Revise Muddy Insurer Contract Language, Consumers Urge NAIC

The hearing was held during the NAIC Spring National Meeting here.

"Almost all insurers either use this form directly or base their own policies on it," he said.

Outlining the complexity, Mr. Schwarz's written testimony said, "The policy itself is split into three sections: Section I, Property Coverage; Section II, Liability Coverage; and Sections I and II, Conditions." He added, "Section I is itself divided into four subsections: (i) Property Covered, (ii) Perils Insured Against, (iii) Exclusions, and (iv) Conditions."

To trigger coverage, he noted, the policyholder must satisfy all four subsections of Section I, and must comply with the second "Conditions" section at the end of the policy.

"In other words," said Mr. Schwarz, "to understand whether or not this policy provides coverage for any type of property damage–and, perhaps more importantly, to understand why it might not–the policyholder must look at and understand the relationship among five different portions of the contract located throughout the policy. Yet nowhere does the policy's structure or logic clearly suggest this."

"In sum," Mr. Schwarz said, "the homeowners insurance contract is a beautiful example of how not to write a clear contract."

Contracts are written this way, he explained, because without regulation, "insurers have very little reason to care about the clarity of their contracts so long as they achieve some degree of precision."

Additionally, Mr. Schwarz said insurers have gradually added to the contract over time, responding to court opinions and changing coverage provisions, and they simply insert new language wherever it fits rather than writing the policy over in a clear manner.

"Third," said Mr. Schwarz, "insurers have become very comfortable with this contract. Their lawyers have mastered it. Their actuaries base their models on it. And they know from experience what interpretations will hold up in court and what interpretations will not."

He contended the way to address this problem is "an organized commitment on the part of state regulators to work with industry and consumer representatives in a collaborative fashion to improve the clarity of insurance policies."

He added, "As such, what is needed now is not additional statutes or regulations, but rather a deeper appreciation and willingness to tackle this problem, even though the solution will necessarily be difficult and require hard work."

David Snyder, American Insurance Association assistant vice president and general counsel, said in his prepared testimony to be delivered at the hearing that personal lines property and casualty insurance contract readability is already heavily regulated.

"Current regulation represents an effective compromise between the desire for simplification and the fact that insurance policies are legal instruments that are heavily influenced by statutory law and judicial decisions," he said.

Changing the status quo, he said, "will bring on many unintended negative results in terms of loss of certainty, increased costs and wasteful expenditures on litigation provoked just because linguistic changes have been made."

He called for increased financial literacy through "broader use of existing resources and enhanced cooperation between the public and private sectors."

Bob Detlefsen, vice president of public policy at the National Association of Mutual Insurance Companies (NAMIC), said after the hearing that he pointed out the "first principle of insurance law" is that any ambiguity in contract language is automatically resolved in favor of the policyholder.

This ambiguity doctrine, he said, means that "almost by definition, language that is simple and straightforward is going to inevitably be found to be ambiguous."

He used as an example the lawsuits over the application of flood exclusion language in policies after Hurricane Katrina. Policies define flood "in a painstaking way," he said, and there was still litigation over what flood means.

In a statement, North Carolina Insurance Commissioner Wayne Goodwin, who chaired the hearing, said: "The hearing provides an important starting point for discussion on the issue of insurance contract readability standards. The current economic downturn makes it increasingly important that consumers are able to understand their insurance policies so they are not at a financial disadvantage and can make well-informed decisions about their insurance needs."