at 995.

Understood in the Owens-Illinois context in which it arose, therefore, the unavailability exception should apply ' if at all ' only in the narrow situation where no coverage of any kind for the subject risk is available in the insurance market. An actor cannot be incentivized to purchase coverage which is not available to be purchased; so in that situation, according to the rationale of the Owens-Illinois court, it is not “reasonable” to require the risk-bearer to share in the allocation. Clearly, that rationale does not apply in the various other situations ' e.g., highly priced premiums, exclusions from coverage, or allegedly misplaced policies ' that can give rise to periods of no insurance, even if such circumstances might conceivably be characterized as rendering insurance “unavailable.” Therefore, the unavailability exception envisioned by the Owens-Illinois court does not apply in those situations. Not surprisingly, however, that has not stopped policyholders from arguing that insurance “unavailability” precludes allocation to them in those situations as well.

Confronted with policyholder arguments along those lines, the Second Circuit limited the scope of the unavailability exception five years after Stonewall, in Olin Corp. v. Insurance Company of North America, 221 F.3d 307 (2d Cir. 2000). In Olin, an environmental coverage case, the policyholder argued that coverage became “unavailable” after the point at which it could no longer obtain comprehensive general liability insurance without a pollution exclusion, and further, that it did not subjectively “elect” to be self-insured during those periods. According to the court, however, the evidence demonstrated that a “new type of insurance” became available “to fill the void created by the unavailability of CGL policies without pollution exclusion clauses” during the periods at issue, i.e., claims-made environmental impairment liability (EIL) insurance, and the policyholder failed to purchase it.

We continue discussion of the Olin court's reasoning in next month's issue.

Elaine A. Panagakos is Counsel in Crowell & Moring LLP's Insurance and Reinsurance Group.

In cases involving insurance coverage for injury or damage that has been held to have taken place over an extended time period, a majority of courts today allocate costs using the pro rata method, which assigns to each policy in effect during the applicable time period the share of costs proportionate to the amount of injury or damage that took place while the policy was in effect.

Pro rata allocation is often predicated on language contained in most general liability policies that limits coverage to injury or damage that takes place during the policy period. As is also consistent with that policy language, courts applying pro rata allocation generally require the policyholder to pay the costs attributable to periods for which it has no insurance coverage, either because it did not purchase any (or not enough), it claims to have purchased insurance but lost the policies, or it purchased insurance from an insurer which subsequently became insolvent.

A few courts, however, do not require the policyholder to pay the costs attributable to periods of injury when coverage for the risk at issue was not available in the insurance market, instead excluding those periods from the total number of years over which costs are allocated. That approach, sometimes called the “unavailability exception,” forces insurers for other policy periods to bear the costs of the periods when no insurance was found to have been available.

The 'Unavailability Exception'

The “unavailability exception” originated with Owens-Illinois, Inc. v. United Insurance Co. , 650 A.2d 974 (N.J. 1994), one of the first state supreme court decisions to adopt pro rata allocation. Following a lengthy analysis, the New Jersey Supreme Court concluded that “[a] fair method of allocation appears to be one that is related to both the time on the risk and the degree of risk assumed,” and that “[w]hen periods of no insurance reflect a decision by an actor to assume or retain a risk, as opposed to periods when coverage for a risk is not available, to expect the risk-bearer to share in the allocation is reasonable.” Id. at 995.

The next year, in Stonewall Insurance Co. v. Asbestos Claims Management Corp. , 73 F.3d 1178 (2d Cir. 1995), the Second Circuit, citing the latter sentence, agreed that proration to the insured was appropriate “only to oblige a manufacturer to accept a proportionate share of a risk that it elected to assume, either by declining to purchase available insurance or by purchasing what turned out to be an insufficient amount of insurance.” Id . at 1203-04. Over the two decades that have passed since Owens-Illinois and Stonewall were decided, one other state supreme court ' Minnesota's ' has adopted the unavailability exception. Wooddale Builders, Inc. v. Maryland Casualty Co. , 722 N.W.2d 283, 297 (Minn. 2006).

The unavailability exception is not tied to policy language. Indeed, it contravenes the very policy language upon which most courts rely to apply pro rata allocation ' i.e., the language that limits coverage to injury or damage that takes place during the policy period ' because it results in the allocation of the costs incurred during the “unavailability” periods to the policies that provide coverage for different time periods, thereby requiring those policies to pay for injury or damage they do not cover. That disconnect between the unavailability exception and the basic principles of contract law underlying pro rata allocation was pointed out by the Seventh Circuit in Sybron Transition Corp. v. Security Insurance of Hartford , 258 F.3d 595 (7th Cir. 2001):

' instead of asking whether Sybron had some kind of insurance, we prefer to ask why it should matter whether Sybron was insured. ' Why would this affect the legal obligations of a firm whose last policy expired in 1971? The whole idea of a time-on-the-risk calculation is that any given insurer's share reflects the ratio of its coverage (and thus the premiums it collected) to the total risk. The full risk is not affected by whether insurance is available later.

* * * *

To require Security to pay extra because Sybron did not find it cost-effective to purchase coverage during 1986 to 1988 would be the economic equivalent of requiring Security to furnish free coverage during 1986-88 ' . Why an underwriter who furnishes low-price coverage during a period before the magnitude of the risk became apparent should be required to furnish, for nothing, an additional period of high-price coverage escapes us.

Id. at 600 (emphasis in original). See also AAA Disposal Systems, Inc. v. Aetna Casualty and Surety Co. , 821 N.E.2d 1278, 1290 (Ill. App. 2005) (noting that “fundamental principles of contract law” preclude “allocat[ing] the damages occurring during the uninsured period to an insurer that did not agree to provide coverage during that time”).

In the States

Recent years have seen a growing number of state supreme courts coming to the same conclusion, and refusing to adopt an unavailability exception. For example, in Boston Gas Co. v. Century Indemnity Co. , 910 N.E.2d 290, 315 (Mass. 2009), the Massachusetts Supreme Court explained that to adopt such an exception “would contravene the limitation of coverage in the [defendant insurer's] policies to liability attributable to property damage during the policy periods.” The court agreed with the insurer that “the unavailability exception 'effectively provides insurance where insurers made the calculated decision not to assume risk and not to accept premiums.'” Thereafter, the South Carolina Supreme Court, agreeing with Boston Gas , similarly noted that “the effect” of the unavailability exception “is to shift losses from one policy period to another in order to create coverage where none was purchased.” Crossmann Communities of North Carolina, Inc. v. Harleysville Mutual Insurance Co. , 717 S.E.2d 589, 602 n.16 (S.C. 2011).

And in Bradford Oil Co., Inc. v. Stonington Insurance Co. , 54 A.3d 983, 991 (Vermont 2011), the Vermont Supreme Court concluded that “the reason for the absence of effective insurance is not determinative” in allocating uninsured periods to the policyholder. Elsewhere, the unavailability exception has been rejected at the trial court level. See Midamerican Energy Co. v. Certain Underwriters at Lloyd's London, 2011 WL 2011374 (Iowa Dist. April 13, 2011) (policyholder was responsible for periods of damage “in which there is no insurance coverage, regardless of the reason that no coverage was obtained or available”; court found that approach to be “most consistent with the contractual genesis” for pro rata allocation).

Nevertheless, there are jurisdictions ' i.e., New Jersey and Minnesota ' where the unavailability exception arguably remains the controlling rule; Stonewall arguably remains authority for the exception under New York law; and the exception was recently applied anew by a Connecticut state trial court (even as that court acknowledged that the state supreme court's decision adopting pro rata allocation did not “specifically reference an 'unavailability of insurance' rule by name”). R.T. Vanderbilt Co., Inc. v. Hartford Accident & Indemnity Co., 2014 WL 1647135 at *7 (Conn. Super. March 28, 2014). Thus, the exception continues to be a factor in allocation disputes ' despite the fact that, as Sybron, Boston Gas, and Crossman collectively explain, the exception forces an insurer to cover a risk it not only did not assume, but “made the calculated decision” not to assume; forces the insurer to do so for free, when it “made the calculated decision” not to accept premiums; and, in short, “create[s] coverage where none was purchased.”

Public Policy

The stated rationale for the unavailability exception focuses on public policy considerations. The New Jersey Supreme Court in Owens-Illinois, “unable to find the answer to allocation in the language of the policies” and finding “the usual rules of interpretation” to be “less helpful in this context,” expressly turned to “public interest factors” for guidance in determining an allocation methodology. One such factor that the court identified was “the extent to which our decision will make the most efficient use of the resources available to cope with environmental disease or damage.” 650 A.2d 990, 992. The court felt that its decision should “provide incentives that parties should engage in responsible conduct that will increase, not decrease, available resources,” id. at 472, and one such course of “responsible conduct” that the court felt it should incentivize was the purchase of insurance: Because insurance companies can spread costs throughout an industry and thus achieve cost efficiency, the law should, at a minimum, not provide disincentives to parties to acquire insurance when available to cover their risks. Spreading the risk is conceptually more efficient.” Id.' at 992 (emphasis added).

That was the context in which New Jersey Supreme Court concluded that, “[w]hen periods of no insurance reflect a decision by an actor to assume or retain a risk, as opposed to periods when coverage for a risk is not available, to expect the risk-bearer to share in the allocation is reasonable.” Id. at 995.

Understood in the Owens-Illinois context in which it arose, therefore, the unavailability exception should apply ' if at all ' only in the narrow situation where no coverage of any kind for the subject risk is available in the insurance market. An actor cannot be incentivized to purchase coverage which is not available to be purchased; so in that situation, according to the rationale of the Owens-Illinois court, it is not “reasonable” to require the risk-bearer to share in the allocation. Clearly, that rationale does not apply in the various other situations ' e.g., highly priced premiums, exclusions from coverage, or allegedly misplaced policies ' that can give rise to periods of no insurance, even if such circumstances might conceivably be characterized as rendering insurance “unavailable.” Therefore, the unavailability exception envisioned by the Owens-Illinois court does not apply in those situations. Not surprisingly, however, that has not stopped policyholders from arguing that insurance “unavailability” precludes allocation to them in those situations as well.

Confronted with policyholder arguments along those lines, the Second Circuit limited the scope of the unavailability exception five years after Stonewall , in Olin Corp. v. Insurance Company of North America , 221 F.3d 307 (2d Cir. 2000). In Olin, an environmental coverage case, the policyholder argued that coverage became “unavailable” after the point at which it could no longer obtain comprehensive general liability insurance without a pollution exclusion, and further, that it did not subjectively “elect” to be self-insured during those periods. According to the court, however, the evidence demonstrated that a “new type of insurance” became available “to fill the void created by the unavailability of CGL policies without pollution exclusion clauses” during the periods at issue, i.e., claims-made environmental impairment liability (EIL) insurance, and the policyholder failed to purchase it.

We continue discussion of the Olin court's reasoning in next month's issue.

Elaine A. Panagakos is Counsel in Crowell & Moring LLP's Insurance and Reinsurance Group.