VI. The Duty To Disclose Insurance Coverage

VI. The Duty To Disclose Insurance Coverage

Insurance companies have an affirmative duty to disclose information regarding coverage to their policyholders. The duty to disclose is widely recognized as a component of an insurance company's duty of good faith and fair dealing. This duty is often systematically violated by insurance companies which seek to conceal, rather than disclose, coverage for insurance claims.

A. Insurance Companies Have A Duty To Disclose Insurance Coverage To Their Policyholders

The duty to disclose information is premised on an insurance company's responsibility to look for coverage, not ways to deny coverage:

A trier of fact may find that an insurer acted unreasonably if the insurer ignores evidence available to it which supports the claim. The insurer may not just focus on those facts which justify denial of a claim.

A leading insurance professor has argued that the duty to disclose insurance coverage is only one of several elements comprising an insurance company's obligations to its policyholders:

Following notification of an occurrence, I believe an insurer is obligated to disclose all applicable benefits, or to clearly inform insureds about the existence of rights and duties regarding all coverages, or to explain why the insurance benefits will not be paid in order to (a) fulfill the insurer's contractual commitment, (b) comply with the obligation--implied as a matter of law in all contracts--to deal fairly and in good faith, (c) protect the insured's reasonable expectations, and (d) avoid omissions that could constitute fraudulent misrepresentation.

This last theoretical foundation--the doctrine of fraudulent misrepresentation--illustrates the way in which the courts have viewed the duty to disclose as an affirmative duty. If an insurance company fails to disclose information which might have assisted the policyholder in securing coverage, the insurance company's omission may constitute an actionable misrepresentation.

An insurance company may breach its duty to disclose where it learns of a claim, determines that the policyholder may be entitled to coverage, but nevertheless fails to inform the policyholder of this potential for coverage. Such behavior may be characterized as a breach of contract because "[i]nvestigation, fair evaluation, and prompt rejection or settlement constitute `performances' that are `the essence of what the insured has bargained and paid for....'"

In the landmark decision of Dercoli v. Pennsylvania National Mutual Insurance Company, the Supreme Court of Pennsylvania held that "the duty of an insurance company to deal with the insured fairly and in good faith includes the duty of full and complete disclosure as to all of the benefits and every coverage that is provided by the applicable policy or policies along with all requirements, including any time limitations for making a claim."

In one case cited by the Dercoli court, Gatlin v. Tennessee Farmers Mutual Insurance Company, Tennessee Farmers Mutual Insurance Company ("Farmers Mutual") issued policies to each automobile involved in a two-car collision. M. Annette Gatlin, one of the drivers, was injured in the accident. She filed suit against the other driver, James K. Williams. When she discovered that her settlement demand was in excess of the limits of the policy held by Williams, she turned to Farmers Mutual for coverage her own uninsured motorist insurance. Farmers Mutual refused to pay for the reason, among others, that Gatlin's notice of claim was untimely. Reversing an appellate state court decision, the Tennessee Supreme Court held that the late-notice defense was without merit. The court noted that Farmers Mutual "was an active participant in all phases of this case," and that the insurance company "had liability insurance coverage on both automobiles." The duty of good faith and fair dealing required Farmers Mutual to disclose information regarding what Gatlin had to do to secure coverage:

[A]n insurer has the duty to deal with its insured "fairly and in good faith." This includes informing an insured as to coverage and policy requirements when (1) it is apparent to the insurer that there is a strong likelihood that its insured only can be compensated fully under her own policy and (2) that the insured has no basis to believe that she must rely upon her policy for coverage."

In Bowler v. Fidelity & Casualty Co., the New Jersey Supreme Court held that an insurance company was estopped from asserting a statute of limitations defense because the company had breached its duty to inform the policyholder of the steps it needed to take to secure coverage. The court characterized an insurance company's duty to disclose as a "contractual undertaking":

In situations where a layman might give the controlling language of the policy a more restrictive interpretation than the insurer knows the courts have given it and as a result the uninformed insured might be inclined to be quiescent about the disregard or nonpayment of his claim and not to press it in a timely fashion, the company cannot ignore its obligation. It cannot hide behind the insurer's ignorance of the law; it cannot conceal its liability. In these circumstances it has the duty to speak and disclose, and to act in accordance with its contractual undertaking. The slightest evidence of deception or overreaching will bar reliance upon time limitations for prosecution of the claim.

In Bowler, the policyholder endured serious fractures to his leg, and eventually developed osteomyelitis, a serious bone infection. As a result of this condition, the policyholder was disabled. The insurance company was obligated to pay the policyholder weekly indemnity payments for up to 199 weeks of disability. Assuming that the policyholder was deemed permanently disabled by the 200th week, the insurance company was then obligated to make a final weekly payment and a lump sum payment equal to 600 weeks. Shortly before the 200th week, the policyholder was examined by his own doctor and a doctor assigned by the insurance company. The doctor reports both found that the policyholder was disabled within the meaning of the policy. The insurance company sent the policyholder a number of forms to complete. The policyholder returned the forms, but never heard again from the insurance company. More than six years later, the policyholder filed suit against the insurance company. In litigation, the insurance company took the position that coverage was barred on the basis of the statute of limitations. The New Jersey Supreme Court found the insurance company's behavior to be "shocking and unconscionable." The court noted:

Instead of fulfilling its contractual obligations, the company lapsed into silence.... Bowler, a layman obviously not versed in insurance law took no legal action until in some manner, not explained in the present record, he got into the hands of an attorney, and this suit was brought--more than six years after the end of the 200 week total disability period. When this was done, the insurer pleaded the six-year statute of limitations, N.J.S. 2A:14-1 as a bar. We regard such treatment of its policyholder as shocking and unconscionable.

The court added that when there is doubt regarding coverage, the insurance company is obligated to inform its policyholder of the precise steps it must take to secure coverage:

[I]f the insurer has factual information in its possession substantially supporting the policyholder's rights to benefits, but it has a reasonable doubt as to whether the evidence is sufficient to require payment, the obligation to exercise good faith, upon which it knows or should know the insured is relying, cannot be satisfied by silence or inaction. It must notify the insured of its decision not to pay his claim. But mere naked rejection would not be sufficient. The giving of such notice should be accompanied by a full and fair statement of the reasons for its decision not to pay the benefits, and by a clear statement that if the insured wished to enforce his claim it will be necessary from him to obtain the services of an attorney and institute a court action within the appropriate time. The "appropriate time" means the time remaining under the policy or the applicable statute of limitations within which the suit must be brought. Failure on the insurer's part to follow such a course will bar reliance on the statute of limitations or a time restriction on court action expressed in the policy.

B. The Reasonable Expectations Doctrine

In a 1970 law review article, Professor Robert E. Keeton recognized a broad principle underlying the "congeries of doctrines" which make up the rules of insurance policy interpretation. He identified the principle as follows:

"The objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations."

The reasonable expectations doctrine, an outgrowth of modern contract theory, is based in part on the understanding that most policyholders do not draft, negotiate, or assent to the specific provisions in standard-form insurance policies. As many commentators have noted, most policyholders do not see their policies until after they have purchased coverage; and after they receive the policies, most policyholders do not read them. In most cases, if the policyholder has assented to anything, it is only to the general scope or type of insurance coverage provided by the policy, the premium, or the amount of the policy limits. By honoring the policyholder's reasonable expectations, the court recognizes that which was actually bargained for or negotiated.

The reasonable expectations doctrine offers an attractive alternative theory upon which to base the duty to disclose. In many jurisdictions, the express language of the policy need not provide in literal terms what the policyholder has come to reasonably expect. One such expectation, argues Widiss, is that the insurance company "will respond by clearly specifying what the insured must do to initiate a claim and, when those actions are taken, will then either pay those benefits or explain why insurance benefits will not be paid."

While Widiss cites no cases directly on point, he quotes Rawlings v. Apodaca, in which the Arizona Supreme Court held "that one of the benefits that flow from the insurance contract is the insured's expectation that his insurance company will not wrongfully deprive him of the very security for which he bargained." In Apodaca, the insurance company issued a policy covering Rawlings, the victim of a negligent fire. The policy insured only a small portion of the losses. The insurance company failed to disclose that it had also issued a policy to the perpetrator of the fire. The court found that the insurance company's willful failure to disclose this information not only violated the policyholder's reasonable expectations of coverage, but also constituted a breach of the duty of good faith and fair dealing.

The reasonable expectations doctrine probably arose from the tensions between tort law and contract law. Remedies for breach of contract are quite limited, while tort law provides a broader array of damages. When Professor (now Judge) Keeton wrote his famous articles, there were few remedies for opportunistic breach of contract. Contract law is in evolution.

C. Fraudulent Misrepresentation

A fraudulent misrepresentation may be a falsehood or a "lie of omission." "A representation need not be an affirmative misstatement; it can arise as easily from a failure to disclose facts."

If an insurance company fails to disclose information which might have assisted the policyholder in securing coverage, the insurance company's omission may constitute an actionable misrepresentation. In Weber v. State Farm Mut. Automobile Insurance, the insurance company made indemnity payments to the claimant based on the claimant's automobile insurance policy but failed to disclose that there was also coverage available under the uninsured motorist coverage. The court granted the claimant's summary judgment motion "to the extent that in connection with the fraudulent nondisclosure claim the defendant was under a duty to exercise reasonable care to disclose the uninsured motorist coverage provisions of the policy."

D. Insurance Company Defenses to Claims Alleging Breach of the Duty to Disclose

Insurance companies generally argue that the duty to disclose is limited to cases in which (a) the insurance company was on notice that the policyholder was unaware of potential coverage, and (2) where the policyholder solely relied upon the advice of the insurance company, and was not represented by an attorney. Neither of these defenses is supported by the caselaw.

E. The Insurance Company Must Disclose Insurance Coverage Even When The Policyholder Believes There is None

Q. It is also correct that an insurance company should fully disclose all important facts related to an insurance policy [to] the policyholder?

A. They should.

Q. An insurance company should always tell the truth to the policyholder?

A. They should.

So testified the insurance company district manager in Foremost Insurance Company v. Parnham. The Alabama Supreme Court held:

[A] duty does arise on the part of an insurer to disclose the existence of a specific coverage under the policy when, as shown by the evidence in this case, the insurer has specific knowledge that a significant number of customers may not want or have a need for the coverage and that the coverage could be dropped with a corresponding savings in premium to the customer.

The breadth of the duty to disclose coverage is illustrated by Travelers' briefs in the case of Travelers Insurance Co. v. Buffalo Reinsurance Co. Travelers sued its reinsurers to recover $9,000,000 of losses paid in hundreds of property damage claims against its policyholder, Koppers Company, Inc. The losses arose from premature failures of Koppers' "KMM" roofing system. In March 1984, representatives for Koppers met with a team of professionals from Travelers' claims and engineering department to discuss the claims. During that meeting, Koppers assumed that the losses were not covered for a variety of reasons -- including an erroneous view of exclusions and deductibles in the policy. In the face of the reinsurers' argument that Travelers should not have provided coverage where the policyholder itself did not believe there was coverage, Travelers responded that "it was bound by ethical claims-handling practices to apprise its insured . . . that indemnity coverage might exist." Travelers reiterated the point:

Reinsurers argue that they were prejudiced by Travelers' decision to provide coverage at all, notwithstanding that Koppers had never claimed that coverage existed. [citation omitted]. However, once Travelers receives notice of claims that are potentially covered under its policies -- even where the insured may not recognize that coverage is available -- Travelers had an ethical obligation to advise its insured.

F. Insurance Companies Have An Affirmative Duty To Come Forward And Disclose Insurance Coverage

Insurance companies have a duty to tell their policyholders --and the courts-- of their own positions favoring coverage. Support for this proposition is found in the Restatement (2nd) of Contracts. Comment (e) of Section 205 of the Restatement (2nd) of Contracts (1981) states:

(e) Good Faith in Enforcement. The obligation of good faith and fair dealing extends to the assertion, settlement in litigation of contract claims and offenses. See, e.g., §§ 73, 89. The obligation is violated by dishonest conduct such as conjuring up a pretended dispute, asserting an interpretation contrary to one's own understanding, or falsification of facts.

Aetna Casualty and Surety Company has argued that this provision precludes a party from arguing a position contrary to its pre-litigation understanding.

The obligation of good faith and fair dealing is very basic; it is an obligation to be fair and honest. The RESTATEMENT is clear in stating that it is unfair and dishonest for a party seeking enforcement of a contract to assert an interpretation that is contrary to that party's pre-enforcement understanding. Whether the asserted interpretation is supported by evolving case law, learned treatises, or other authorities is irrelevant to the fundamental issues of fairness and honesty. A party cannot fairly or honestly use the benefit of 20/20 hindsight to excuse the unconscionability of asserting an argument that is entirely inconsistent with the actual fact of its own understanding of a contract. The violation of the covenant of good faith and fair dealing comes not from claiming "the benefit of legal rulings from" the courts, but from the basic unfairness and dishonesty inherent in a contracting party's assertion of a legal position contrary to its factual understanding. It is just not right.

Under these principles, insurance companies should advise policyholders of their positions favoring coverage. Because the duty to disclose coverage is based upon the covenant of good faith and fair dealing, insurance companies that fail to disclose their prior positions favoring coverage subject themselves to bad faith liability.

BAD FAITH IN INSURANCE COVERAGE DISPUTES AND THE PUBLIC NATURE OF INSURANCE -- UNDERSTANDING THE RECOVERY TOOLS AVAILABLE TO POLICYHOLDERS

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last modified Dec 29, 2003 / 12:53 AM, GMT