Insurance Policy Interpretation and ERISA Conflict of Interests

Insurance coverage could learn a bit from the law of ERISA, particularly from the concept of structural conflicts of interest that is so much in play in ERISA litigation at the moment. In the world of insurance coverage litigation, insurers almost invariably stand in exactly the position that ERISA decisions view as a structural conflict: they both decide the claims for coverage and pay the claims if there is coverage. And yet we don't talk in insurance coverage about such conflicts, and this issue is never the animating principle behind judicial decisions over whether or not a policy covers a particular loss. Instead, insurance coverage law borrows from contract law, and courts purport to be applying contract principles to decide these types of cases.

But the truth of the matter is that many rules of insurance policy interpretation and many rules governing the obligations of insurers and insureds simply don't fit comfortably within a contract law framework. Some of those rules and obligations, however, could be better understood if viewed through the prism of a structural conflict of interest analysis.

For instance, several decisions over the last few years have addressed whether an insurer has the right to be reimbursed by its insured for defense costs incurred on uncovered claims, as discussed here. Some courts allow it, with the thinking being that the insurer did not contract to provide a defense to uncovered claims, but instead only for potentially covered claims, and therefore the insurer should be paid back moneys spent on defending uncovered claims. Yet allowing reimbursement isn't logical if the question is examined from the point of view of traditional contract law. As David Rossmiller pointed out here, the policies don't include an actual contractual term to this effect. Moreover, it has long been, depending on the jurisdiction involved, either an accepted norm or an outright legal rule that the insurer must pay for the defense of the entire case even if only one of many claims in the lawsuit might be covered, and under any traditional approach to contract law, such a long held mutual understanding of the contracting parties would be understood to be part of the contract's terms. Thus, I am skeptical that reimbursement makes any sense under a contract regime, which insurance coverage decisions generally purport to be part of. At a minimum, the answer to whether reimbursement should be allowed under these circumstances certainly isn't clear from the point of view of pure contract interpretation, given that an almost equal number of courts don't allow reimbursement as allow it, as discussed in this article.

But it may be that contract law in its traditional form simply isn't the right framework for understanding this issue, and that instead what we want to do in this situation should instead depend on the outcome that is fairer to both parties to the contract, the insurer and the insured. And the way to figure that out may be to borrow from the law of ERISA the concept of the structural conflict of interest and apply it, and see what we end up with. If the powerful role that the insurer holds as both payor of the loss and initial decision maker on the claim affects this issue, than perhaps it is not fair to interpret the policy to allow such reimbursement, but if it does not have that effect, then perhaps it is appropriate to allow such reimbursement given that the contract terms themselves do not settle the question. Now, in most of these reimbursement cases, the insurer has agreed to pay for the defense of the insured against claims - often ones that are very expensive to defend against - that simply are not covered. An insurer that does so obviously has not made its decision due to any sort of conflict it might face as both the payor of the loss and the decision maker, because it has elected to do something in the insured's favor, and not in its own: namely, defend the insured against a claim that is not even covered. Why would an insurer acting out a conflict do that, one would have to ask, and the short answer is that it wouldn't. Since the insurer was not acting out of a conflict of interest, there is no reason not to simply limit the insured to what it paid for, namely the defense of covered claims, leading to a corresponding obligation to repay the insurer the money spent defending the insured against uncovered claims.

And thus a structural conflict of interest analysis sheds some light on the result that should be reached in a situation in which the terms of the policy itself, and the doctrines of contract law, can't tell us what the outcome should be.