As a continuation of our post series that incudes content of ALI drafts, we now include Section 42 – Allocation in Long-Tail Harm Claims Covered by Occurrence-Based Policies.   Due to the length of the Section, full black letter and the first paragraph of each comment section are included below.  If you are interested in a complete copy of the black letter and comments from this section, please contact us.

Black Letter and Comment from Proposed Final Draft:

§ 42. Allocation in Long-Tail Harm Claims Covered by Occurrence-Based Policies

(1) Except as stated in subsection (2), when indivisible harm occurs over multiple years, the amount of any judgment entered in or settlement of any liability action arising out of that harm is subject to pro rata allocation as follows:

(a) For purposes of determining the share allocated to any occurrence-based liability insurance policy that is triggered by harm during the policy period, the amount of the judgment or settlement is allocated equally across years, beginning with the first year in which the harm occurred and ending with the last year in which the harm would trigger an occurrence-based liability insurance policy; and 

(b) An insurer’s obligation to pay for that pro rata share is subject to the ordinary rules governing any deductible, self-insured retention, policy limit, or exhaustion terms in the policy.

(2) When an insurance policy contains a term that alters the default rule stated in subsection (1), that term will be given effect, except to the extent that the term cannot be harmonized with an allocation term in another policy that provides coverage for the claim.

(3) Defense obligations relating to multiple triggered policies are subject to the rules in § 20.

Comment:

a. The special case of long-tail harm. Liability claims for long-tail harm present difficult issues of contract interpretation and application for occurrence-based commercial general-liability (“CGL”) insurance policies as well as for other similarly worded insurance policies. As discussed in Comment f of § 33, the term “long-tail harm” describes indivisible harm, whether bodily injury or property damage, that is attributable to continuous or repeated exposure over time to the same or similar substances or conditions or that has a long latency period.

b. Divisible harm. The rule in this Section addresses allocation in liability claims involving indivisible harm. For liability claims involving divisible harm, courts generally will attempt to allocate among the policy periods according to the actual injury or harm that occurred during the policy period even if the total harm occurred over a long period of time. For example, in some toxic-tort cases, courts have allocated harm among policy periods and thus among multiple triggered insurers based on the relative amount of harm that occurred, or the relative volume of the injuring substance that was released, in each period.

c. Theories of allocation for long-tail harms. Once the trigger question has been decided in a long-tail harm claim (see § 33, Comment f), the question arises how to allocate the amount of any settlements or judgments arising out of that claim among the triggered policies and, to the extent the insured does not have coverage for part of the triggered period, to the insured. Courts have developed two general approaches to this allocation question when applying occurrence-based liability insurance policies: the “all sums” approach and the “pro rata” approach. Under the all-sums approach, the insured may recover from any of the triggered policies for the full amount of that policy’s coverage limits. The insurance case law uses the term “all sums” to refer to this approach because one of the justifications commonly provided for this approach is the presence of the words “all sums” in the insuring agreement of the version of the standard commercial general-liability insurance policy at issue in the cases that have adopted this approach. The contrary, pro rata approach adopted as the default rule in this Section is sometimes referred to as the pro rata by years or “time on the risk” approach. Under this method of allocation, courts allocate the amounts paid to claimants in long-tail liability actions equally across all triggered years, beginning with the first year in which harm occurred and ending with the last year in which harm triggered an occurrence-based policy, including years for which the insured does not have liability insurance coverage.

d. Pro rata versus all sums as a matter of interpretation. The split of authority regarding the allocation rule reflects the fact that the liability risks presented by the rise of mass toxic-tort suits and environmental-cleanup and property-damage causes of action were not adequately anticipated and addressed in the standard commercial general-liability (CGL) insurance policies sold before the nature and extent of those risks became apparent in the 1980s. A careful assessment of the relevant policy language in those earlier policies must acknowledge that the language is susceptible to both pro rata and all-sums interpretations. The earliest edition of the occurrence form of the CGL provides that the insurer will pay “all sums that the policyholder shall become legally obligated to pay as damages because of bodily injury or property damage to which the insurance applies caused by an occurrence.” The term “occurrence” is then defined to mean “an accident, including injurious exposure to conditions, which results, during the policy period, in bodily injury or property damage.” In later versions of the CGL, the language regarding bodily injury or property damage during the policy period was moved out of the definition of occurrence, first into the bodily-injury and property-damage definitions and then into the insuring agreement.

e. The expectations argument in favor of pro rata. Proponents of the pro rata rule contend that to hold an insurer that issued a policy to cover one year responsible for harms that are statistically certain to have occurred in other years not only runs counter to the language of the policy but also conflicts with commonsense expectations regarding the difference between buying and not buying insurance. A policyholder who does not buy insurance for liability attributable to harm that occurs during a given period should bear greater financial responsibility for harm that in fact occurs during that period than a policyholder who does buy insurance for that liability. This argument can be seen in a simple hypothetical example. Insured A purchases a CGL policy with $1 million coverage limits in each of years one through five and does not purchase a CGL policy in years six through 10. Insured B purchases a CGL policy with $1 million coverage limits in each of years one through 10. Both Insured A and Insured B experience a liability claim totaling $5 million that results from continuous exposure to a long-tail harm over years one through 10. Under the most common all-sums approach, which includes stacking, both Insured A and Insured B would have, in effect, the same amount of coverage for the $5 million claim. Under the pro rata by years approach, however, the amount of coverage would be different: Insured A would have a total of $2.5 million of coverage, which results from $5 million of damages allocated over 10 years of exposure ($500,000 per year) times five years of coverage. Insured B would have a total of $5 million of coverage for the $5 million claim. The pro rata by years result makes the amount of total insurance coverage provided to the insureds over a given period of time a function of the number of years in which coverage was purchased.

f. The extrinsic evidence in favor of the all-sums approach. All-sums proponents contend that the available extrinsic evidence supports their approach. Specifically, based on records from the drafting history of the earlier standard CGL forms, as well as statements made by industry representatives who were involved in the drafting process, they contend that (a) the insurance industry itself interpreted the language in the pre-1986 CGL forms consistently with the all-sums-with-stacking approach and (b) the industry considered several explicit allocation terms that were consistent with the pro rata approach and ultimately rejected them. On that basis, they contend that it is reasonable to interpret the drafting history as supporting the conclusion that the insurance industry acknowledged and accepted, or at least acquiesced in, the all-sums interpretation of the pre-1986 standard form CGL insuring agreement.

g. Pro rata by limits and the unavailability rule. A few courts have adopted a pro rata by limits rule, which is a common formula used for contribution among insurers in the context of concurrently overlapping policies with no or conflicting other-insurance clauses. See § 43, Comment b. The pro rata by limits rule differs from the ordinary pro rata by years rule in two respects. First, the pro rata by limits approach uses policy limits in the calculation of the amount allocable to each of the relevant years, so that more of the indemnity obligation is allocated to policies with higher limits. Second, the pro rata by limits approach allocates long-tail losses to uninsured years only to the extent that the policyholder intentionally opted not to purchase coverage that was available—and then only to the extent of that available coverage. This second aspect of the pro rata by limits approach is sometimes called the “unavailability rule.”

h. Exhaustion, deductibles, SIRs, and settlement. In addition to the issues of trigger and allocation, long-tail-harm claims raise related issues such as the application of deductibles, self-insured retentions (SIRs), exhaustion, and the effect of settlements. The pro rata by years rule addresses each of these issues in a more straightforward and easier to administer manner than the all-sums rule. Long-tail harms are allocated to each policy period as if the pro rata portion of the loss occurred in each triggered year, with the application of deductible, SIR, policy-limit, and exhaustion provisions following the usual course without the need for any special rules for the long-tail-harm situation. As soon as one policy in a given year is exhausted, the next-level policy takes over for the remaining portion of the liability allocated to that year, and so on, until that tower of insurance is exhausted, at which point the insured is financially responsible for losses allocated to that policy period. This is a form of “horizontal exhaustion,” which is the majority approach to exhaustion in pro rata by years jurisdictions. Under the all-sums approach, by contrast, insureds exhaust the coverage available in one year using a “vertical-exhaustion” approach before accessing the coverage available in another year, once again requiring all of the insurers that have not yet exhausted to track the payments. Moreover, vertical exhaustion under the all-sums approach puts some excess insurers in the position of paying long before primary insurers, which is inconsistent with the pricing of excess and primary coverage. One of the benefits of the pro rata allocation approach is that it avoids these problems as well.

i. Other-insurance clauses. While some pro rata proponents have suggested, and a few courts have agreed, that the other-insurance clauses found in most CGL policies should be understood as a sort of allocation provision for the long-tail-harm situation, the majority of courts that have addressed the question conclude that such other-insurance clauses address a different situation: namely, the situation in which multiple insurance policies issued during the same policy period cover the same insured concurrently for a given loss. See § 41, Comment c.

j. Opting out of the default rule. The default rule of pro rata allocation can be altered by contractual terms that provide an alternative method of allocation or priority. For example, if an insurance policy contains a term that clearly specifies the all-sums approach to allocation (perhaps by eliminating the “during the policy period” language), such a term will be enforced. However, if such allocation terms conflict with each other, courts should apply the pro rata method of allocation as a matter of public policy. For example, if multiple policies contain allocation terms that purport to apply to the long-tail-claim situation and that amount to escape clauses, such terms should not be enforced. Rather, the pro rata default rule should apply in such situations. This result is analogous to how courts have interpreted other-insurance clauses. See § 41, Comments d and e.

Kyle D. Logue

Associate Reporter, Liability Insurance Restatement

Kyle D. Logue is the Wade H. McCree and Dores M. McCree Collegiate Professor of Law at The University of Michigan Law School. He teaches and writes in the fields of insurance, torts, tax, and law and economics. In 201, he was awarded the Liberty Mutual Prize for the outstanding paper in the area of property and casualty insurance law.

Tom Baker

Reporter, Liability Insurance Restatement

Tom Baker is the William Maul Measey Professor of Law and Health Sciences at Penn Law.   A preeminent scholar in insurance law, he explores insurance, risk, and responsibility using methods and perspectives drawn from economics, sociology, psychology, and history.

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