It is axiomatic that traditional insurance policies cannot be purchased to cover losses known to exist. A classic example is the homeowner standing in his basement, with water up to his ankles, who tries to order flood insurance for the first time. 

Insurance companies attempt to expand this general rule by advocating for a “known loss” bar to coverage (the “Known Loss Doctrine”), asking courts to analyze whether circumstances known to the policyholder before the policy was sold portended a future loss and should have been disclosed to the insurance company.  In other words, insurance companies argue, coverage should be excluded for any subsequent losses somehow arising from facts the policyholder knew about. 

Policyholders can theoretically “contract around” the Known Loss Doctrine via policy language addressing situations insurance companies would otherwise argue are governed by the doctrine.  The policyholder should negotiate clear prior circumstances/losses language specifying what information must be disclosed to the insurance company, and when.  For example, what types of facts sufficiently indicate a potential future occurrence that they must be disclosed?  What degree of conflict with a third party sufficiently portends a future claim that it must be disclosed?  The clearer the language the better.

Even when the policyholder has negotiated for a policy that unambiguously covers a type of loss, however, the insurance company might invoke potentially more favorable common law by asserting the Known Loss Doctrine.  Two leading state supreme court cases demonstrate how different results can be reached despite similar facts.

In Rohm & Haas Co. v. Continental Cas. Co., 781 A.2d 1172 (Pa. 2001), the Pennsylvania Supreme Court held that if the policyholder was aware or should have been aware of likely future losses triggering the policy, the insurance company can deny coverage in certain instances.  The policyholder, a chemical company, knew of arsenic pollution at its facility since 1964, but did not tell its insurance company until 1988.  On one hand, the company was never sued by private citizens and until 1980 was unhindered by modern regulations, suggesting future liability was unlikely.  On the other hand, the policyholder was previously held liable for the arsenic pollution under a 1937 law and had voluntarily paid medical bills likely arising from the pollution for nearby residents, seemingly to avoid lawsuits. 

After the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) was passed in 1980, the policyholder was assessed significant cleanup costs and subsequently informed its insurance company of the pollution.  A plurality of the court held that even though covered losses were not inevitable in the 1960s, the company was or should have been aware of likely future losses; it therefore upheld the insurance company’s Known Loss Doctrine defense.

By contrast, in Montrose Chemical Corp. v. Admiral Ins. Co., 913 P.2d 878 (Cal. 1995), which also involved a chemical company’s potential CERCLA liability, the California Supreme Court applied its version of the Known Loss Doctrine (the ”loss-in-progress” rule) to find for the policyholder.  Prior to the policy period, the policyholder received a letter from the EPA informing it of potential CERCLA liability.  The policyholder was therefore aware of the potential liability, at the latest, when it received this letter.  Even though the letter suggested future CERCLA action against the policyholder by the EPA (and Montrose was in fact later sued by the EPA), the Court emphasized that there was no certainty of liability arising during the relevant policy periods—the policyholder was merely potentially responsible for cleanup costs.  Without certainty, the Court held, there was a known risk, but no known loss.  The insurance company was required to provide coverage for the subsequent lawsuit.  In a later California case involving a pollution site at issue in Montrose, the court reiterated California’s pro-policyholder approach: “Being aware of a risk of a particular event is not equivalent to knowing or believing the event is highly likely to occur.”  State of California v. Allstate Ins. Co., 201 P.3d 1147, 1161 (Cal. 2009).

The Rohm & Haas and Montrose policyholders were both subject to potential CERCLA liability, yet the courts reached opposite conclusions.  Given this divergence, it is difficult to predict how a given court will apply the Known Loss Doctrine.  Even in Pennsylvania, despite what insurance companies may consider the favorable Rohm & Haas standard, courts have subsequently reached pro-policyholder decisions.  See, e.g., Cincinnati Insurance Cos. v. Pestco, Inc., 374 F. Supp. 2d 451 (W.D. Pa. 2004); Behringer Saws, Inc. v. Travelers Indemnity Co. of Illinois, 2003 WL 21962949 (Pa. Com. Pl. Aug. 19, 2003).  Policyholders should expect that regardless of how a state interprets the Known Loss Doctrine, their insurance company might argue that the doctrine applies.  In response, policyholders should: (i) focus on their particular policy language; and (ii) emphasize that the doctrine applies only to known losses, as in Montrose, not to known risks.

Nicholas R. Maxwell is an attorney in the New York office of Anderson Kill, a national law firm.  Mr. Maxwell’s practice concentrates in insurance recovery, exclusively on behalf of policyholders, and in environmental and employment law. (212) 278-1161 | nmaxwell@andersonkill.com.