Introduction
New Jersey's Appellate Division recently held that an insurance company, which accepts additional premiums to extend its policy's termination date for less than twelve months, must pay additional policy limits for claims triggering the extended "stub policy" period. The Court reasoned that "an insured who pays a prorated premium for insurance coverage for an additional period with all other terms of the policy to remain the same would reasonably expect that such a prorated premium reflects only the insurer's reduced time on the risk, not a reduction in the policy's aggregate coverage limits." United States Mineral Products Company v. American Insurance Company et al., (USM v. American), 792 A.2d 500, 502 (N.J. Super. Ct. App. Div. 2002).
United States Mineral Products Company ("USM") manufactured a spray-applied insulation product which contained asbestos. Based upon its sale of this product, which ended in 1972, USM received hundreds of thousands of product liability lawsuits and claims for bodily injury and property damage allegedly resulting from asbestos exposure. USM, in 1992, filed USM v. American against fourteen insurers from which it had purchased liability policies seeking coverage for its asbestos claims.
Several of USM's insurers, including Twin City Fire Insurance Company ("Twin City"), sold USM policy extensions or, as policyholders like to call them, stub policies. Twin City sold USM excess liability insurance coverage from August 8, 1983 through November 11, 1984. Twin City's policy provides $10 million liability limits which, according to the policy, apply separately to certain "Annual Aggregate Periods":
IT IS AGREED THAT FOR THE PURPOSE OF THIS INSURANCE THE ANNUAL AGGREGATE PERIODS SHALL APPLY AS FOLLOWS:
1ST FROM 8-1-83 TO 11-11-83
2ND FROM 11-11-83 TO 11-11-84
USM then purchased additional coverage from Twin City for the two week period from November 11, 1984 through November 25, 1984 ("Stub Policy"). An endorsement to the policy memorialized this additional coverage:
IN CONSIDERATION OF THE ADDITIONAL PREMIUM CHARGE OF $152.00, IT IS AGREED THAT THE POLICY PERIOD IS AMENDED TO EXPIRE AS FOLLOWS:
NOVEMBER 25, 1984
The endorsement also provided that "ALL OTHER TERMS AND CONDITIONS REMAIN THE SAME." The additional premium USM paid for the Stub Policy represents slightly more than a pro rata portion of the $5,040 premium USM paid for Twin City's initial policy.
USM argued Twin City must pay an additional $10 million for asbestos claims triggering the Stub Policy; i.e., Twin City now provided liability limits of $30 million broken down as follows:
PERIOD LIMITS 8-1-83 to 11-11-83
$10 Million
11-11-83 to 11-11-84
$10 Million
11-11-84 to 11-25-84
$10 Million
Twin City disagreed and argued its policy extension created no new policy limits. Twin City, therefore, broke down its policy limits as follows:
PERIOD LIMITS 8-1-83 to 11-11-83
$10 Million
11-11-83 to 11-25-84
$10 Million
Insurance Policy Interpretation
The Appellate Division approached this dispute by looking first to the special rules governing the construction and application of insurance policies. These rules arise from: (1) the standardization of insurance policy language, Sparks v. St. Paul Ins. Co., 495 A.2d 406, 414 (N.J. 1985); (2) the need, in the case of casualty insurance, to compensate innocent third parties for injury or damage allegedly caused by the insured, Odolecki v. Hartford Acc. & Indem. Co., 264 A.2d 38, 42 (N.J. 1970); and (3) the duty, imposed by law, requiring the insurer to place its policyholder's interests above its own, Pickett v. Lloyds, 621 A.2d 445 (N.J. 1993); Bowler v. Fidelity & Cas. Co. of N.Y., 250 A.2d 580 (N.J. 1969); Haardt v. Farmer's Mut. Ins. Co., 796 F. Supp. 804 (D.N.J. 1992).
These factors give rise to three fundamental principles of insurance policy interpretation:
(1) the objective in construing the policies' coverage of liability must be to give effect to the policies' dominant purpose of indemnity; (2) ambiguity in an insurance contract must be construed in favor of the insured; and (3) the court should ordinarily strive to give effect to the objectively reasonable expectations of the insured.
Keene Corp. v. Insurance Co. of N. Am., 667 F.2d 1034, 1041 (D.C. Cir. 1981), cert. denied, 455 U.S. 1007 (1982). USM argued these principles required the Court to construe the Stub Policy as providing additional liability limits.
USM argued further that an insurer bears the burden of proving its stub policy provides no additional liability limits. In Flintkote Co. v. American Mut. Liab. Ins., the court applied this principle in holding a stub policy provides additional liability limits:
[I]n construing these policies, the Court is mindful of the rule that the insurer has the burden of proof to show the applicability of a particular exception. Inasmuch as a limitation on the aggregate limit reduces coverage, it is in the nature of an exception and the insurance company bears the burden of proof.
Flintkote Co. v. American Mut. Liab. Ins., No. 808 594, Statement of Decision (Cal. Super. Oct. 14, 1992), reprinted in Vol. 6 Mealey's Litigation Reports: Insurance, No. 48, at B-40 – B-41 (Oct. 27, 1992). Flintkote conforms with New Jersey law -- and the law of most other states -- which requires courts to construe coverage limitations strictly against the insurer. See, e.g., Ruvolo v. American Cas. Co., 189 A.2d 204, 208-209 (N.J. 1963). The insurer, moreover, bears the burden of proving the scope and applicability of coverage limitations. Carter-Wallace, Inc. v. Admiral Ins. Co., 712 A.2d 1116 (N.J. 1998).
If insurance companies intend their stub policies to provide no additional liability limits, then they know how to draft language which specifically effectuates this result. The insurance industry has adopted language that Twin City could have used in its policies sold to USM and that any insurer can use in its policies sold to its policyholders:
If the policy period is extended after issuance for an additional period of less than 12 months, then the additional period will be deemed part of the last preceding period for purposes of determining the Limits of Insurance.
If an insurance company fails to use this language, then it cannot achieve the same result through litigation. As New Jersey's Supreme Court has held:
[I]n evaluating the insurer's claim as to the meaning of the language under study, courts necessarily consider whether alternative or more precise language, if used, would have put the matter beyond reasonable question.
Mazzilli v. Accident & Cas. Ins. Co., 170 A.2d 800, 803 (N.J. 1961).
The Case Law
Nearly every court examining this issue has held stub policies provide policyholders with additional liability limits. See, e.g., H.K. Porter Co., Inc. v. Columbia Cas. Co., No. 94-3638 (3d Cir. Sept. 8, 1995), reprinted in Vol. 9 Mealey's Litigation Reports: Insurance, No. 44, at A-1 – A-9 (Sept. 26, 1995) (applying Pennsylvania law); Stonewall Ins. Co. v. Asbestos Claims Mgmt. Corp., 73 F.3d 1178, 1216-17 (2d Cir. 1995) (applying New York law); Flintkote Co. v. American Mut. Liab. Ins. Co., supra (applying California law); In re Asbestos Insurance Coverage Cases, Phase IV, J.C.C.P. No. 1072 (Cal. Super. Jan. 24, 1990), reprinted in Vol. 2 Mealey's Litigation Reports: Insurance, No. 21, at 6-8 (Feb. 27, 1990) (applying California law); Unigard Sec. Ins. Co. v. North River Ins. Co., 762 F. Supp. 566 (S.D.N.Y. 1991) (applying Ohio law), rev'd o.g., 4 F.3d 1049 (2d Cir. 1993); Independent Petrochemical Corp. v. Aetna Cas. & Sur. Co., 1988 U.S. Dist. LEXIS 15839 (D.D.C. 1988) (applying Missouri law).
In Flintkote, the court rejected the insurer's argument that its stub policy afforded no additional policy limits. We quote at length from the court's opinion because it discusses many of the grounds courts rely upon in ruling consistently for policyholders on this issue:
The parties to the suit seek clarification of the limit of liability under policies that were effective for less than a full year....Each policy's declaration page sets out the aggregate limits available as well as the policy term or policy period. The parties do not dispute that the aggregate limits for the issued policies are applied separately to each annual term ....
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Each of the policies at issue was modified to cover an extended period of time. Nothing in the policy language makes the annual limit contingent on the policy remaining in effect for a year. The plain language of the policy does not address the treatment of a policy in effect for a fraction of the annual period.
The parties clearly intended some aggregate limit to apply to the extended fractional annual period. Three different constructions of the policies are possible. First, the aggregate limit from the prior annual term could be carried over to apply to the additional fractional period. Second, a new prorated aggregate limit could be applied to the fractional period.... Third, as Flintkote argues, the full aggregate limit could apply.... As all three of the constructions are reasonable, the Court determines that the provision is ambiguous.
Ambiguities are resolved in favor of Flintkote, the insured. Because the insurers drafted the endorsements which extended the policies in question, they were in the best position to prevent the ambiguity created....
Flintkote would have had available the full aggregate limit for a covered injury or series of injuries during the first month of a full term policy. Logic requires that, barring an express provision to the contrary, the prorated premium paid for some fraction of the full policy term would entitle Flintkote to the same annual aggregate limit. The prorated premium cannot reflect both a reduction in the duration of the risk to the insurer and a reduction in the full aggregate limit.... [Id. at B-39]
Stub Policies and Policy Cancellations
One can understand most easily this issue by analogizing stub policies to canceled full year policies. USM posited the following scenario to the Court in USM v. American:
- Twin City sells to USM an insurance policy for the policy periods from August 8, 1983 through November 11, 1984;
- USM pays Twin City $5,040 to purchase this policy;
- Twin City's policy provides, for product liability claims, $10 million liability limits calculated for each of the policy's "Annual Aggregate Periods," which the policy designates as August 8, 1983 through November 11, 1983 and November 11, 1983 through November 11, 1984;
- On February 2, 1984, Twin City issues an endorsement, which extends the policy for an additional one year period through November 11, 1985. This endorsement specifically provides that "ALL OTHER TERMS AND CONDITIONS REMAIN THE SAME";
- USM pays to Twin City slightly more than the original policy premium for the one-year extension; and
- On November 25, 1984, Twin City lawfully cancels the one-year policy extension and, pursuant to the policy terms, returns to USM most of the additional premium but retains the "pro rata" proportion of the premium for the two-week period the policy was in force; i.e., $152.
Twin City agreed -- because every insurer must agree -- that under this scenario, USM could recover additional aggregate liability limits for claims triggering the two week period from November 11, 1984 through November 25, 1984.
USM then posited an alternative scenario -- which, in fact, was the actual scenario before the Court -- where instead of Twin City canceling the one-year extension:
- The February 2, 1984 endorsement extends the policy for only a two-week period, from November 11, 1984 through November 25, 1984; and
- The policyholder pays to the insurer, for this two-week extension, the same pro rata premium amount; i.e., $152.
Twin City -- represented by the best insurer counsel available -- never could explain why the single, facially inconsequential distinction between the two scenarios relieved the insurance company, and deprived the policyholder, of $10 million in insurance coverage. Twin City could not distinguish the two scenarios because the two scenarios are indistinguishable: in both cases, the policyholder pays exactly the same amount of money for exactly the same type of coverage for exactly the same length of time.
Conclusion
If you paid additional premiums for an extension of your policy, then check the extension language carefully. In addition to extra time on the risk, you may have purchased a new set of liability limits. Remember; you get what you pay for.