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Managing Risk: A Closer Look at Liability Insurance

Risk is a part of everyone's life. Driving a car for example involves the risk of being hurt in a wreck. Some risks are understood and accepted - like driving a car - while others are less visible. Regardless of the type of risk, people are always looking for a way to manage the impact of these risks on themselves. Liability insurance is a common method for reducing the risk of being held financially responsible for any injuries caused to another person by an individual or corporate entity. Liability insurance is everywhere in most western countries - especially the United State. This paper examines several different types of liability insurance, looks at what happens when an insurance company fails to uphold their contractual obligations in good faith, and concludes with a discussion of the alternative public insurance model utilized by several Canadian provinces to insure automobiles.

Liability Insurance

Liability insurance is an insurance product that covers financial liability which may arise through negligence or other wrongful acts by a person or corporate entity (Guria 2007, 5). Liability insurance is distinguished from similar no-fault insurance in that the insurer will only provide payment if it is proven that the insured was at fault and therefore liable for the damages cause (Guria 2007, 6 &15; Oregon DCBS 2013). There are three broad categories of liability insurance: public liability insurance, product liability insurance, and employer liability insurance. Each of these broad categories contain various subcategories which are discussed in greater length below.

Public liability insurance is designed to shield companies from liability resulting from injuries to a third party - not an employee or volunteer (New South Wales 2010). It is referred to as public liability insurance because it is commonly used in situations where an individual or company is liable for injuries suffered by a member of the general public. One of the most common types of public insurance is a Commercial General Liability (CGL) policy which covers any liability up to a set amount - typically around $1,000,000 (O'Connor & Swenson 1997, 18). Many public venues such as amusement parks are required by local or state law to carry this type of liability insurance in order to operate (O'Connor & Swenson 1997, 13). The exact scope and amount of coverage required varies by jurisdiction, but 35 states have a requirement for at least $100,000 of coverage (O'Connor & Swenson 1997, 18). For the average company, public liability insurance is recommended as a supplement to employer's liability insurance but is not required (United Kingdoms 2013). If a company not covered by insurance is found liable for damages, the resulting financial award could cripple the company and even force it to shut down.

Two other sub-types of public insurance are auto insurance and professional liability insurance. Professional liability insurance applies to professionals providing services with an inherent risk for harm - such as medical professionals. Many jurisdictions in the United States require some kind of professional liability insurance for medical professionals although the amount varies by location (American Medical Association 2012). Even if such insurance is not required, the frequency of malpractice lawsuits makes it advisable. Auto insurance on the other hand is required in virtually every state although some states allow a financial bond guaranteeing payment in case of liability to be used in lieu of insurance (Alabama 2013). Auto liability insurance is much narrower than casualty insurance which can cover damage to the insured or their property (Texas 2012). Liability insurance only covers damages to a third party for which the insured is liable up to a set amount (Pennsylvania 2013). Auto insurance may also have a deductible which is a fixed amount the insured is required to pay before the insurer steps in to pay the remaining sum. Failure to carry auto liability insurance in the US is not only a crime but also limits the ability of a driver to make an insurance claim against another driver for damages suffered (Larson 2013).

Product liability insurance is similar to public insurance in that it protects a company against claims from the general public (Guria 2007, 12). However, there are differences between the two. For example, in order for a company to be liable for their product it must have left the company's control - usually by being sold (Guria 2007, 14). Public liability on the other hand generally occurs on the premises owned by the individual or corporate entity (Guria 2007, 13-14). Product liability insurance is not generally required by law although strict liability regimes such the UK Consumer Protection Act of 1987 and European Economic Community directive 85/374 certainly encourage companies to purchase such instruments (National Archives 2013; EEC 1985). Product liability insurance is used in manufacturing sectors as diverse as toys, cars, medical devices, recreational equipment, and agriculture. Product liability covers the insured for any damages caused by the insured's product up to a certain preset amount.

The final category of liability insurance is employer's insurance. As the name suggests, employer's insurance covers injuries suffered by employees while carrying out their job responsibilities (American Insurance Association 2013). In the US, basic employer's insurance has been replaced by no-fault workers' compensation (workers' comp) plans under which an employee receives compensation for workplace injuries regardless of the company's liability (Oregon DCBS 2013). Companies in the UK are required to carry employer's insurance with the exception of self-employed individuals and some small family businesses (United Kingdoms 2013). Workers' comp insurance is not comprehensive as it only handles injury liability up to a set amount and fails to cover discrimination or harassment liability at all (Grotell & Monteleone 1999, 271). As a result, many companies cover additional employer's insurance beyond the workers' comp limits including Employment Practices Liability (EPL) insurance for harassment incidents (Grotell & Monteleone 1999, 249). If additional insurance is not purchased and a company is found liable for damages beyond the cap for workers' comp, the resulting financial award could drive the company out of business (Nationwide 2013). Many companies recognize this risk and protect against it with additional insurance.

Bad Faith

As in any business arrangement, liability insurance requires both parties to uphold the agreement in good faith. An insurance company that fails to do so can be punished for this bad faith through compensatory damages or even punitive damages (Asmat & Tennyson 2013; Chaney 2011, 894). Bad faith occurs when an insurer fails to uphold its obligation in either a first or third party context. First party bad faith occurs when a company directly writes a policy - such as homeowners' or casualty insurance - and then fails to uphold its responsibility to properly investigate a claim, valuate the damage, or even acknowledge the claim (Chaney 2011, 855-56). Bad faith in the context of liability insurance falls in the category of third party claims.

Under U.S. liability law, the insurer has a series of obligations that it must uphold. This includes a duty to defend the insured against a liability claim and in most cases a duty to protect the policyholder's assets by settling for less than the policy limit. The first duty of an insurer is to defend a claim even if parts of the lawsuit are not covered by the insurance company (Morgan, Lewis, & Bockius 1997). In practice, this means that if a lawsuit makes seven claims of liability an insurer is still responsible for defending against the entire claim even if the insurance policy only covers one of those claims. This responsibility is based on that an insurer has a response to defend the insured immediately and fully, and that it is impossible to defend fully without addressing all part of the liability claim (Morgan, Lewis, & Bockius 1997). This duty is complicated when the insurance policy includes a self- consuming limit by which defense costs count against the insurance coverage cap however this does not absolve the insurer from its duty to defend (Brandon 2004, 32-33).

The general method for determining whether an insurer must defend a claim is the "eight- corners" method. The name refers to the four corners of pages of the insurance contract four corners of the liability claim. If any claim is made which would be covered by the contract, then the insurer is bound to defend the whole case regardless of the validity of those claims (Roach 2003, 1). Conversely, if none of the claims are covered by the insurance contract then the insurer is relieved of its obligation to defend even if it has knowledge of facts which would make it liable for damages or the final judgment is for claims covered by the contract (Indiana Law Journal 1965, 89). In cases where there is uncertainty over an insurer's responsibility to defend a claim, the insurer may ask the judge for a declaratory ruling prior to litigation binding to or absolving them from a responsibility to pay defense costs (Indiana law Journal 1965, 96-97).

The most contentious duty of an insurance company involves the responsibility to settle claims in a manner which considers the interests of the insured as equal to those of the insurer (Chaney 2011, 856). The case Comunale v. Traders and General Insurance Company in 1958 established that an insurer's vast resources put in in a position of power during liability litigation which means that it must fairly represent the interests of the insured as well as the insurer's (Selvin 2013). In practice, this means that an insurer has a duty to attempt to settle the lawsuit for an amount less than the policy's limit to protect the policyholder's assets (Asmat & Tennyson 2013, 3). Because any judgment above the policy limit will only affect the insured and not the insurer, the insurer must accept a lower settlement even if it believes a trial could result in a lower award (Chaney 2011, 857). In the Comunale case, the insurer rejected a settlement offer within the policy limits because it believed the eventual award would be lower than the settlement. When the eventual jury award far exceeded the policy's limits, the insured party sued the insurer for the resulting financial costs for with the insured rather than the insurer was liable (Selvin 2013). The court sided with the plaintiffs establishing the duty to accept a reasonable settlement as a requirement for good faith.

A breach of any of these duties can serve as grounds for a claim of bad faith on the part of the insurer. Because legislation regarding bad faith is lacking, most of the precedent for punishing bad faith is based on case law (Asmat & Tennyson 2013). Examples of bad faith include an undue delay in handling claims which can harm defense efforts for the insured, a failure to investigate claims, a refusal to defend the insured, a refusal to make a reasonable settlement offer, or an unreasonable interpretation of the policy's terms. Failures to investigate and handle claims in a timely manner have been determined to undermine the ability to adequately defend a client and so breach the first duty of an insurer (McAnany, Van Cleave, & Phillips 2013). Refusal of a reasonable settlement offer has already been discussed under the burden of insurance providers to indemnify the insured against personal liability. If an insurer is found by the court to have acted in bad faith, they will be forced to compensate to insured for any financial damages caused by their actions - such as defense costs or additional financial judgments - and in extreme cases may also have to pay punitive damages to deter future bad faith (Chaney 2011, 894).

Public Auto Insurance

In contrast to the private liability car insurance system prevalent in the United States, four Canadian provinces instead have government run public auto insurance plans. British Columbia, Saskatchewan, Manitoba, and Quebec, all have government run insurance companies which have been granted a monopoly over legally required minimum liability insurance coverage sales (Hasan 2011, 25- 26). These insurers are the Insurance Corporation of British Columbia (ICBC), Saskatchewan Government Insurance (SGI), Manitoba Public Insurance (MPI), and the Quebec Auto Insurance Board (SAAQ). With the exception of Quebec, these provinces require liability coverage of at least C$200,000 (Hasan 2011, 27). In British Columbia, Saskatchewan, and Manitoba, government insurance companies also compete in the voluntary insurance market where their favorable position has given them a virtual monopoly over private insurers (Hasan 2011, 25). In Quebec, the public auto insurance only offers minimum liability insurance plans with additional insurance coverage offered competitively by private insurers (Hasan 2011, 26). It is important to note that public insurance plans are based on the principle of no-fault compensation rather than assigning liability (Kent 2003).

Public auto insurance plans in Canada have a long history. Saskatchewan founded the first system in 1945 followed by Manitoba in 1971, British Columbia in 1973, and Quebec in 1977 (Saskatchewan 2013; British Columbia 2012; Manitoba 2013; Dionne 2001). Other provinces have considered following their lead at various times. In Ontario, the New Democratic Party proposed a public auto insurance scheme, but dropped the idea after coming to power in 1990 (Walkom February 7, 2013). Skyrocketing insurance rates cause the provincial government of New Brunswick to consider a government plan, but the idea was dropped in the face of mounting opposition (Public Citizen 2013). The New Democratic Party of Nova Scotia also included public car insurance in its 2006 election platform, but the item disappeared by the time of the 2009 elections (MacDonald June 9, 2009). Despite some measure of support for government run insurance plans, it seems unlikely that they will appear in other provinces at this time.

One of the main misconceptions regarding public car insurance is that such a system decreases premiums for drivers (Milke 2006, 8). A study published by the Insurance Bureau of Canada found that such claims are based on flawed studies of the insurance market which discount consumers' tendency to shop around for the lowest possible price rather than settling for the median cost estimate (Milke 2006, 17). From 2005, average premiums in British Columbia ranged from the third highest (2003) to the highest (2000 - 2002) in all of Canada (Milke 2006, 8). When average premium prices are compared rather than median insurance quotes, provinces with public plans have the highest premiums in the country (Hasan 2011, 27). This reality is hardly surprising as government monopolies have a history of inefficiencies and often fail to realize cost savings that could be passed along to consumers (Skinner 2007, 6-7). Even in provinces without public auto insurance, private insurers are highly regulated leading to higher premiums and potentially a lower volume of competition in the marketplace (Hasan 2011, 26). The government monopoly over mandatory liability insurance also reduces competition in the market for voluntary insurance as private insurers are unable to achieve the economies of scale available to their publicly funded competition (Skinner 2007, 4).

Liability insurance serves a valuable purpose by allowing victims of negligence to be compensated for their damages while avoiding the undesirable outcome of driving every guilty company into bankruptcy. The wide variety of liability insurance - public insurance, car insurance, product insurance, and employer's insurance to name a few - means that companies and individuals have access to this valuable risk management tool regardless of the specific situation. The liability insurance system give tremendous power to the insurers to act on their clients behalf, but this power is balanced by the responsibility to act in good faith. Acting in bad faith is treated harshly by the courts to deter such behavior in the future. The Canadian auto insurance system provides a counter-point to the generally private liability insurance framework in the United State. While its no-fault system ensures compensation for injured parties, it falls victim to the inefficiencies of a monopolistic system. Ultimately, liability insurance provides a way to manage life's inherent risks and uncertainties.

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