Legal Liability Concepts
Casualty insurance pays for an insured’s legal liability to others. To understand what a liability policy pays and why, you need a few legal ideas: how courts read an insurance contract, the kinds of damages a court can award, the different bases on which a person can be held liable, and how a policy’s limits cap what it will pay. The rules of negligence, and the defenses to it, were covered in Casualty Insurance Basics.
Legal interpretations affecting contracts
An insurance policy is a contract of adhesion. The insurer writes it and the insured must accept it as written, with no chance to negotiate its wording. Two rules of interpretation follow from that:
- Ambiguities are construed against the insurer. If a policy’s wording can reasonably be read two ways, a court generally adopts the reading that favors the insured, because the insurer chose the words
- Reasonable expectations. Under the doctrine of reasonable expectations, which some states follow, a court may interpret coverage according to what a reasonable person in the insured’s position would have expected the policy to provide, even if a close reading of the fine print suggests otherwise
These rules sit beside the other legal principles that shape an insurance contract: indemnity (restoring the insured to their position before the loss, without profit), utmost good faith, and the law of warranties, representations, misrepresentation and concealment, and fraud. Those are covered in the chapters on insurance basics and insurance contracts.
Damages
Damages are the money a court awards to a person injured by another’s wrongful act. Liability insurance pays damages the insured becomes legally obligated to pay, up to the policy limits.
Compensatory versus punitive
- Compensatory damages repay the injured person for the harm actually suffered. Their purpose is to make the person whole. Compensatory damages are divided into special and general damages (below)
- Punitive damages, also called exemplary damages, are awarded not to repay the injured person but to punish the wrongdoer and deter similar conduct. Courts award them for conduct worse than ordinary negligence, such as gross negligence or willful, reckless or malicious acts. Whether punitive damages may be insured, and whether a given policy covers them, varies by state and by policy
General versus special
- Special damages compensate for specific, measurable out-of-pocket losses: medical and hospital bills, lost wages, the cost to repair or replace damaged property. They can be proved with bills, receipts and records
- General damages compensate for losses that have no set price: pain and suffering, mental anguish, disfigurement, loss of enjoyment of life, and loss of companionship (loss of consortium). A judge or jury decides their amount
Liability
Most liability claims rest on negligence, which requires proof that the defendant failed to use reasonable care. Some kinds of liability do not require proof of negligence at all.
Absolute
Absolute liability is imposed regardless of fault or care. A person who engages in an inherently or abnormally dangerous activity, such as blasting with explosives, keeping wild animals or handling highly hazardous materials, is liable for the harm it causes even if they took every possible precaution. Almost no defense is available.
Strict
Strict liability is liability imposed without proof of negligence. It is most often applied to defective products. A person injured by a product need not show that the manufacturer or seller was careless, only that the product was defective and that the defect caused the injury. The two terms are sometimes used interchangeably, but strict liability generally leaves the defendant some defenses, such as the injured person’s misuse of the product.
Vicarious
Vicarious liability is liability for someone else’s negligent acts because of a relationship with that person. Common examples:
- An employer is liable for the negligence of its employees acting within the scope of their employment (the doctrine of respondeat superior, “let the master answer”)
- A principal is liable for the acts of its agent within the agent’s express, implied or apparent authority, which is why an insurer answers for its producers
- A business may be liable for the acts of an independent contractor it hires in some circumstances, and state laws can make parents liable for certain acts of their children or vehicle owners liable for those who drive with permission
Vicarious liability is one reason liability policies cover more people than the named insured, such as employees acting for the business.
Accident versus occurrence
Liability policies describe the event that triggers coverage in one of two ways.
- An accident is a sudden, unexpected and unintended event that happens at an identifiable time and place, such as a car crash or a customer slipping on a wet floor
- An occurrence is broader. It is an accident, including continuous or repeated exposure to substantially the same general harmful conditions. Damage that develops gradually, such as water seeping from a leaking pipe for months, or a slow leak that damages a tenant’s stock over several months, is an occurrence even though no single sudden event caused it
Either way, liability policies exclude injury the insured intended. The commercial general liability policy also excludes injury the insured expected, except bodily injury from reasonable force used to protect persons or property. The CGL’s occurrence form covers injury or damage that occurs during the policy period, and its each-occurrence limit caps what it pays for all injury and damage arising out of any one occurrence. A claims-made form is also available.
Limits of liability
A liability policy’s limits set the most the insurer will pay. Limits can be stated in several ways, often in combination.
- Per accident / per occurrence: the most paid for all injury and damage arising from one accident or occurrence, no matter how many people are hurt or claims are made
- Per person: the most paid for bodily injury to any one person in an accident
- Aggregate: the most paid for all covered losses during the policy period. Once the aggregate is used up, the policy pays nothing more until it renews. The commercial general liability policy, for example, has a general aggregate and a separate products-completed operations aggregate
- Split limits: separate limits for bodily injury per person, bodily injury per accident and property damage per accident, written as three numbers. A policy written 100/300/50 pays up to $100,000 for one person’s injuries, $300,000 for all injuries in one accident, and $50,000 for property damage in one accident
- Combined single limit (CSL): one limit per accident that applies to bodily injury and property damage combined, however the loss divides. A $300,000 CSL could pay $300,000 to one injured person if the claim required it
Lesson summary
- An insurance policy is a contract of adhesion: ambiguities are read against the insurer, and courts may honor the insured’s reasonable expectations.
- Compensatory damages repay the injured person and are either special (measurable out-of-pocket costs such as medical bills and lost wages) or general (pain and suffering, mental anguish, disfigurement).
- Punitive damages punish and deter gross, willful or malicious conduct.
- Absolute liability applies to inherently dangerous activities regardless of care. Strict liability applies without proof of negligence, most often to defective products. Vicarious liability makes one person answer for another’s negligence, as an employer does for an employee.
- An accident is a sudden event. An occurrence also includes continuous or repeated exposure to the same harmful conditions.
- Limits may be stated per accident or occurrence, per person, in the aggregate for the policy period, as split limits such as 100/300/50, or as a combined single limit covering bodily injury and property damage together.