Why You Need to Read Policy Definitions
The Definitions Section Serves as Glossary For the Policy
Most insurance policies contain a section entitled Definitions, which often appears at the end of the policy form. While they are easy to overlook, the definitions are important as they establish the meanings of key terms in the policy.
Identifying Important Terms
Most policy forms contain defined terms. ISO highlights such terms by the use of quotation marks. Some insurers use italics while others use bold text or underlining. No matter how they are identified, highlighted words should be listed in the policy's Definitions section.
Policies that provide multiple coverages may contain a separate definitions section for each. An example is the ISO Business Owners Policy (BOP), which includes general liability and commercial property coverages. The BOP contains two sets of definitions, one for liability coverage and another for property coverage. Some policies also contain a set of common definitions that apply to all coverages.
While most defined terms appear in the Definitions section, some can be found in other parts of the policy. An example is the word you in the ISO general liability policy. 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 define words or phrases to limit their scope. Their goal is to prevent policyholders (and the courts) from interpreting terms more broadly than insurers intended.
For example, the standard ISO liability policy cites two types of vehicles, autos and mobile equipment. The policy covers claims arising from accidents that result from the operation of mobile equipment, such as forklifts and backhoes. It excludes claims arising from accidents stemming from the operation of autos. The policy defines auto and mobile equipment to distinguish excluded vehicles from those that are covered.
Definitions may be added to a policy to head off future disputes over words or phrases that have generated controversy in the past. For example, pre-1998 versions of the standard ISO liability policy covered personal and advertising injury but did not define advertising. Not surprisingly, insurers and policyholders often disagreed about the types of advertising-related activities that qualified for coverage under the policy. ISO attempted to end the debate by adding a definition of the word advertisement to the policy.
Some definitions are part of policy exclusions. For example, volcanic action is defined in the earth movement exclusion that appears in the ISO commercial property policy. Part Five of the exclusion precludes loss or damage caused by volcanic eruption. However, an exception applies to ensuing loss by volcanic action. Few policyholders are familiar with this term so it is defined in the exclusion. Volcanic action is not listed in the property definitions section.
Another term that's defined in an exclusion is electronic data. The meaning of this word is explained in the electronic data exclusion found in the ISO liability policy under Bodily Injury and Property Damage Liability. It does not appear in the liability definitions.
Definitions That Act As Exclusions
Some definitions serve as exclusions. An example is the explanation of the term employee in the ISO general liability policy. The definition doesn't indicate who does (or doesn't) qualify as an employee. 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 functions as an exclusion is the meaning of sinkhole collapse. This term is defined in the ISO commercial property Causes of Loss forms. The definition excludes the sinking or collapse of land into man-made underground cavities. In other words, sinkhole collapse means the collapse of natural sinkholes, not man-made ones.
Policyholders may interpret policy language differently from insurers, and this can lead to a coverage dispute. When a policyholder disagrees with an insurer's interpretation of a word or phrase, he or she may argue 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 policy excludes loss or damage caused by collapse but does not define collapse. The building has been damaged, and the policyholder and insurer disagree as to whether the collapse exclusion is relevant. The insurer argues that the building has collapsed because it is sagging so the exclusion applies. The policyholder contends that the building has not collapsed because it has not fallen down.
A court determines that the word collapse is ambiguous since both interpretations of the word are reasonable.
Insurance policies are contracts of adhesion, meaning contracts drafted by one party only. The insurer writes the policy and offers it to the buyer. Most buyers have little power to negotiate policy terms. They can either accept the policy "as is" 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). This means that if a term has two or more reasonable interpretations, a court will likely choose the one that benefits the insured.
When a policyholder and an insurer disagree about the meaning of a term that isn't defined in the policy, how does a court resolve the dispute? First, the court might 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 none is relevant, a court might rely on the definition in a standard dictionary. It may also consider how a policyholder would likely interpret the word.
Importance of Definitions
Do policy definitions really matter? As Silverstein Properties and its property insurers learned the hard way, the answer is yes.
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 purchased about $3.5 billion in insurance, including a primary property policy and many excess policies.
Two months into the lease the Twin Towers were destroyed by terrorists flying hijacked planes. When the attacks occurred 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, each tower had been hit by a separate plane. 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 constituted 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).