Insurance Is Personal, Isn’t It?

It is fair to say that the law is of two minds when it comes to viewing insurance policies as personal services contracts between specific insureds and their insurers.

In some contexts, courts focus on the personal nature of risk and the relationship between the insured and the insurer, and impose coverage restrictions where there has been an unwarranted change in the personal nature of the risk transfer. Examples of this view include enforcement of a vacancy exclusion in a homeowner’s policy, misrepresentation defenses for non-disclosure of medical conditions under a life insurance policy, and even late notice or notice/prejudice determinations which focus on the insured’s actual knowledge and conduct and the impact of notice deficiencies on the insurer in the specific circumstances of individual claims.

In other situations, courts view insurance as a transferable asset that lubricates the wheels of commerce, or as a means to accomplish a desired social outcome. Examples of this view include decisions applying mandatory insurance requirements, such as no-fault auto insurance, notwithstanding non-compliant conduct by the specific insured, or upholding statutes precluding individualized underwriting considerations, such as precluding consideration of race based mortality differences by life insurers, or decisions which view insurance contracts as fungible assets of the insured to be allocated among various creditors in bankruptcy. In this latter context, the ability to transfer the insurance as an asset of the insured in a bankruptcy proceeding, may depend on whether the loss has already occurred and whether the proposed transfer is limited to the insurer’s payment obligation and on the specific assignment provisions in the policy.

A recent filing by Chartis (f/k/a Commerce & Industry Insurance Co. and American International Specialty Lines Insurance Company) in the United States Bankruptcy Court for the Southern District of New York objecting to an environmental property damage settlement and assignment of insurance proceeds between the debtor, Tronox Inc., a specialty chemical maker, and certain newly created trusts, illustrates this dichotomy. A copy of Chartis’s filing is available here: Chartis Objections to Settlement and Assignment of Policies

The plan for Tronox’s reorganization included a settlement agreement between Tronox and various governmental entities for Tronox’s share of environmental liabilities at owned and non-owned sites. Pursuant to the settlement agreement which is an integral part of the proposed reorganization plan, Tronox’s environmental liabilities were acknowledged and funded through several special purpose trusts which were to be funded in part by Tronox and in part by anticipated insurance recoveries from policies issued to Tronox by Chartis.

Of note here is that the Chartis policies at issue are not garden variety CGL policies providing coverage for property damage caused by pollution based upon an inability to apply a pollution exclusion with a sudden and accidental exception, or a legacy CGL policy dated prior to the adoption of the pollution exclusion. Instead, these policies are recently issued specialty liability insurance policies specifically designed to address the insured’s legal liability resulting from pollution. Two of the polices are entitled “Pollution Legal Liability and Cost Cap Insurance,” while the third provides “Pollution Clean-Up and Legal Liability” coverage.

Such specialized coverages are usually individually evaluated and priced by underwriters with technical expertise in pollution costs, and involve either individual project based assessments regarding the extent and timing of an insured’s liability at a single known site or collection of sites. This individualized underwriting and policy issuance may include a number of factors which are insured specific, including the insured’s financial incentives as an ongoing business to minimize its liability at known sites and/or the insured’s ability to control clean up costs by influencing the adoption of specific clean up methods, or the insured’s anticipated participation in testing or clean up at the site.

Chartis’s objections to the environmental settlement agreement incorporated into the reorganization plan and the assignment of the Chartis policies to the newly created trusts included an assertion that the insured (pre-bankruptcy) had a financial incentive to avoid and/or minimize such liabilities, while the special purpose trusts had the incentive to fully address environmental liabilities and maximize insurance recoveries. In making its objections, Chartis focused on the personal nature of the risk transfer between Tronox and Chartis:

The duties of the insured to the insurer (including the insured’s duties to cooperate and to minimize costs) are current and ongoing. Accordingly, as we now demonstrate, assignment of these policies violates sections 1129(a)(1) and (3) of the Bankruptcy Code because the assignment is prohibited by applicable non-bankruptcy law and is not authorized by the Bankruptcy Code. Assignment without Chartis’s consent is also prohibited by section 365(c)(1)(a) of the Code because Chartis is excused from accepting performance from anyone but the debtor.

Because the policies are in-force and executory, applicable nonbankruptcy
law enforces the consent-to-assignment provision of the policies. E.g.,
Travelers Casualty & Surety Co. v. United States Filter Corp.
, 895 N.E.2d 1172 (Ind. 2008). That is, because the duties of an insured under an in-force policy are personal to the insured, see, e.g., Couch on Insurance § 35:5-7 (3d ed. 2004); 2A-70 Appleman on Insurance § 1193 (2005), Chartis is not required to accept performance from any party other than its insured. As the Court stated in Travelers: “Insurance providers have a legitimate business interest in restraining assignment — these provisions protect them from a material increase in risk for which they did not bargain, specifically because of a change in the nature of the insured. Consequently a consent-to-assignment clause is generally enforced against attempted transfers of the policy itself . . . .

Chartis also argues that pursuant to the voluntary payment provisions of the policy, the environmental settlement itself cannot bind Chartis in the absence of its consent which it is withholding. Because its policies are not “expired,” Chartis argues that judicial decisions permitting the assignment of liability policies in bankruptcy are inapposite. Chartis also notes that two such decisions (allowing assignment) are pending before the US Court of Appeals for the Third Circuit, citing In re Federal-Mogul Global Inc., 385 B.R. 560, 567 (Bankr. D. Del. 2008), aff’d, 2009 U.S. Dist. LEXIS 24302 (D. Del. Mar. 24, 2009), appeal pending, No. 09-2230 (3d Cir.) and In re Global Indus. Techs., Inc., No. 08-3650 (3d Cir.) (en banc argument October 13, 2010).

While it is clear that Chartis was forced to react to the proposed settlement and insurance policy assignment in the Tronox case on short notice, it would be well advised to develop the facts supporting the personal nature of the risk insured and the specific circumstances of the underwriting. Other insurers faced with assignment efforts in bankruptcy proceedings would be well advised to do the same, and to be ready to document the personal nature of the insured’s cooperation obligations, which continue even after the loss has occurred.

The social objective of using insurance proceeds to fund environmental clean ups that a bankrupt insured cannot otherwise afford may, at first blush, seem laudable, there is, however, a real danger to this “insurance as fungible asset” based view in the context of risk management. The individual underwriting involved in modern pollution legal liability insurance considers the insured’s ability to limit its pollution legal liability and sets pricing based on the risk and on the insurer’s assumption that in the event of a covered loss, that specific insured will perform its cooperation obligations to mitigate pollution losses. This individual risk assessment/premium setting process, repeated across the market increases the costs of any individual insured’s environmental non-compliance and effectively promotes risk reduction practices. The alternative “fungible asset” view of insurance results in higher premiums for all, as insurers must spread the increased cost across all policies, thereby removing at least some portion of the insured’s financial incentive to control risk in exchange for lower premiums.

If you have questions, please contact Joseph S. Sano, a partner in Prince Lobel’s Insurance and Reinsurance Practice. You can reach Joe at 617 456 8000 or jsano@PrinceLobel.com.