Coinsurance and Other Insurance Policy Clauses Don’t Mix

In a methodically crafted decision filed January 18, 2018 on cross-motions for summary judgment, Stefan R. Underhill, judge of the United States District Court for the District of Connecticut, ruled that a business property insurance policy containing “Other Insurance” and “Coinsurance” provisions may not invoke them in combination to reduce the amount payable to the policyholder for fire damage. This is especially true where, as here, the “Other Insurance” clause does not even apply to the claim, because the loss amount exceeded the combined coverage limits of the insurance in force at the time of loss.

The case, Preferred Display v. Great American Insurance Company, is reported at 2018 U.S. Dist. LEXIS 7977.

The basic facts of the case do not appear to have been in dispute. The insurance policy in litigation was issued by defendant Great American Insurance Company. In force at the time of loss, the Great American policy provided up to $4 million coverage for damage to business personal property in the insured’s possession in East Glasonbury, Connecticut. The same policyholder purchased an additional $2 million of similar insurance from The Hartford Insurance Company, so at the time of loss, the insured had a total of $6 million in coverage, considerably less than the $7,907,217 value of the covered property at that time. The actual cash value of the fire loss was $6,392,119. The issue decided by the court was whether the “Other Insurance” and “Coinsurance” clauses of the Great American policy operated in combination to cumulatively reduce the amount payable to the policyholder on account of the loss it sustained. The insurance law portion of the court’s opinion commenced with a discussion of the operation and purpose of the two types of insurance policy clauses.

“Other Insurance” clauses are common insurance policy provisions inserted by insurers to preclude payment of a disproportionate amount of a loss borne by multiple insurers on the risk at the time of loss. Applying Connecticut law, the court noted that there are three basic types of “Other Insurance” clauses: excess, pro rata and escape. Connecticut recognizes “Other Insurance” clauses as valid for the purpose of establishing the order of coverage payments between or among insurers, but importantly for this case, only “as long as their enforcement does not compromise coverage for the insured.”

The court summarized the operation of the three basic types of “Other Insurance” policy provisions, stating that an excess “Other Insurance” clause provides that if there is other valid insurance covering the loss, the excess policy applies only if and after the claimant’s loss exceeds and exhausts the policy limits of the other insurer, referred to as the “primary” insurer. A pro rata “Other Insurance” clause provides that if there is other valid coverage for a loss, each insurer is liable only for its pro rata share of the loss, calculated as the proportion that its policy limit bears to the total of all policies’ limits of liability. An escape-type “Other Insurance” clause, valid as long as the insured is protected (See, e.g., California Practice Guide (2016), The Rutter Group, ¶ 8:21) but disfavored by public policy (ibid, ¶ 8:22), provides that the existence of other coverage extinguishes the liability to the insured of the insurer with that clause.

The Great American policy had an “Other Insurance” provision containing both a pro rata clause and what the court referred to as a “contingent excess” clause. The pro rata clause governed payment of the loss if and to the extent that the insured’s other insurance covered the loss on the “same basis” as the Great American policy. If the insured had other insurance covering the loss on a different basis than the Great American policy, the Great American coverage under its policy would become excess to that other insurance, paying only after the other policy was exhausted.

The court found it unnecessary to decide whether The Hartford’s insurance coverage was provided on the same terms as Great American’s, and thus whether the pro rata clause or the excess clause of the Great American policy applied to the loss. The reason: The amount of the loss, $6,392,119, exceeded the total insurance available from all insurers, $6,000,000. Under those circumstances, neither of the two Great American “Other Insurance” clauses may operate to reduce Great American’s liability to the policyholder below the Great American coverage limit of $4 million. Put another way, because the total loss exceeded the total combined coverage limits of the two insurers, Great American’s pro rata share of that loss must be higher than its coverage limit, and its liability must therefore default down to its coverage limit.

The same is true if the Great American excess other insurance clause applies to the loss. The amount Great American must pay the insured is not reduced below its policy limit, even if The Hartford is required by the Great American excess other insurance clause to pay its policy limits before Great American begins to pay its share of the loss. Because the loss is more than the combined policy limits of both insurance policies, first fully subtracting The Hartford’s policy limit from the amount of the loss would still leave the insured with more unpaid loss than Great American’s entire policy limit of $4 million. “The order of payment in this case is therefore inconsequential and each insurer is liable for the full amount due under its policy.” In summary, because this was not a case of potential double recovery by the policyholder, the Great American “Other Insurance” clause had no impact on the amount owed for the loss by Great American under its policy.

The court next considered Great American’s argument that the coinsurance clause of its policy, in combination with the “Other Insurance” provision, required Great American to pay only $2,680,250.23 to the policyholder, based on a coinsurance calculation using Great American’s “pro rata share of the total amount of the loss,” in place of the “total amount of loss.”

Before digging into the numbers, the court noted that coinsurance clauses are insurance policy provisions requiring the insured to maintain coverage to a specified value of its covered property. Such provisions typically stipulate that, if the policyholder fails to do so, it becomes a “coinsurer” with the insurance company, because it must bear its proportional part of the loss. Its alternative to absorbing loss itself is to purchase and rely on additional insurance.

The Great American coinsurance clause did potentially limit Great American’s exposure to this loss, because the value of the covered property of the time of loss, multiplied by the 80% coinsurance percentage stipulated in the “declarations” of the Great American policy, results in a sum (about $6.3 million) that is greater than the limit of insurance under the Great American policy ($4 million). Based on these figures, the Great American coinsurance clause required Great American to pay the lesser of a calculated sum specifically called out in the clause itself, or the $4 million limit of insurance under that policy. Put another way, the coinsurance clause imposes a “coinsurance penalty” upon the policyholder if and to the extent it fails to purchase, in this case from Great American, insurance with a limit of liability equal to or greater than 80% of the value of the property covered by the Great American policy.

The calculation specified in the coinsurance clause was divided into four steps:

“1. Multiply the value of Covered Property at the time of loss by the coinsurance percentage [here 80%]:
“$7,907,217 x 80% = $6,325,773.60
“2. Divide the Limit Of Insurance of the Property by the figure determined in Step 1:
“$4,000,000/$6,325,773.60 = 0.6323
“3. Multiply the total amount of loss, before application of any deductible, by the figure determined in Step 2:
“$6,392,119 x 0.6323 = $4,041,736.84
“4. Subtract the deductible from the figure determined in Step 3:
“$4,041,736.84 – $25,000 = $4,016,736.84.”

The coinsurance clause stated, also, that the most Great American would pay on account of any loss was $4 million, its policy’s limit of liability, so that was the amount due from Great American on account of the loss.

The court rejected Great American’s modification of Step 3 of the coinsurance calculation. That step required that the “total amount of loss” ($6,392,119) be multiplied, before application of any deductible, by the figure determined in Step 2, 0.6323 – the decimal fraction of how much insurance the policyholder purchased from Great American compared to the 80 percent it needed to avoid a “coinsurance penalty.” Instead of using the actual total amount of loss in the Step 3 coinsurance calculation, Great American used the “Other Insurance” calculation – not even applicable to the loss, as we have seen, because the loss exceeded the total insurance coverage amount of $6 million –– to “determine” that the “total amount of loss” was $4,261,412.67. In fact, that sum was the total amount of loss ($6,392,229) reduced by one-third, the fraction of the loss represented by the $2 million limit of The Hartford’s policy. Great American explained in a footnote in its summary judgment memorandum that, “[i]n light of the other insurance provision, the total amount of the loss would be $4,261,412.67, which is Great American’s pro rata share of the total amount of the loss.”

The court criticized Great American’s approach to the loss because it sought to rewrite the terms of the coinsurance clause, by improperly reducing by one-third the total amount of loss figure used in the Step 3 calculation.

In a second attempt to justify paying a lower amount to its policyholder, Great American explained in its reply brief that it properly calculated Step 3, but then, rather than obeying Step 4’s instruction to use “the figure determined in Step 3” ($4,041,736.94), it instead reduced that figure by one-third and used it in the Step 4 calculation. The court said, “Neither of the one-third reductions was required – or permitted – by the terms of the Coinsurance Clause.”

The court also explained that Great American’s approach was in conflict with the terms and purpose of insurance policy “Other Insurance” clauses, which is to prioritize payouts among insurers; their purpose is not to reduce the coverage provided to the insured.

Finally, the court found Great American’s policy position to be unreasonable, because under Great American’s interpretation, the insured was much worse off – more than $1.3 million – because it had purchased $2 million in additional insurance from The Hartford. But for that purchase, Great American would have to concede that the insurer owed its policyholder $4 million, the limit of its insurance, not $2680250.23, as the insurer contended, because, there being no other insurance, the other insurance clause would not apply to reduce the amount due under the coinsurance calculation.