Liability insurance
Encyclopedia
Liability insurance is a part of the general insurance
system of risk
financing to protect the purchaser (the "insured") from the risks of liabilities imposed by lawsuits and similar claims. It protects the insured in the event he or she is sued for claims that come within the coverage of the insurance policy. Originally, individuals or companies that faced a common peril, formed a group and created a self-help fund out of which to pay compensation should any member incur loss (in other words, a mutual insurance arrangement). The modern system relies on dedicated carriers, usually for-profit, to offer protection against specified perils in consideration
of a premium. Liability insurance is designed to offer specific protection against third party insurance claims, i.e., payment is not typically made to the insured, but rather to someone suffering loss who is not a party to the insurance contract. In general, damage caused intentionally as well as contractual liability are not covered under liability insurance policies. When a claim is made, the insurance carrier has the duty (and right) to defend the insured. The legal costs of a defense normally do not affect policy limits unless the policy expressly states otherwise; this default rule is useful because defense costs tend to soar when cases go to trial.
The duty to defend is triggered when the insured is sued and in turn "tenders" defense of the claim to its liability insurer. Usually this is done by sending a copy of the complaint
along with a cover letter referencing the relevant insurance policy or policies and demanding an immediate defense. At this point, the insurer has three options, to:(1) seek a declaratory judgment of no coverage; (2) defend; or (3) refuse either to defend or to seek a declaratory judgment .
If a declaratory judgment is sought, the issue of the insurer's duty to defend will be resolved.
If the insurer decides to defend, it has thus either waived its defense of no coverage (later estopped), or it must defend under a reservation of rights. The latter means that the insurer reserves the right to withdraw from defending in the event that it turns out the claim is not covered, and to recover from the insured any funds expended to date.
If the insurer chooses to defend, it may either defend the claim with its own in-house lawyers (where allowed), or give the claim to an outside law firm on a "panel" of preferred firms which have negotiated a standard fee schedule with the insurer in exchange for a regular flow of work. The decision to defend under a reservation of rights must be undertaken with extreme caution in jurisdictions where the insured has a right to Cumis counsel
.
The choice to do nothing can be very risky because a later determination that the duty applied often leads to the tort of bad faith. (So, insurers often prefer to defend under a reservation of rights rather than simply do nothing.)
The duty to indemnify means the duty to pay "all sums" for which the insured is held liable, up to a set policy limit.
In some jurisdictions, there is a third duty, the duty to settle a reasonably clear claim against the insured. The duty is of greatest import during situations in which the settlement demand equals or exceeds the policy limits. In that case, the insurer has an incentive not to settle, since if it settles, it will certainly pay the policy limit. But this interest is at odds with the interest of its insured. The company has incentive not to settle since if the case goes to trial, there are only two possibilities: its insured loses and insurer pays the policy limits (nothing gained nothing lost), or its insured wins, leaving the insurer with no liability. But, if the insurer refuses to settle, and the case goes to trial, the insured might be held liable for a sum far exceeding the settlement offer.
This is where the duty to settle comes in. To avoid endangering an insured to gain a remote possibility of avoiding paying on the policy, the duty to defend obligates the insurance company to settle reasonably clear claims. The standard judicial test is that an insurer must settle a claim if a reasonable insurer, notwithstanding any policy limits, would have settled the claim.
An insurer who breaches any of these three duties may be held liable for the tort of insurance bad faith
in addition to breach of contract
.
. The most usual classes of mandatory policy
cover the drivers of vehicles, those who offer professional services to the public, those who manufacture products that may be harmful, constructors and those who offer employment. The reason for such laws is that the classes of insured are deliberately engaging in activities that put others at risk of injury
or loss. Public policy
therefore requires that such individuals should carry insurance so that, if their activities do cause loss or damage to another, money will be available to pay compensation
. In addition, there are a further range of perils that people insure against and, consequently, the number and range of liability policies has increased in line with the rise of contingency fee litigation offered by lawyers (sometimes on a class action
basis). Such policies fall into three main classes:
even though the conditions, exclusions, and warranties included within the standard policies can be a burden. A company owning an industrial facility, for instance, may buy pollution insurance
to cover lawsuits resulting from environmental accidents.
Many small businesses do not secure general or professional liability insurance due to the high cost of premiums. However, in the event of a claim, out-of-pocket costs for a legal defense or settlement can far exceed premium costs. In some cases, the costs of a claim could be enough to shut down a small business.
Businesses must consider all potential risk exposures when deciding whether liability insurance is needed, and, if so, how much coverage is appropriate and cost-effective.
Those with the greatest public liability
risk exposure are occupiers of premises where large numbers of third parties frequent at leisure including shopping centers, pubs, clubs, theaters, sporting venues, markets, hotels and resorts. The risk increases dramatically when consumption of alcohol and sporting events are included. Certain industries such as security and cleaning are considered high risk by underwriters. In some cases underwriters even refuse to insure the liability of these industries or choose to apply a large deductible in order to minimize the potential compensations.
Private individuals also occupy land and engage in potentially dangerous activities. For example, a rotten branch may fall from an old tree and injure a pedestrian, and many people ride bicycles and skateboards in public places. The majority of states require motorists to carry insurance and criminalise those who drive without a valid policy. Many also require insurance companies to provide a default fund to offer compensation to those physically injured in accidents where the driver did not have a valid policy.
In many countries claims are dealt with under common law
principles established through a long history of case law
and, if litigated, are made by way of civil actions in the relevant jurisdiction.
Note that in the United Kingdom
Employers Liability Insurance is compulsory, unless the only employee is the owner of the company (who holds at least 50% of the shares) or the business is a family business which is not incorporated as a limited company.
Workers' compensation in the United States in most states operates through administrative adjudication outside of the federal and state courts; in turn, workers' comp insurance is regulated and underwritten separately from liability insurance. That is, most businesses will go to a liability insurer for a Commercial General Liability policy, and to a specialized workers' comp insurer for a workers' comp policy (which is usually compulsory unless the employer can demonstrate the capability to self-insure for workers' comp).
In the United States, general liability insurance coverage most often appears in the Commercial General Liability policies obtained by businesses, and in homeowners' insurance policies obtained by individual homeowners.
or strict liability
torts, but not any tort or crime with a higher level of mens rea
. This is usually mandated either by the policy language itself or case law or statutes in the jurisdiction where the insured resides or does business.
In other words, liability insurance does not protect against liability resulting from crimes or intentional torts committed by the insured. This is intended to prevent criminals, particularly organized crime
, from obtaining liability insurance to cover the costs of defending themselves in criminal actions brought by the state or civil actions brought by their victims. A contrary rule would encourage the commission of crime
, and allow insurance companies to indirectly profit from it, by allowing criminals to insure themselves from adverse consequences of their own actions.
It should be noted that crime is not uninsurable per se. In contrast to liability insurance, it is possible to obtain loss insurance to compensate one's losses as the victim of a crime.
, most states make only the carrying of auto insurance mandatory. Where the carrying of a policy is not mandatory and a third party makes a claim for injuries suffered, evidence
that a party has liability insurance is generally inadmissible in a lawsuit
on public policy
grounds, because the courts do not want to discourage parties from carrying such insurance. There are two exceptions to this rule:
Typically, professional liability insurance protects technology firms from litigation resulting from charges of professional negligence or failure to perform professional duties. Covered incidents may include errors and omissions that result in the loss of client data, software or system failure, claims of non-performance, or negligent overselling of services. For example, some client companies have won large settlements after technology subcontractors’ actions resulted in the loss of irreplaceable data. Professional liability insurance would generally cover such settlements and legal defense, within policy limits.
Additionally, client contracts often require technology subcontractors working on-site to provide proof of general liability and professional liability insurance.
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
system of risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
financing to protect the purchaser (the "insured") from the risks of liabilities imposed by lawsuits and similar claims. It protects the insured in the event he or she is sued for claims that come within the coverage of the insurance policy. Originally, individuals or companies that faced a common peril, formed a group and created a self-help fund out of which to pay compensation should any member incur loss (in other words, a mutual insurance arrangement). The modern system relies on dedicated carriers, usually for-profit, to offer protection against specified perils in consideration
Consideration
Consideration is the central concept in the common law of contracts and is required, in most cases, for a contract to be enforceable. Consideration is the price one pays for another's promise. It can take a number of forms: money, property, a promise, the doing of an act, or even refraining from...
of a premium. Liability insurance is designed to offer specific protection against third party insurance claims, i.e., payment is not typically made to the insured, but rather to someone suffering loss who is not a party to the insurance contract. In general, damage caused intentionally as well as contractual liability are not covered under liability insurance policies. When a claim is made, the insurance carrier has the duty (and right) to defend the insured. The legal costs of a defense normally do not affect policy limits unless the policy expressly states otherwise; this default rule is useful because defense costs tend to soar when cases go to trial.
What liability insurance provides
Liability insurers have two (or three, in some jurisdictions) major duties: 1) the duty to defend, 2) the duty to indemnify and (in some jurisdictions), 3) the duty to settle a reasonably clear claim.- To defend
The duty to defend is triggered when the insured is sued and in turn "tenders" defense of the claim to its liability insurer. Usually this is done by sending a copy of the complaint
Complaint
In legal terminology, a complaint is a formal legal document that sets out the facts and legal reasons that the filing party or parties In legal terminology, a complaint is a formal legal document that sets out the facts and legal reasons (see: cause of action) that the filing party or parties In...
along with a cover letter referencing the relevant insurance policy or policies and demanding an immediate defense. At this point, the insurer has three options, to:(1) seek a declaratory judgment of no coverage; (2) defend; or (3) refuse either to defend or to seek a declaratory judgment .
If a declaratory judgment is sought, the issue of the insurer's duty to defend will be resolved.
If the insurer decides to defend, it has thus either waived its defense of no coverage (later estopped), or it must defend under a reservation of rights. The latter means that the insurer reserves the right to withdraw from defending in the event that it turns out the claim is not covered, and to recover from the insured any funds expended to date.
If the insurer chooses to defend, it may either defend the claim with its own in-house lawyers (where allowed), or give the claim to an outside law firm on a "panel" of preferred firms which have negotiated a standard fee schedule with the insurer in exchange for a regular flow of work. The decision to defend under a reservation of rights must be undertaken with extreme caution in jurisdictions where the insured has a right to Cumis counsel
Cumis counsel
A Cumis counsel is "an attorney employed by a defendant in a lawsuit when there is an insurance policy supposedly covering the claim, but there is a conflict of interest between the insurance company and the insured defendant."...
.
The choice to do nothing can be very risky because a later determination that the duty applied often leads to the tort of bad faith. (So, insurers often prefer to defend under a reservation of rights rather than simply do nothing.)
- To indemnify
The duty to indemnify means the duty to pay "all sums" for which the insured is held liable, up to a set policy limit.
- To settle reasonable claims
In some jurisdictions, there is a third duty, the duty to settle a reasonably clear claim against the insured. The duty is of greatest import during situations in which the settlement demand equals or exceeds the policy limits. In that case, the insurer has an incentive not to settle, since if it settles, it will certainly pay the policy limit. But this interest is at odds with the interest of its insured. The company has incentive not to settle since if the case goes to trial, there are only two possibilities: its insured loses and insurer pays the policy limits (nothing gained nothing lost), or its insured wins, leaving the insurer with no liability. But, if the insurer refuses to settle, and the case goes to trial, the insured might be held liable for a sum far exceeding the settlement offer.
This is where the duty to settle comes in. To avoid endangering an insured to gain a remote possibility of avoiding paying on the policy, the duty to defend obligates the insurance company to settle reasonably clear claims. The standard judicial test is that an insurer must settle a claim if a reasonable insurer, notwithstanding any policy limits, would have settled the claim.
- Effects of breach
An insurer who breaches any of these three duties may be held liable for the tort of insurance bad faith
Insurance bad faith
Insurance bad faith is a legal term of art that describes a tort claim that an insured person may have against an insurance company for its bad acts. Under the law of most jurisdictions in the United States, insurance companies owe a duty of good faith and fair dealing to the persons they insure...
in addition to breach of contract
Breach of contract
Breach of contract is a legal cause of action in which a binding agreement or bargained-for exchange is not honored by one or more of the parties to the contract by non-performance or interference with the other party's performance....
.
Retained limits and SIRs
One way for businesses to cut down their liability insurance premiums is to negotiate a policy with a retained limit or self-insured retention (SIR), which is somewhat like a deductible. With such policies, the insured is essentially agreeing to self-insure and self-defend for smaller claims, and to tender only for liability claims that exceed a certain number. However, writing such insurance is itself risky for insurers. The California Courts of Appeal have held that primary insurers on policies with a SIR must still provide an "immediate, 'first dollar' defense" (subject, of course, to their right to later recover the SIR amount from the insured) unless the policy expressly imposes exhaustion of the SIR as a precondition to the duty to defend.Types of liability insurance
In many countries, liability insurance is a compulsory form of insurance for those at risk of being sued by third parties for negligenceNegligence
Negligence is a failure to exercise the care that a reasonably prudent person would exercise in like circumstances. The area of tort law known as negligence involves harm caused by carelessness, not intentional harm.According to Jay M...
. The most usual classes of mandatory policy
Policy
A policy is typically described as a principle or rule to guide decisions and achieve rational outcome. The term is not normally used to denote what is actually done, this is normally referred to as either procedure or protocol...
cover the drivers of vehicles, those who offer professional services to the public, those who manufacture products that may be harmful, constructors and those who offer employment. The reason for such laws is that the classes of insured are deliberately engaging in activities that put others at risk of injury
Injury
-By cause:*Traumatic injury, a body wound or shock produced by sudden physical injury, as from violence or accident*Other injuries from external physical causes, such as radiation injury, burn injury or frostbite*Injury from infection...
or loss. Public policy
Public policy
Public policy as government action is generally the principled guide to action taken by the administrative or executive branches of the state with regard to a class of issues in a manner consistent with law and institutional customs. In general, the foundation is the pertinent national and...
therefore requires that such individuals should carry insurance so that, if their activities do cause loss or damage to another, money will be available to pay compensation
Damages
In law, damages is an award, typically of money, to be paid to a person as compensation for loss or injury; grammatically, it is a singular noun, not plural.- Compensatory damages :...
. In addition, there are a further range of perils that people insure against and, consequently, the number and range of liability policies has increased in line with the rise of contingency fee litigation offered by lawyers (sometimes on a class action
Class action
In law, a class action, a class suit, or a representative action is a form of lawsuit in which a large group of people collectively bring a claim to court and/or in which a class of defendants is being sued...
basis). Such policies fall into three main classes:
Public liability
Industry and commerce are based on a range of processes and activities that have the potential to affect third parties (members of the public, visitors, trespassers, sub-contractors, etc. who may be physically injured or whose property may be damaged or both). It varies from state to state as to whether either or both employer's liability insurance and public liability insurance have been made compulsory by law. Regardless of compulsion, however, most organizations include public liability insurance in their insurance portfolioPortfolio (finance)
Portfolio is a financial term denoting a collection of investments held by an investment company, hedge fund, financial institution or individual.-Definition:The term portfolio refers to any collection of financial assets such as stocks, bonds and cash...
even though the conditions, exclusions, and warranties included within the standard policies can be a burden. A company owning an industrial facility, for instance, may buy pollution insurance
Pollution insurance
Pollution insurance is a type of insurance that covers costs related to pollution. This can include the costs of brownfield restoration and cleanup, liability for injuries and deaths caused by pollution....
to cover lawsuits resulting from environmental accidents.
Many small businesses do not secure general or professional liability insurance due to the high cost of premiums. However, in the event of a claim, out-of-pocket costs for a legal defense or settlement can far exceed premium costs. In some cases, the costs of a claim could be enough to shut down a small business.
Businesses must consider all potential risk exposures when deciding whether liability insurance is needed, and, if so, how much coverage is appropriate and cost-effective.
Those with the greatest public liability
Public liability
Public liability is part of the law of tort which focuses on civil wrongs. An applicant usually sues the respondent under common law based on negligence and/or damages...
risk exposure are occupiers of premises where large numbers of third parties frequent at leisure including shopping centers, pubs, clubs, theaters, sporting venues, markets, hotels and resorts. The risk increases dramatically when consumption of alcohol and sporting events are included. Certain industries such as security and cleaning are considered high risk by underwriters. In some cases underwriters even refuse to insure the liability of these industries or choose to apply a large deductible in order to minimize the potential compensations.
Private individuals also occupy land and engage in potentially dangerous activities. For example, a rotten branch may fall from an old tree and injure a pedestrian, and many people ride bicycles and skateboards in public places. The majority of states require motorists to carry insurance and criminalise those who drive without a valid policy. Many also require insurance companies to provide a default fund to offer compensation to those physically injured in accidents where the driver did not have a valid policy.
In many countries claims are dealt with under common law
Common law
Common law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
principles established through a long history of case law
Case law
In law, case law is the set of reported judicial decisions of selected appellate courts and other courts of first instance which make new interpretations of the law and, therefore, can be cited as precedents in a process known as stare decisis...
and, if litigated, are made by way of civil actions in the relevant jurisdiction.
Product
Product liability insurance is not a compulsory class of insurance in all countries, but legislation such as the UK Consumer Protection Act 1987 and the EC Directive on Product Liability (25/7/85) require those manufacturing or supplying goods to carry some form of product liability insurance, usually as part of a combined liability policy. The scale of potential liability is illustrated by cases such as those involving Mercedes-Benz for unstable vehicles and Perrier for benzene contamination, but the full list covers pharmaceuticals and medical devices, asbestos, tobacco, recreational equipment, mechanical and electrical products, chemicals and pesticides, agricultural products and equipment, food contamination, and all other major product classes.Employers
New policies have been developed to cover any liability that might be imposed on an employer if an employee is injured in the course of his or her employment. In many states in the US, the insurers are prohibited from including conditions within their policies that seek to impose any unreasonable conditions precedent to liability, or require the insured either to take reasonable precautions or to comply with current legislation and regulations. In those countries where such insurance is not compulsory, smaller organizations are often driven into bankruptcy when faced by claims not covered by insurance.Note that in the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
Employers Liability Insurance is compulsory, unless the only employee is the owner of the company (who holds at least 50% of the shares) or the business is a family business which is not incorporated as a limited company.
Workers' compensation in the United States in most states operates through administrative adjudication outside of the federal and state courts; in turn, workers' comp insurance is regulated and underwritten separately from liability insurance. That is, most businesses will go to a liability insurer for a Commercial General Liability policy, and to a specialized workers' comp insurer for a workers' comp policy (which is usually compulsory unless the employer can demonstrate the capability to self-insure for workers' comp).
General liability
Many of the public and product liability risks are often covered together under a general liability policy. These risks may include bodily injury or property damage caused by direct or indirect actions of the insured.In the United States, general liability insurance coverage most often appears in the Commercial General Liability policies obtained by businesses, and in homeowners' insurance policies obtained by individual homeowners.
Insurable risks
Generally, liability insurance covers only the risk of being sued for negligenceNegligence
Negligence is a failure to exercise the care that a reasonably prudent person would exercise in like circumstances. The area of tort law known as negligence involves harm caused by carelessness, not intentional harm.According to Jay M...
or strict liability
Strict liability
In law, strict liability is a standard for liability which may exist in either a criminal or civil context. A rule specifying strict liability makes a person legally responsible for the damage and loss caused by his or her acts and omissions regardless of culpability...
torts, but not any tort or crime with a higher level of mens rea
Mens rea
Mens rea is Latin for "guilty mind". In criminal law, it is viewed as one of the necessary elements of a crime. The standard common law test of criminal liability is usually expressed in the Latin phrase, actus non facit reum nisi mens sit rea, which means "the act does not make a person guilty...
. This is usually mandated either by the policy language itself or case law or statutes in the jurisdiction where the insured resides or does business.
In other words, liability insurance does not protect against liability resulting from crimes or intentional torts committed by the insured. This is intended to prevent criminals, particularly organized crime
Organized crime
Organized crime or criminal organizations are transnational, national, or local groupings of highly centralized enterprises run by criminals for the purpose of engaging in illegal activity, most commonly for monetary profit. Some criminal organizations, such as terrorist organizations, are...
, from obtaining liability insurance to cover the costs of defending themselves in criminal actions brought by the state or civil actions brought by their victims. A contrary rule would encourage the commission of crime
Crime
Crime is the breach of rules or laws for which some governing authority can ultimately prescribe a conviction...
, and allow insurance companies to indirectly profit from it, by allowing criminals to insure themselves from adverse consequences of their own actions.
It should be noted that crime is not uninsurable per se. In contrast to liability insurance, it is possible to obtain loss insurance to compensate one's losses as the victim of a crime.
Evidentiary rules regarding liability insurance
In the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, most states make only the carrying of auto insurance mandatory. Where the carrying of a policy is not mandatory and a third party makes a claim for injuries suffered, evidence
Evidence (law)
The law of evidence encompasses the rules and legal principles that govern the proof of facts in a legal proceeding. These rules determine what evidence can be considered by the trier of fact in reaching its decision and, sometimes, the weight that may be given to that evidence...
that a party has liability insurance is generally inadmissible in a lawsuit
Lawsuit
A lawsuit or "suit in law" is a civil action brought in a court of law in which a plaintiff, a party who claims to have incurred loss as a result of a defendant's actions, demands a legal or equitable remedy. The defendant is required to respond to the plaintiff's complaint...
on public policy
Relevance (law)
Relevance, in the common law of evidence, is the tendency of a given item of evidence to prove or disprove one of the legal elements of the case, or to have probative value to make one of the elements of the case likelier or not. Probative is a term used in law to signify "tending to prove."...
grounds, because the courts do not want to discourage parties from carrying such insurance. There are two exceptions to this rule:
- If the owner of the insurance policy disputes ownership or control of the property, evidence of liability insurance can be introduced to show that it is likely that the owner of the policy probably does own or control the property.
- If a witness has an interest in the policy that gives the witness a motive or bias with respect to specific testimony, the existence of the policy can be introduced to show this motive or bias. Federal rules of civil procedure rule 26 was amended in 1993 to require that any insurance policy that may pay or may reimburse be made available for photocopying by the opposing litigants, although the policies are not normally information given to the jury. Federal Rules of Appellate Procedure rule 46 says that an appeal can be dismissed or affirmed if counsel does not update their notice of appearance to acknowledge insurance. The Cornell University Legal Institute web site includes congressional notes.
Liability insurance and the technology industry
Because technology companies represent a relatively new industry that deals largely with intangible yet highly valuable data, some definitions of legal liability may still be evolving in this field. Technology firms must carefully read and fully understand their policy limits to ensure coverage of all potential risks inherent in their work.Typically, professional liability insurance protects technology firms from litigation resulting from charges of professional negligence or failure to perform professional duties. Covered incidents may include errors and omissions that result in the loss of client data, software or system failure, claims of non-performance, or negligent overselling of services. For example, some client companies have won large settlements after technology subcontractors’ actions resulted in the loss of irreplaceable data. Professional liability insurance would generally cover such settlements and legal defense, within policy limits.
Additionally, client contracts often require technology subcontractors working on-site to provide proof of general liability and professional liability insurance.