The Special Nature of the Insurance Contract, Slides of Law

Download The Special Nature of the Insurance Contract and more Slides Law in PDF only on Docsity! THE SPECIAL NATURE OF THE INSURANCE CONTRACT: A FEW SUGGESTIONS FOR FURTHER STUDY "What do they know of the law of the insurance contract who only the law of contract know?"* FRANKLIN M. SCHULTZt John Doe picks up the phone and dials his insurance agent. "I just bought my wife a mink coat for our twenty-fifth anniversary," says Doe. "It set me back $3,500. I'd like to insure it at full value." "Sure," replies the agent, "I'll write it up on a floater right away and send you the policy. The premium will run about $64." Several weeks later Doe receives the policy and a bill in the mail. He notes the policy is a "fur floater" and in the amount of $3,500., He puts it in his strong box and writes out a check for the amount of the bill on the first of the month when he pays his other monthly bills. • If you were to ask Doe what he has done, he would probably say that he has "bought" some insurance. From whom has he bought it? His local agent-the one that handles his "general" insurance; another agent handles his life insurance. Does he know which company issued the policy? No, and he doesn't care. Does he question the amount of the premium? No-he understands that is "standard." Does he know whether his wife's coat is covered under all circumstances? No-he hasn't read the policy; he tried to read one once and fell asleep in the process; he assumes his agent took care of full coverage. Does he know how long the policy runs? No-he assumes three years; the agent always takes care of renewals and bills him as a matter of course. Has he signed any paper? No-he never does in these insurance deals unless it involves life insurance. Does he realize he has entered into an insurance contract? No-he has never thought of it in that way. Now, if one were to ask what John Doe has done in the "eye of the law," the response would probably be: Doe has entered into a unilateral, aleatory contract, the consideration on his side being the payment of an insurance premium, the considera- tion on the other side being a promise to indemnify for a three year period in the event the mink coat disappears-subject to numerous conditions, as, for example, that Doe make proof of loss within sixty days, cooperate with the insurer in recovering the property, bring any action against the insurer within two years, etc. Should Doe fail to comply with any of these conditions pr&edent or subsequent, as the case may be, he cannot recover from the insurer. * EDwIN H. WOODRUFF, SELECTION OF CASES ON THE LAW OF INSURANCE 5 (2d ed. 1924). -A.B. 1939, LL.B. 1942, Yale University. Assistant Professor of Law, Indiana University School of Law. Member of the Ohio Bar. THE SPECIAL NATURE OF THE INSURANCE CONmtACr 377 There are at least two points to make about the "lay" as compared with the "law" reaction to this simple business transaction. One is that "language-wise" they are poles apart. Doe is speaking of having "bought" something, which he may call "protection" or "coverage"; the law speaks of his having entered, through bargain- ing and negotiation, a "contract"-a consensual, continuing relationship. Second, the legal term-unilateral, aleatory contract-which the "law" uses to classify Doe's transaction embraces many other commercial and non-commercial transactions. Doe, for example, would have entered into a unilateral, aleatory contract if he had given a prospector $ioo to stake out a claim in Alaska in return for the prospector's promise of $io,ooo if the grubstake turned out to be a bonanza. Yet, traditionally in both the insurance and grubstake transactions, the contractual presuppositions are the same: each party knew with whom he was dealing; each bargained, haggled, or dickered over the consideration to be received; each knew exactly what he was receiving in return for what he gave (a premium or cash for a promise of cash in the future on the happening of a contingency-loss of a mink coat or "striking it rich"); and finally, each assented to the "bargain" in every respect, i.e., there was a "'meeting of the minds." Crane, J., speaking for the New York Court of Appeals, summarizes the traditional view thus: "A contract for insurance is no different than any other contract. The insurance company is entitled to have its contract enforced by the courts as written."' But one need only run through modern legal literature to discover that there has long been a strong dissent from the traditional tendency to lump insurance contracts with other contracts. Burch, J., speaking for the Kansas Supreme Court, was among the first to strike this dissident note. "The subject, therefore, is sui generis, and the rules of a legal system devised to govern the forma- tion of ordinary contracts between man and man cannot be mechanically applied to it."'2 If one were to paraphrase Judge Burch's phrase "sui generis" in modern terms, it might read: Insurance protection, first, is a necessity, in almost a class with everyday utilities such as water, gas, and light. As in the case of utilities, neither the price nor other terms are bargained for. Embodied in a printed, standardized, mass-produced form, drawn up by the insurer's lawyers, and presented to the buyer as a finished product, insurance is one of the few complicated legal transactions a layman enters into without a lawyer at his elbow. It is undoubtedly as detailed and complex as a contract for the sale of land, a deed, or a will, none of which a careful layman would undertake to negotiate without benefit of counsel. Moreover, the insured deals directly with an agent and is seldom concerned about the identity of the principal (except in life insurance). Once received by the insured, the policy is seldom read, almost never fully understood. In a word, an insurance transaction is a one-sided "bargain"; if it merits the label "contract," it is in a very specialized, not an ordinary, sense. 'Drilling v. New York Life Ins. Co., 234 N. Y. 234, 241, 137 N. E. 314, 316 (1922). 'Pfiester v. Missouri State Life Ins. Co., 85 Kan. 97, 102, 116 Pac. 245, 247 (19,'). I am indebted to Dean Havighurst for pointing out the juxtaposition of this opinion with the Drilling case, svepra note I, in GEORGE NV. GOBLE, CASES AND OTHER MATERIALS ON THE LAW OF INSURANCE 872, 876 (2d ed. 1949). LAW AND CONTEMPORARY PROBLEMS policy provisions are presumably drafted by the stdte agencies, representing all the policyholders, logically, the language should be construed against the insured rather than the company.' But the logic of this argument fails to square with the case results. In the main the courts still reach judgment for plaintiff by construing the standard policies against the company, just as if they were still drafted by the com- pany. 17 The judicial rationales make interesting reading. As early as 1911, a North Caro- lina court, quoting Professor Vance, stated that since the "terms of these statutory policies were chosen with reference to the construction given by the precedent cases to similar terms in other policies, and, therefore, ought to be regarded as being used in the sense of their previous construction,"'" there was no reason to abandon the strict construction rule. The court also explained that the statutory terms were really chosen by the underwriters with particular reference to their own interests, and hence should be construed strictly against them as the real villains of the piece. Such a charge could be well substantiated as to the i886 standard fire policy, which was prepared exclusively by the New York Board of Fire Underwriters (a private in- surance group), 9 but could hardly be supported as to the latest 1943 standard policy.20 A recent North Carolina court has added this rationale: "The rights of the parties after the policy has been issued must be ascertained and determined in accordance with the terms and provisions of the contract and derive no extra validity by reason of the fact that the form is prescribed by law."'" In other words, even though the form of the policy is legislatively prescribed, the insurance contract still derives its validity from the "consent" of the parties.' Logic, it seems, particularly as related to the contract canons of construction, finds little support in the insurance literature. II THE LiFE CYCLE OF A LIFE INSURANCE CONTRACT In addition to the study of the peculiar rules of construction just noted, another way to determine whether modern judges recognize the uniqueness of the insur- ance contract is to examine in terms of recent litigation several phases in the life 6 See Calhoun, The Liberal Construction of Insurance Contracts, I CONN. BAR J. 49, 50 (1927). " VANCE, op. cit. supra note 5, at 691. " Gazzam v. German Union Fire Ins. Co., 155 N. C. 330, 338-339, 71 S. E. 434, 438 (191i). 1" EDWIN W. PATTERSON, THE INSURANCE COMMISSIONER IN THE UNITED STATES 249 (1927). "°Patterson, Insurance Law During the War Years, 46 COL. L. REv. 345, 347 (1946). 2' Atlantic Joint Stock Land Bank of Raleigh v. Foster, 217 N. C. 415, 419, 8 S. E. 2d 235, 237 (1940). " It has also been suggested that "even a statute adopted for the purpose of avoiding the equivocalitics of company-drafted policies may be ambiguous. In such a situation, public policy may similarly require construction against the insurer, by predicating it not upon the drafter's fault, but upon the risk-sharing purpose of insurance." 44 COL. L. REV. 766, 770-771 (1944). It is a little difficult to see how the insurers cquld share the risk of "ambiguities" in the statutory form unless they could pre-estimate the cost of litigation and judgments resulting from discoverable ambiguities and increase the premium rates accord- ingly. THE SPECIAL NATURE OF THE INSURANCE CONTRACT 381 history of an insurance contract. For this purpose the life insurance transaction is probably better laboratory material than fire, casualty, or some other type of in- surance. From the average individual's point of view, life is the keystone of insur- ance protection; it represents not only the sole security but the bulk of total savings and most acceptable loan collateral of the vast majority of people. As compared with fire and casualty, it also comes closer, though not very close, to the classical bar- gained-for contractual transaction. At least, between the first approach of the life agent ("no one has endurance like the man who sells insurance") and the delivery of the policy there is a waiting period which may suggest the possibility for negotiation, bargaining, perhaps even re-drafting. The insurer examines the subject of the contract, the insured, before delivery, not after, as in casualty insurance. Here the insured signs a paper, not the policy, it is true, but an application which becomes a part of the policy. Hence, if the label "contract" in its classical sense is to fit any modern insurance transaction (other than re-insurance, reciprocal insurance, or the like where near equal bargainers are involved), life insurance would appear the most likely candidate. A. Formation of Contract: The Application for Life Insurance To trace the life cycle of a life insurance contract, one normally begins with the application. At this stage an investigation discloses two frequently recurring contract-formation situations which reveal unusual judicial attitudes. One is where the life insurance applicant dies while the company is still processing his application and it is charged that the company has unreasonably delayed approval. The other is where under similar circumstances it is alleged that the applicant was already "insured" because he had paid the first premium and received a "binding receipt" in return. Professor Kessler has recently demonstrated that courts which have dealt with the first situation have been unable to agree as to who shall bear the risk of "loss without insurance" caused by the unreasonable delay of the insurer.2 3 Those courts which view the application as a "bare offer" imposing no liability on the company until it is accepted, cannot find the "acceptance" essential to recovery in contract, nor can they find the requisite consideration for an implied promise on the part of the company to act promptly, since the applicant is free to withdraw his offer at any time before acceptance and seek insurance elsewhere. Though there is an almost unanimous feeling' against recovery in contract as "contrary to the well settled principles of contract law," the majority of courts still allow recovery by the "back door," so to speak, on a tort theory. The failure of the company to take prompt action is said to be tantamount to a breach of a general duty towards the "2 Kessler, Contracts of Adhesion-Some Thoughts About Freedom of Contract, 43 COL. L. Rlv. 629 '(1943)- 2A few courts have based recovery on contract. E.g., Columbia Nat. Life Ins. Co. v. Lemmons, 96 Okla. 228, 222 Pac. 255 (1923). 382 LAW AND CONTEMPORARY PROBLEMS public to act without undue delay on applications involving acceptable risks. Kessler says that the courts which espouse this view- are sure that the policy of insurance cannot be treated like any other contract. The state, by granting a franchise to the insurance company, by regulating and supervising its business, recognizes the great social importance of insurance business; it is, therefore, in the public interest that applications for acceptable risks shall not be unduly delayed. Thus the courts pay merely lip service to the dogma that the common law of contracts governs insurance contracts. With the help of the law of torts they nullify those parts of the law of contracts which in the public interest are regarded as inapplicable. The second situation to reveal an unorthodox judicial attitude toward forma- tion-of-contract principles centers around the legal consequences of prepayment of the first premium by a life insurance applicant who dies subsequent to the medical examination but prior to final approval. Gaunt v. John Hancock Mutual Life Insur- ance Co.26 posed the problem to one of our most distinguished courts. The relevant facts were simple. On August 3, Gaunt signed a life insurance application and paid the soliciting agent the full first premium for which he received a receipt which read in part: "if the company is satisfied that on the date of the completion of [the medical part] of this application I was insurable and if this application [including the medical part] is, prior to my death, approved by the company at its Home Office, the insurance applied for shall be in force as of the date of completion of [the medi- cal part]. ' On the same day the company's local examining physician found Gaunt insurable and recommended the risk for acceptance. After the company received satisfactory reports from several re-examinations of Gaunt made at its re- quest, the medical department of the home office on August 26 approved the applica- tion from a medical standpoint. But the home office, having received word on the same day that Gaunt had been kiled prior to this medical approval, refused to give the application final approval, though the trial judge found that if Gaunt had lived, it would have done so. It was evident that the application was not finally approved at the home office "prior to" Gaunt's death. Nevertheless, Judge Learned Hand, speaking for the court, affirmed a judgment for Gaunt's beneficiary. Admitting that, literally read, the " Id. at 635. Kessler's incisive comment raises the question whether the insurance contract is "affected with a public interest." Ever since the landmark German Alliance Ins. Co. v. Kansas, 233 U. S. 389 (1914), it has been assumed almost without question that the insurance business, in its various ramifi- cations, is "affected with a public interest." Justice McKenna, speaking for a bare majority, there recognized that insurance contracts had "greater public consequences than contracts between individuals to do or not to do a particular thing whose effect stops with the individual." Id. at 413. There is no intimation, however, that the Court regarded "the insurance corporation as a public service company, under a legal duty to insure upon reasonable terms all properly qualified applicants--just as a railroad company is under a similar duty to furnish transportation," a point toward which, Patterson once sug- gested, the law might be tending. Patterson, supra note xo, at 216. At most, the insurance business is a quasi-public utility, although as a constitutional matter, it is arguable that the states always had, and the federal government now has, the power to regard it as a full-fledged public utility, owing duties to the public as to the negotiation and writing as well as the pricing of its contracts. 26 s6o F. 2d 599 (2d Cir. 1947), 6o HARv. L. REv. 1164. 2 Id. at 599-6oo. THE SPECIAL NATURE OF THE INSURANCE CoNTrRAcr court, recognizing that in "1924, when this policy was written, submarines, airplanes, dirigibles, even balloons had not been developed to the condition in which they exist today,"34 decided the clause intended to exclude every aviation risk, even regularly scheduled commercial flights. A dozen years later, however, when the New York Court of Appeals in the Hartol Products case3 5 had to decide whether a i93o accidental death benefit clause (which excluded death resulting "'from having been engaged in military or naval service in time of war; or in submarine operations or in aviation or aeronautics, as a passenger or otherwise ... ,',) covered the in- sured who had been killed while a fare-paying passenger on a regularly scheduled flight over an established route, the beneficiary was permitted to recover the $5oooo at stake. Though the clause read practically word for word like the one in the Gibbs case, this time the court found abundant ambiguity in the word "engaged" (par- ticularly its use in an occupational sense in reference to military service and sub- marine operations, and in a different sense in reference to aviation). Appealing to a lay reaction to this "ambiguity," the majority asserted that the "average person applying for a policy would no more think of a passenger on an airplane as being engaged in aviation or aeronautics than he would think of a passenger on a railroad train as being engaged in railroading or a passenger on an ocean liner as being en- gaged in navigation."37 In order to distinguish the Gibbs case, the court quoted "passenger air mile" statistics for i93o to prove that a trip by air was not "uncommon for the average individual, was neither an extraordinary event nor accompanied by unusual hazards" 3 -- a paraphrase of air travel in 1924 as described by the Gibbs court. The court saw nothing in the Gibbs opinion to foreclose "consideration of current changes in the common understanding of the ordinary everyday meaning of words and phrases which changing conditions of life over a lapse of time have effected." 9 The lapse of time, it should be noted, was only six years, and the court did not take the pains to quote "passenger air mile" statistics .for 1924.' . One would expect that the aviation risk clause would fare no better in the w ar- time aviation death cases. In the 1946 Clapper case,41 the circuit court for the Dis- trict of Columbia construed a policy issued in 1928 providing for double indemnity "if the death of the insured occurs ... from bodily inju~ries effected solely through external, violent, and accidental means . . [and] not . . from an aeronautic flight... ,"42 to cover a situation where the insured, a famous correspondent, lost his "Id. at 21o, 176 N. E. at X45. "Hartol Products Corp. v. Prudential Insurance Co. of America, 29o N. Y. 44, 47 N. E. 2d 687 (1943). "Id. at 46, 47 N. E. 2d at 689. I Id. at 48, 47 N. E. 2d at 689-690. "Id. at 51, 47 N. E. 2d at 69 . "Lehman, C. J., and Desmond, J., dissented on the ground that "by the clear and unambiguous language of the policy the accident was excluded from the coverage of the 'accidental death benefit provisions.'" Ibid. 'o On the general problem, see the exhapstive study by Glass, Aeronautic Risk Exclusion in Life In- surance Contracts, 7 J. AIR L. 305, 560 (1936). "Clapper v. Aetna Life Ins. Co., i57 F. 2d 76 (D. C. Cir. 1946), 14 U. oF Cm. L. REv. 693 (1947). "' Clapper v. Aetna Life Ins. Co., supra. 386 LAw AND CONTEMPORARY PROBLEMS life while an invited guest-passenger on a naval flight in the Marshall Islands. Here, there was no justification for the court to bring the policy clause up to date, because it would not be within "common understanding," that such a clause covered a military flight at the time of insured's death any more than in 1928. Relying on Webster's New International Dictionary, the court suggested, however, that "aeronautic flight" had an occupational significance, and "even if this interpretation is subject to challenge, the same result would follow, since at best the phrase is so ambiguous as to compel a decision in favor of the insured."43 The decision is questionable on two counts: Was the phrase ambiguous? Even if so, would not a reasonable person expect it to exclude a military flight? On its side the insurer had as an additional excuse in many of the World War II cases a war risk clause. But the availability of a war risk clause often turned out to be a two-edged weapon. For example, in the Schifter case,44 where in one clause the policy expressly excluded war-time military and naval service but by a later endorsement covered continental war service, and the insured was killed in a state-side training flight, admittedly excluded by the aviation risk clause, the New York court held the insured covered by the endorsement which spoke of all kinds of continental military service. Because of the internal contradiction, the result here seems reasonable. It does not, however, in the Conaway case4" where the failure of the insurer to insert in the policy proper a war risk clause while incorporating it in the double indemnity clause led the Ohio Supreme Court to draw the negative inference that the insurer did not intend its aviation risk clause to apply where the insured had met his death while piloting a military craft on a military mission. Though war was imminent when the insured applied for the policy, the majority interpreted the phrase in the policy "on account of the aviation hazard of the insured" to read "civilian aviation hazard" and accordingly gave judgment for the beneficiary.4" Even if war was not imminent, one wonders whether a reason- able man would not perceive that an insurance company concerned with the risks incident to civil aviation would a fortiori be concerned with the risk incident to military aviation. If the above cases can be considered at all typical, the courts seem here, as com- pared with their treatment of the formation-of-contract cases, to have done more than balance the scales in favor of the insured's reasonable expectations. Perhaps the results suggest the extremes to which the "interpretative device" can be put, once it becomes accepted as a tool of judicial construction. "Id. at 77. "Schifter v. Commercial Travelers Mutual Accident Ass'n of America, X83 Misc. 74, 50 N. Y. S. 2d 376 (Sup. Ct. 1944). 'n Conaway v. The Life Insurance Co. of Virginia, 148 Ohio St. 598, 76 N. E. 2d 284 (1947) (three judges dissented). ' See also Quinones v. Life & Casualty Insurance Co. of Tennessee, 2o9 La. 76, 24 So. 2d 270 (945), where the aviation rider in the usual form covering fare-paying flights only was held to cover a routine military flight. Tim SPECIAL NATURE OF THE INSURANCE CONTRACT C. Discharge: Settlement Practices A third stage open to possible* investigation in the life cycle of a life policy pre- sents itself after the death of the insured when the insurer attempts to "settle" with the beneficiary. Kellogg v. Iowa State Traveling Men's Ass'nY a 1947 Iowa decision, suggests that the classical contract rule of accord and satisfaction may be by-passed where a court concludes the insurer has been over-reaching in making a quick settlement with the beneficiary. In the Kellogg case the defendant insurer, a fraternal association, refused to pay the plaintiff beneficiary the full $5,000 in the membership certificate on the ground that the insured's death, which occurred within an hour after a highway collision, had been "effected or aggravated by heart disease," in which event the insurer's liability was limited to xo per cent, or $5oo, a check for which the company had sent the plaintiff in full settlement, and which check plaintiff had cashed. Though it is arguable that there was not an effective accord and satisfaction because the part payment was not tendered in satisfaction of a dis- puted or unliquidated claim and thus came within the prohibition of Foakes v. Beer,4 the Iowa Supreme Court stressed at some length that this was a situation "where the relationship between the parties is closely akin to a fiduciary one, and where the insurer should be most meticulous and conscientiously scrupulous to pro- tect the rights of the beneficiary and to give every opportunity to fully establish her rights."4 The spokesman for the three dissenting judges did not let the opportunity pass to point out that no authority was cited for this novel theory of fiduciary re- lationship which undercut the traditional assumption that "the parties were dealing at 'arm's length.' Defendant owed to the beneficiary the duty it would owe to any other person with whom it dealt-the duty to deal uprightly." In effect, the dis- senters did not see that the "settlement" in this case differed from one between a grocer and his debtor. The Kellogg case carries recognition of the inequality of the bargaining power of the parties beyond the negotiation stage over into the final settlement stage. In so doing it makes orthodox contract notions such as accord and satisfaction burst at the seams. Life insurance, of course, is not the only kind of one-sided transaction which has recently been subjected to the same kind of judicial treatment, as witness the railroad release cases. 5' III LEGISLATIVE CONCERN WITH THE INSURANCE CONTRACT If, as the recent cases seem to indicate, the judges have such difficulty squaring the general principles of contract law with the facts of insurance life, one might "Kellogg v. Iowa State Traveling Men's Ass'n, 239 Iowa 196, 29 N. W. 2d 559 (1947), 16 U. o CHi. L. REV. 177 (948). 489 App. Cas. 605 (1884). "Kellogg v. Iowa State Traveling Men's Ass'n, 239 Iowa 196, 213, 29 N. W. 559, 568 (1947). " Id. at 232, 29 N. W. 2d at 578. " See Frank, J., concurring in Ricketts v. Pennsylvania R. R., 153 F. 2d 757, 760 (2d Cir. 1946); c/. Callen v. Pennsylvania R. R., 332 U. S. 625 (1948).