In this article, David Rubin discusses why this exclusion may eliminate the difficulties associated with the known loss doctrine while enforcing its core principle.
While the “known loss” doctrine is a basic concept of insurance, its application is often difficult and complicated. In Atl. Cas. Ins. Co. v. Garcia, 878 F.3d 566 (7th Cir. 2017), aff’g 227 F. Supp. 3d 990 (N.D. Ind. 2017), the United States Court of Appeals for the Seventh Circuit and the United States District Court for the Northern District of Indiana examined a “claims in process” exclusion which may eliminate the difficulties associated with the known loss doctrine while enforcing its core principle.
The Garcia case was an insurance coverage dispute over investigation and remediation costs for environmental contamination decided under Indiana law. Insurers in Indiana face a unique dilemma with claims for environmental contamination. Under Indiana law, unless a pollution exclusion specifically names the excluded substances in its definition of “pollutant,” the exclusion is ambiguous and therefore unenforceable. See State Auto. Mut. Ins.Co. v. Flexdar, Inc., 964 N.E.2d 845 (Ind. 2012); Am. States Ins. Co. v. Kiger, 662 N.E.2d 945 (Ind. 1996). Because the standard pollution exclusion in most liability policies does not specifically list what substances are considered “pollutants,” insurers are faced with the prospect of providing coverage for typically expensive environmental remediation actions which they never intended to cover.
The Known Loss Doctrine
Without an enforceable pollution exclusion, insurers often turn to the known loss doctrine as a defense to coverage for environmental contamination claims. As the Indiana Court of Appeals has explained, “the known loss doctrine is not so much an exception, limitation, or exclusion as it is a principle intrinsic to the very concept of insurance.” Gen. Housewares Corp. v. Nat’l Sur. Corp., 741 N.E.2d 408, 415 (Ind. Ct. App. 2000).
In the Gen. Housewares case, the Indiana Court of Appeals addressed the known loss doctrine as a matter of first impression under Indiana law. The court described the doctrine as “a common law concept deriving from the fundamental requirement in insurance law that the loss be fortuitous. Simply put, the known loss doctrine states that one may not obtain insurance for a loss that has already taken place.” Id. at 413 (citation omitted). The doctrine exists because “fortuity is a concept inherent to insurance. ‘Insurance has been defined as a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from an unknown or contingent event.’ ‘Implicit in the concept of insurance is that the loss occur as a result of an event that is fortuitous, rather than planned, intended, or anticipated.’” Id. at 414-15 (citations omitted).
The principle of fortuity and the underlying rationale of the known loss doctrine is perhaps best summarized by the United States District Court for the Southern District of Indiana in Warnock v. Office of Servicemembers’ Grp. Life Ins., No. 1:03-CV-1329-DFH, 2004 WL 1087364, at *3 (S.D. Ind. Apr. 28, 2004): “No insurer would issue a fire insurance policy on a house that has already burned down or a life insurance policy on a person who has already died.”
As the Indiana Court of Appeals noted in the Gen. Housewares case, however, application of the known loss doctrine can vary from jurisdiction to jurisdiction. 741 N.E.2d at 413. Potential application of the known loss doctrine can involve complicated and often fact-intensive questions of the level of knowledge required of the policyholder, the timing of the policyholder’s knowledge, as well as the status or existence of formal legal proceedings against the policy holder.
For example, under the known loss doctrine as applied in Indiana and other jurisdictions, it is not enough that the policyholder knows their property is contaminated when an insurance policy was issued.
In Thomson, Inc. v. XL Ins. Am., Inc., 22 N.E.3d 809 (Ind. Ct. App. 2014), a policyholder (“Thomson”) acquired a manufacturing plant located in Taiwan in 1987. Thomson was aware of environmental contamination at the site when the plant was acquired. In 1994, a Taiwanese legislator held a press conference to publicly accuse Thomson’s subsidiary of contaminating the soil and groundwater at and around the plant. Thomson, however, did not remediate the soil or groundwater because there was no statute at the time authorizing Taiwanese authorities to compel them to remediation. Also in 1994, Thomson notified its insurer at the time that “Taiwan authorities inform[ed] us of the existence of toxic substances in the ground” and “are holding us responsible.” Id. at 811.
Although Thomson voluntarily remediated the soil contamination in 1998, Thomson determined that groundwater remediation was neither required nor feasible. Although the Taiwanese government disagreed, it lacked the authority to require remediation at that time. In 2000, however, Taiwan passed a law that gave Taiwanese environmental agencies the power to require remediation. As a result, Thomson was required to remediate the groundwater.
In 2008, Thomson sought coverage for the remediation costs from one of its insurers (“XL”), which had issued primary and umbrella policies to Thomson from 2000 through 2006. Coverage litigation ensued, and XL obtained summary judgment in its favor based on the known loss doctrine. Thomson appealed the trial court’s summary judgment ruling.
On appeal, the Indiana Court of Appeals recognized that “[t]o be sure, Thomson had actual knowledge of the contamination of the soil and groundwater on the Taiwan Plant long before January 1, 2000, when the first XL policies became effective.” Id. at 815. However, the court found that:
Thomson is not seeking coverage for the environmental contamination to the Taiwan Plant. Rather, it is seeking coverage for the legal liability to remediate that contamination. That liability did not exist until the legislature in Taiwan enacted the legislation providing for retroactive liability for remediating environmental contamination in 2000. Prior to such enactment, Thomson could not have had actual knowledge of such liability or known that it was substantially certain to occur.
Indiana requires actual knowledge of the known loss. Therefore, it is irrelevant whether Thomson or others predicted the legislative enactment, whether it considered such enactment possible or even likely, or whether certain legislators publicly complained about the contamination and called for legislation to remediate it. Legislative enactments and the losses that result from them are fortuitous events that cannot be known until the day of enactment. Until the legislation was enacted, there was no liability, only the potential for such liability. Such a potential may constitute a known risk, but not a known loss. Id. at 815 (citation omitted).
As a result, the Indiana Court of Appeals reversed the grant of summary judgment in favor of XL, concluding that “Thomson did not have actual knowledge of its retroactive liability for remediating environmental contamination until after the effective dates of the policies purchased from XL. Therefore, the known loss doctrine did not preclude coverage for Thomson’s remediation costs under both XL’s primary and umbrella policies.” Id. at 816.
This formulation of the known loss doctrine begs the question: If a policyholder knows their property is contaminated, does the fact they have not been required to clean up the contamination make the property any less contaminated? Also, as noted by a dissenting opinion, the inapplicability of the known loss doctrine in such circumstances raises public policy concerns:
Thomson knew that the ground was contaminated. Thomson knew that the Taiwanese government was understandably unhappy with the situation. Thomson knew that the government held Thomson responsible for the contamination. And while Thomson received a No Further Action letter from Taiwan regarding the soil remediation, Thomson knew that the Taiwanese government was dissatisfied with its lack of effort regarding remediation of the groundwater contamination. Although it is true that the Taiwanese government lacked the authority to enforce its cleanup demands until 2000, Thomson was well aware of the underlying issues long before the statute and EPB Order were issued. To hold that Thomson did not “know” of this “loss” when it entered into the insurance policies at issue would be to turn the known loss doctrine on its head and to encourage would-be insureds to put on their blinders with superglue. I believe that such a result would be poor public policy. Id. at 817 (Baker, J., dissenting).
In addition to the public policy concerns about policyholders ignoring environmental contamination and other liabilities until forced to deal with them in order to avoid the known loss doctrine and obtain insurance coverage, there is a more fundamental question about the doctrine itself. If a loss is non-fortuitous (i.e., damage or injury has already happened or is happening when a policy is issued), should it really matter if the insured knew about it or not? By placing emphasis on the insured’s knowledge, the known loss doctrine can inadvertently “encourage would-be insureds to put on their blinders with superglue.” This is where the “claims in process” exclusion examined in the Garcia case comes into the picture.
The Garcia Case & the “Claims in Process” Exclusion
In the Garcia case, the policyholders (the “Garcias”) purchased property in Lake Station, Indiana in 2004. Although the property was contaminated at the time of the Garcias’ purchase, they claimed they had no knowledge of the preexisting contamination when they bought the property. The Garcias also stated they were unaware of the contamination until September 2014, when they learned of the Indiana Department of Environmental Management’s (“IDEM”) claim seeking to have the Garcias conduct and pay for further investigation and remediation of environmental contamination originating on the property.
Atlantic Casualty Insurance Company (“Atlantic”) issued two consecutive commercial general liability (CGL) policies to the Garcias in 2009 and 2010. In November 2014, the Garcias sought coverage from Atlantic for the IDEM claim. Atlantic denied coverage, and filed a declaratory judgment action in the United States District Court for the Northern District of Indiana requesting a declaration that its policies did not provide coverage to the Garcias. The Garcias subsequently filed a counterclaim for breach of contract and bad faith against Atlantic.
Both Atlantic and the Garcias moved for summary judgment in the district court. Atlantic argued two exclusions in its policies precluded coverage: (1) a pollution exclusion which Atlantic claimed included a sufficiently specific definition of “pollutants” to be enforceable under Indiana law; and (2) a “claims in process” exclusion which precluded coverage for:
- any loss or claim for damages arising out of or related to “bodily injury” or “property damage,” whether known or unknown:
- which first occurred prior to the inception date of this policy; or
- which is, or is alleged to be, in the process of occurring as of the inception date of this policy.
- any loss or claim for damages arising out of or related to “bodily injury” or “property damage,” whether known or unknown, which is in the process of settlement, adjustment or “suit” as of the inception date of this policy. 878 F.3d at 568.
Demonstrating the difficulties in enforcing pollution exclusions under Indiana law, the district court found the Atlantic policies’ pollution exclusion could be ambiguous because although the definition of “pollutants” listed some substances by name, it included others by reference to federal law. 227 F. Supp. 3d at 996-97. However, the district court found it was unnecessary to resolve the issue because of the “claims in process” exclusion. Id. at 997.
Atlantic argued that the “claims in process” exclusion “precludes coverage for losses or claims for damages arising out of property damage—known or unknown—that occurred or was in the process of occurring before the policy’s inception. So if the property damage happened before the policy period but the damage had not been discovered, the exclusion bars coverage.” Id.
The Garcias, on the other hand, argued that the relevant “loss” or “claim for damages” was the IDEM claim, which did not begin until 2014 when IDEM advised the Garcias of their obligation to clean up the contamination. Id. The Garcias also argued that they did not begin incurring expenses related to the claim until they entered into IDEM’s voluntary remediation program in 2015. Id. As a result, according to the Garcias, the “claims in process” exclusion was inapplicable because there was no loss or claim for damages in process before Atlantic issued the first policy in 2009. Id.
Rejecting the Garcia’s argument, the district court held that:
[T]o accept the Garcias’ position would be to ignore the claims-in-process exclusion’s plain language. That language excludes losses or claims for damages arising out of property damage, whether known or unknown, that first occurred or began occurring before the policy’s inception. The Garcias interpret the exclusion as barring coverage for claims or expenses that occurred or began occurring before the policy’s inception, but the relevant question is when the damage occurred or began occurring.
Here, there is no question that the pollution at issue—and hence the damage to the Garcias’ property—began long before the Garcias even bought the property. So the exclusion applies, and the policy does not provide coverage to the Garcias. Id. at 997-98 (citations omitted).
The district court granted summary judgment in favor of Atlantic, and the Garcias appealed the district court’s ruling to the United States Court of Appeals for the Seventh Circuit. On appeal, the Garcias argued the “claims in process” exclusion was ambiguous. As the Seventh Circuit explained:
Accepting the Garcias’ interpretation would exclude coverage for a claim for damages that occurred or was in the process of occurring before inception of the policy. On the other hand, accepting the district court’s interpretation would exclude coverage for any injury or damage that occurred or was in the process of occurring before inception of the policy. 878 F.3d at 569-70.
The Seventh Circuit rejected the Garcias’ claim of ambiguity, affirmed the district court’s summary judgment ruling in favor of Atlantic, and held that:
we read the exclusion to preclude coverage for losses or claims for damages arising out of property damage—known or unknown—that occurred or was in the process of occurring before the policy’s inception. Thus, if the property damage happened before the policy period, but the damage had not been discovered, the exclusion bars coverage. With no dispute that the damage to the Property began before the inception of the policies, we find that the “Claims in Process” exclusion bars recovery on behalf of the Garcias. Id. at 570.
The Garcias essentially made the same argument as the policyholder in the Thomson case discussed above. The Garcias claimed that no “loss” or “claim for damages” existed until they were required to begin remediation and incurred expenses to do so. However, as both the district court and the appellate court found, the plain language of the “claims in process” exclusion focuses on when the property damage or bodily injury occurred, not when claims based on the damage or injury are asserted. The explicit language of the exclusion also provides it applies to bodily injury or property damage “whether known or unknown.”
As the Garcia case demonstrates, the “claims in process” exclusion both bypasses the pollution exclusion problem for Indiana insurers (since it does not matter how the policy defines a “pollutant” when there can be no claim for coverage without “property damage,” and if the contamination occurred before the policy period, all losses or claims for damages arising from that “property damage” are excluded), and eliminates the issue under the known loss doctrine regarding the state of the policyholder’s knowledge.
“The Claims in Process” Exclusion Enforces the Concept of Fortuity
Although this article discusses the “claims in process” exclusion in the context of environmental contamination claims under Indiana law, the effect of this exclusion has applications for insurers nationwide in all types of claims. The “claims in process” exclusion eliminates the vagaries and potential unintended consequences of the known loss doctrine. There is no need to resolve the often fact-intensive and disputed question of what the insured knew and when they knew it. It also eliminates disputes regarding the legal authority or status of claims against the insured.
As discussed above, the concept of fortuity is inherent to insurance. Insurers underwrite policies and calculate appropriate premiums based on risk. The risk to be determined, however, is the risk of what might happen, and not the risk of what has already happened. In the latter scenario, there is in fact no risk to be insured against and there is no proper subject of insurance coverage. The known loss doctrine is intended to enforce this principle of fortuity.
In its application, however, the known loss doctrine can produce varied results, which may or may not be consistent with the concept of fortuity and its underlying principles. The “claims in process” exclusion enforces and expands upon the concept of fortuity with clear and unambiguous language that removes the issue of the policyholder’s knowledge and focuses on the damage or injury causing liability, rather than the sometimes arbitrary date of when liability could be or was imposed.
The “claims in process” exclusion benefits both insurers and policyholders. Insurers can underwrite and issue policies knowing that only truly fortuitous losses will be covered, and policyholders have clear guidance as to what claims will and will not be covered under their policies.
This article was first published in Insurance Law Essentials Deep Dives by International Risk Management Institute, Inc. (IRMI). Dave Rubin is senior counsel at KGR, and he primarily practices in the areas of insurance coverage, appellate law and commercial litigation.