Why You Need to Read Policy Definitions
Most insurance policies contain a section entitled Definitions. This section often appears at the end of the policy form, where it is easy to overlook. Yet, definitions are an important part of an insurance contract. They establish the meaning of key terms in the policy.
Identifying Defined Terms
In most policy forms, defined terms are highlighted in some manner, such as bold text or italics. ISO emphasizes defined terms by showing them in quotation marks. Regardless of the method used to distinguish them, all highlighted words should be listed in the policy's Definitions section.
Policies that provide multiple coverages often contain more than one definitions section. For example, suppose you have purchased a package policy that includes general liability and commercial property coverages. Your policy will likely contain two sets of definitions, one that applies to liability coverage and another that applies to property coverage. Your policy may also contain a set of common definitions, which apply to both coverages.
Most words or phrases that are defined in the policy can be found in the definitions section. However, some may appear in other parts of the policy. These can be easy to miss. For example, the ISO general liability policy defines the word you. This term means the named insured. You is defined in the beginning of the policy (in paragraph two on page one). Because you is not shown in quotation marks, it does not appear in the general liability definitions.
Purpose of Definitions
Insurers utilize definitions to specify the meaning of certain terms. Typically, insurers define a word or phrase to limit its scope. The goal is to prevent policyholders (and the courts) from interpreting terms more broadly than the insurer intended.
For example, the standard ISO liability policy mentions two types of vehicles, autos and mobile equipment. Liability policies cover claims arising from accidents that result from the operation of mobile equipment, such as forklifts and backhoes. They exclude claims arising from accidents stemming from the operation of autos. Policies define the terms auto and mobile equipment to distinguish the excluded vehicles from those that are covered.
An insurer may add a definition to a policy to eliminate disputes over the meaning of a word or phrase. For example, prior to 1998, the standard ISO liability policy did not define the term advertising. Numerous disagreements arose between insurers and policyholders about the types of activities that qualified for coverage under advertising injury. To address the problem, ISO added a definition of the word advertisement to the policy.
Some definitions are designed to clarify policy exclusions. For example, the ISO commercial property policy excludes loss or damage caused by volcanic eruption. The exclusion contains an exception for ensuing loss by volcanic action. Because many policyholders are unfamiliar with the term volcanic action, it is defined in the exclusion. This term does not appear in the property definitions section.
Another example of a term defined in an exclusion is electronic data. This term is defined in the ISO liability policy, but it does not appear in the policy definitions. Rather, its meaning is explained in the electronic data exclusion under Bodily Injury and Property Damage Liability.
Exclusions in Definitions
As noted previously, insurers include definitions to limit the meaning of words or phrases. Thus, definitions may contain exclusions. An example is the defined term employee in the ISO general liability policy. The definition doesn't explain all of the types of individuals that may qualify as employees. Rather, it simply states that the term employee includes a leased worker, but does not include a temporary worker. Essentially, the definition serves as an exclusion for suits against temporary workers.
Another definition that contains an exclusion is the defined term sinkhole collapse. This term is defined in the ISO commercial property Causes of Loss form. The definition states that sinkhole collapse does not include the sinking or collapse of land into man-made underground cavities. In other words, sinkhole collapse means the collapse of natural sinkholes, not those that are man-made.
Insurers and insureds don't always interpret policy language in the same manner. Different interpretations can lead to disputes. When a policyholder disagrees with the insurer's interpretation of a word or phrase, he or she may contend that the language is ambiguous. Generally, policy wording is considered ambiguous if it has two or more reasonable interpretations.
For example, suppose a policyholder owns a building that is insured under a commercial property policy. The policyholder's building has been damaged. The policy excludes loss or damage caused by collapse, but does not define collapse. The policyholder and insurer disagree as to whether the collapse exclusion applies to the loss. The insurer argues that the building has collapsed because it is sagging. The policyholder contends that a building has not collapsed because it has not fallen down. A court determines that the word collapse is ambiguous, since both the insurer's and the policyholder's interpretations of the word are reasonable.
Contracts of Adhesion
Insurance policies are contracts of adhesion, meaning they are drafted by one party only. The insurer writes the policy and offers it to the buyer. Unless the buyer is a very large company, it has little power to negotiate policy terms. Most insurance buyers have only two options. They can accept the policy the insurer has offered, or they can reject it.
Because insurers have the power to draft policy language, courts generally interpret ambiguous terms in the policyholder's favor (against the insurer). That is, if a policyholder and an insurer disagree over the meaning of a term, and that term has two or more reasonable interpretations, a court will likely choose the meaning that benefits the insured.
In the scenario described above, the insurer and the policyholder disagreed about the meaning of an undefined term (collapse). When a word is not defined in the policy, how do courts decide what the word means?
First, a court may consider previous rulings on the meaning of the term. Prior court decisions (called precedent) often serve as guidelines for future decisions. If no previous decisions exist or prior rulings don't apply, a court may consult a standard dictionary to determine the meaning of the word. It may also consider how a policyholder would likely interpret the word. Courts recognize that a typical insurance buyer may interpret insurance terminology differently from an insurer.
Importance of Definitions
Do policy definitions really matter? Silverstein Properties and its property insurers learned the answer to that question the hard way.
Silverstein Properties is a commercial real estate developer based in New York City. In July of 2001, Silverstein purchased a 99-year lease on the World Trade Center, including the Twin Towers. The property was (and still is) owned by the Port Authority of New York and New Jersey. As required by the lease, Silverstein purchased property insurance on the Trade Center buildings. The company insured the property for about $3.5 billion. The insurance consisted of a primary property policy and many excess policies.
Two months into the lease, the Twin Towers were destroyed when terrorists flew hijacked planes into the buildings. At the time of the attacks, only one insurer had issued a policy. The remaining insurers had issued binders, but were still in the process of negotiating coverage.
A fierce debate soon erupted between Silverstein and its insurers. There were two major issues. First, the broker had failed to clarify which of two property forms the insurers were to utilize: one provided by the broker or an insurer's form. Secondly, the towers had been hit by separate planes. Did the attacks constitute one occurrence or two? This was important since property limits apply separately to each occurrence.
The broker's policy form defined the term "occurrence," but the insurer's form did not. A court determined that the two attacks were considered a single event under the broker's form, based on its definition of occurrence. Under the insurer's form, however, the two attacks were considered separate occurrences. Ultimately, some insurers paid losses under the broker's form while others were required to pay under the insurer's policy. Silverstein received approximately $4.6 billion in payments from insurers.
If all insurers had been required to pay under the insurer's policy form, Silverstein could have collected $7 billion (two times the $3.5 billion policy limit).