by Robert Koch
1. Subject and purpose
Liability insurance indemnifies the insured against the financial consequences of his legal liability to third persons (whether established or merely alleged) arising from his acts or omissions. It contrasts with (first party) insurance which covers losses which the insured has sustained to his own property or person. Liability insurance is not insurance of (specific) goods owned or possessed by the insured, but rather of the insured’s pool of assets in that it protects the insured against pecuniary (financial) loss associated with litigation. Depending on the risk insured (eg general liability, product liability or recall, environmental liability, professional indemnity (professional liability), employer’s liability, D&O liability) the insurer will indemnify the insured against third party claims in respect of any bodily injury, property damage, and/or financial loss which results neither from bodily injury nor property damage.
Liability insurance in its present form is closely connected with the development of industry, trade and transport in the 19th century. It emerged from accident insurance which provided the employer with cover where a workman was injured in the course of his employment. In such a case, the employer’s liability would be reduced by the amount of any compensation paid to his employee by the accident insurer, if the employer had contributed to the accident insurance premium because the insurer was deemed to pay in lieu of the employer. Liability insurance grew into a distinct class of insurance towards the end of the 19th century, when many countries started to introduce workers’ compensation laws which replaced employers’ liability with provisions more generous to the employee. Since then there has been an ever-expanding exposure to the risks associated with legal liability due to developments in science and technology, increased litigiousness across the world, the growing mobility of goods and individuals and the development of new categories of legal liability designed to protect and compensate injured parties. Today, liability insurance is the most common—and in the realm of strict liability the most important means of transferring risk from individuals and businesses to an insurer which can better absorb and spread potential losses.
While the function of liability insurance as a risk-transfer tool has not changed, the regulatory focus has shifted from the protection of the policyholder to the position of the injured third party. In the beginning, liability insurance only served the policyholder’s interest in self-protection. Its role was illustrated by the emphasis placed on the defence of the policyholder. The insurer was only required to indemnify the policyholder once the court had found the latter liable. Thus, the injured party had to sue the policyholder to judgment. In the second period, the focus of regulation started to shift to the protection of the third party. The injured third party was given priority over the policyholder and his creditors, in respect of insurance money. Payment to the injured party became an optional and later the only method by which the insurer could discharge his obligation, and the insurer was required to make proportionate payments where the amount of insurance cover was insufficient to satisfy the claims of several injured parties.
In the third period, we can observe the growth of compulsory liability insurance. The objective of compulsory liability insurance is primarily the protection of the injured party since it provides a guarantee that his claim for compensation against the policyholder will be met if it is successful. Moreover, the insurer can no longer rely on defences based on the policyholder’s non-compliance with policy terms or statutory duties. Even where insurance remains optional, many countries now permit an injured third party to bring a direct action against the insurer. The insurer is only entitled to raise defences regarding the policyholder’s liability.
2. Legal developments
A further growth of compulsory liability insurance is to be expected for two reasons. First, the ongoing trend in legislation and jurisprudence towards increased protection of injured parties is fuelling the development of new categories of legal liability. Secondly, there will be an increase in the scope of strict liability in response to new risks, the gravity of which may be unclear as yet (eg electro-magnetic fields, bio-genetic modifications, nano-technologies). The goal of strict liability, namely to improve the position of the injured party since liability is not dependent on the tortfeasor’s fault or negligence can only be achieved if the liability regime is coupled with financial guarantees such as compulsory insurance.
A few European states such as France and Spain now permit a third party claimant to bring a direct action against the insurer in respect of all kinds of liability insurance. The Swiss draft of a new insurance contracts act also permits the injured party to bring a direct action in respect of voluntary liability insurance. Other European jurisdictions such as Denmark, Finland, Ireland, the Netherlands, Norway, Sweden, and the United Kingdom follow a different approach. They do not grant the injured party an independent right to compensation against the insurer, but transfer the policyholder’s claim against the insurer to the injured third party in certain circumstances. In other words, the injured party is treated as if he were subrogated to the policyholder’s claim against the insurer. The conceptual differences involved in these two approaches may lead to discrepancies since the range of defences available to the insurer will differ significantly. In the case of subrogation, the insurer as a general rule retains against the injured party the same defences as he would have had against the insured. There is no such rule where the injured party has an independent claim against the insurer. Instead, special provisions regarding the defences the insurer may raise are required (eg that the damage resulted from the policyholder’s wilful misconduct or that the direct claim is time-barred).
In some European jurisdictions, a direct action against the insurer is only possible in case of an (actual) assignment or after the attachment of the policyholder’s claim against the insurer and assignment of the claim to the injured party in enforcement proceedings upon obtaining a judgment against the policyholder (eg Germany, Austria). No such enforcement proceedings are required where the policyholder has become insolvent after a judgment has been obtained against him. In either case, the insurer can raise all the defences against the claim based on the policyholder’s non-compliance with policy terms or statutory duties that would have been available in litigation against the policyholder.
Jurisdictions which allow the injured party to bring a direct action against the insurer without the consent of the policyholder and outside the special context of enforcement proceedings against the policyholder often limit the circumstances in which the injured party can bring such a claim. In the United Kingdom, Ireland, Denmark and Sweden, the policyholder’s cause of action is transferred to the injured party only once the policyholder has been declared bankrupt or gone into insolvent liquidation. Moreover, the injured party must establish both that the policyholder is liable to him and the amount of loss he has sustained, either by judgment or by agreement with the policyholder (where the policyholder is not in breach of contract by compromising or admitting liability). In the Netherlands the right to bring a direct action exists only if the injured party’s loss is suffered as a result of personal injury. Similarly, the Swiss draft of a new insurance contracts act provides that the injured party cannot bring a direct action against the insurer where the loss sustained is neither the result of bodily injury nor property damage.
3. Essential characteristics of liability insurance
An insurance against liability is a contract by which the insurer promises to indemnify the policyholder against established legal liabilities and to hold the policyholder harmless where a third party alleges that he is liable. The scope of coverage therefore includes the recovery of the costs of defending any claim against the policyholder or of reaching a settlement in respect of such claim (with the insurer’s consent). The policyholder is not entitled to claim compensation from the insurer unless his liability to the third party has been ascertained by judgment (or binding arbitration award) or by a settlement between the policyholder and the injured party. There is no need for the policyholder to show that he has actually paid the third party however. In some jurisdictions liability insurance is, by law, insurance for the benefit of third parties. For example in Germany and Austria commercial general liability insurance covers the employees of the insured company. By contract, family members and relatives are covered under private liability insurance.
The insurers’ rights and obligations when conducting the policyholder’s defence depend first and foremost upon the wording of the policy. In some European jurisdictions, such as Germany, Austria, Sweden and Spain, the law requires the insurer to defend the policyholder and to pay the defence costs. These rules are optional however and the parties are free to derogate from them by contract. Policies will either be on a ‘costs inclusive’ or on a ‘costs in addition’ basis. In a ‘costs inclusive’ policy, the defence costs have to be subtracted from the amount insured, while in a ‘costs in addition’ policy defence costs are paid by the insurer in addition to the sum insured. When the policyholder’s liability and/or the quantum of damage suffered by the third party are in dispute, the insurer de facto has discretion either to settle the claim and indemnify the policyholder or to defend the claim and indemnify the policyholder if the injured party succeeds in obtaining judgment against him. The insurer’s discretion is only limited by his duty of care to the policyholder. Where the defence costs have to be paid out of the insured sum and total costs and damages (if any) might reach or exceed the policy limits or where the claim already exceeds policy limits, the insurer must act reasonably and keep the policyholder’s interest in mind.
In general, insurers reserve their right to conduct all negotiations with third party claimants against the policyholder, to defend any proceedings which may be brought, and to approve any settlement with the third party on the policyholder’s behalf. As compensation, if a question concerning the extent of insurance cover turns on the same facts or law at issue in the underlying dispute between the injured party and the policyholder, the insurer will be bound by the results of any judgment or arbitration. This is true even when the insurer refuses to conduct negotiations or to defend the insured. It is therefore unnecessary for the insured to join the insurer as a party to the dispute for the insurer to be bound.
The obligation to defend and/or to indemnify the policyholder only arises if the claim against the policyholder falls within the scope of cover. The policyholder’s liability must arise from activities covered by the insurance contract such as the carrying on of a particular business, the ownership of business premises, the use of motor vehicles, the management of companies, the shipment of goods, the manufacture and sale of goods, the provision of professional services, etc. Secondly, the policyholder must be liable to the third party at law (private and/or public) rather than by virtue of a contract. Contractual liability based on agreement is usually only covered if it does not impose legal obligations on the policyholder more onerous than his pre-existing liability at law. Thirdly, the type of damages suffered by the injured party (personal injury, damage to private property, pecuniary loss) must be of a kind insured. Thus, for example, professional indemnity policies often provide coverage only for pecuniary loss and exclude claims for damages resulting from personal injury or damage to property. Finally, the insured event must take place within the period of cover. Since the conduct of the policyholder that gives rise to liability will occur some time before the injured party claims for compensation, the point in time which is relevant in determining when the insurer’s liability is triggered is of great importance.
Where coverage is provided on a ‘claims made’ basis, the insurer is liable for any claim made against the policyholder during the period of cover arising out of an actual or alleged negligent act, error or omission which occurred during the policy period. In a ‘claims made and reported’ policy the claim must not only be made but also reported to the insurer while the insurance contract is on foot. Claims-made policies typically extend coverage to wrongful acts which occurred prior to the inception date of the policy, provided that the policyholder was not aware of the wrongful act when the contract was made. A further typical form of extension can be found in the form of an extended reporting period, which is triggered where the policy is not renewed. The claims-made (and reported) form is used most commonly for errors and omissions and directors and officers’ liability insurance covers. Policies covering liability for personal injury or damage to property are more commonly written on an ‘occurrence’ or ‘events’ basis. An occurrences policy provides coverage for any injury or damage that takes place during the policy period, regardless of when the claim is reported. Under an events-based policy, the immediate cause of bodily injury or property damage triggers the coverage, not the act giving rise to the policyholder’s liability nor the claim made by the injured party at a later date; thus, for example, coverage is triggered when a defectively manufactured product leads to an accident causing bodily injury as opposed to the point when the defective product was manufactured or the injured party’s discovery that the product was defective. Where environmental damage is concerned, ‘the first verifiable discovery’ of the personal injury, damage to property, or financial loss triggers the coverage.
Restrictions in coverage follow from the limit of indemnity, ie the maximum amount that insurers will pay. The limit can operate either on an ‘each and every’ claim basis or on an ‘aggregate’ basis. In the former case, the full limit of indemnity under the policy is available to satisfy each claim which might arise during the period of insurance. In the second alternative, the limit of indemnity applies as a maximum total payment irrespective of the number of claims notified during the period of insurance. The insurer’s liability is further limited by ‘series clauses’. Such clauses work on the basis of two fictions in that two or more claims arising from one specific cause which is attributable, for example, to the same event, condition, defect or hazard, or failure to warn are treated as a single insured event that, depending on the definition of the insured event, is deemed to have happened on the day on which the earliest claim was first made, on the day of the first occurrence, or the first event or the first verifiable first discovery.
Exclusions from coverage play an important role in liability insurance. While the rationale behind statutory exclusions is public policy (eg no cover where the insured wilfully caused the damage), contractual exclusions are aimed at preventing the policyholder from shifting business risks to the insurer (eg no claims due to loss or damage to work or objects manufactured by the policyholder), avoiding collusion (eg claims of the policyholder’s family or between several policyholders under the same insurance policy), protecting the insurer from incalculable risks (eg losses due to the use of genetically modified organisms), or avoiding overlap between different kinds of liability insurance covers offered by the insurer (eg no cover for product recall or environmental damage under commercial general liability policies but only under special recall and environmental liability policies).
The liability insurer may be released from his obligation to indemnify the policyholder where the latter has not complied with contractual or statutory duties (eg duty not to aggravate the risks, duty to give notice and information about the insured event, duty to avert and minimize the loss). Most European insurance laws require the insurer to prove causation when seeking to avoid liability on these grounds. The extent to which the insurer is discharged from liability depends on the degree of fault ascribed to the policyholder.
4. Uniform law
Neither international nor European law contain comprehensive rules regulating insurance contracts except in the area of compulsory liability insurance. The EU Commission’s proposal for a directive on the coordination of laws, regulations and administrative provisions relating to insurance contracts of 1979 did not contain rules on liability insurance. Further attempts to harmonize liability insurance law within the framework of EU legislation are not to be expected in the near future. The Unfair Contract Terms Directive 93/13/EEC has an indirect effect on liability insurance contracts with consumers. It requires contract terms to be drafted in plain, intelligible language and proscribes terms that cause a significant imbalance in the parties’ respective rights and obligations where this would be to the detriment of the consumer. The directive is of particular importance as regards exclusions from coverage.
At the end of 2007, the project group for the Restatement of European Insurance Contract Law published the Principles of European Insurance Contract Law (PEICL). The PEICL do not yet contain rules on compulsory liability insurance. Such rules are currently under consideration by the project group and will be added at a later date.
In the realm of the conflict of laws, the Second Non-Life Insurance Directive 88/357/EEC established a complex system of rules of private international law (PIL) that applied to all kinds of non-life insurance where the risk covered was situated in an EU Member State. Insurance contracts covering risks situated outside the EU were subject to the 1980 Rome Convention on the law applicable to contractual obligations. This double set of rules has been replaced by a single instrument, the Rome I Regulation 593/2008 which applies to all insurance contracts concluded after 17 December 2009. The Second Non-Life Insurance Directive 88/357/EEC remains relevant in determining where the insured risk is situated. For example, in the case of motor vehicle insurance the risk is situated in the Member State of registration. In all other types of liability insurance the risk is situated in the Member State where the policyholder has his habitual residence or, if the policyholder is a legal person, in the Member State where the policyholder’s establishment, to which the contract relates, is situated (Art 7(6) Rome I in conjunction with Art 2 para d of the Second Non-Life Insurance Directive 88/357/EEC).
Under the Rome I Regulation the parties are free to choose the law governing their contract (choice of law by the parties) where the contract is for the insurance of large risks, whether or not the risk is situated in a Member State. In the absence of an express choice of law the insurance contract is governed by the law of the country where the insurer has his habitual residence (Art 7(2)). For insurance contracts covering mass risks situated in a Member State, the parties are free to choose the law of any Member State where the risk is situated when the contract is concluded; the law of the country where the policyholder has his habitual residence; the law of any of the Member States concerned or the law of the country where the policyholder has his habitual residence; where the policyholder pursues a commercial or industrial activity or a liberal profession and the insurance contract covers two or more risks which relate to such activities and are situated in different Member States; and for insurance contracts covering risks limited to events occurring in one Member State other than the Member State where the risk is situated, the law of the former state (Art 7(3)). To the extent that the law applicable has not been chosen by the parties, the contract is governed by the law of the Member State in which the risk is situated at the time the contract is concluded (Art 7(3)). Insurance contracts with consumers are governed by the law of the country where the consumer has his habitual residence (Art 6). Special rules apply to compulsory liability insurance (Art 7(4)). The Rome I Regulation does not apply to Denmark. However, Directive 2009/138 on the taking-up and pursuit of the business of insurance and reinsurance (Solvency II) contains the same provisions in a form that will apply to Denmark (Arts 178, 179).
Christian von Bar, ‘Das “Trennungsprinzip” und die Geschichte des Wandels der Haftpflichtversicherung (1981) 181 AcP 289; Karl Sieg, ‘Haftpflichtversicherung’ in Alfred Manes (ed), Handwörterbuch der Versicherung (1988) 261 ff; Jürgen Basedow, ‘Die Gesetzgebung zum Versicherungsvertrag zwischen europäischer Integration und Verbraucherpolitik’ in Fritz Reichert-Facilides and Anton K Schnyder (eds), Versicherungsrecht in Europa (2000) 13; Jürgen Basedow and Till Fock (eds), Europäisches Versicherungsvertragsrecht, vol 1–3 (2002–3); Helmut Heiss, ‘Europäischer Versicherungsvertrag‘ Versicherungsrecht (VersR) (2005) 1 ff; Robert Merkin, Colinvaux’s Law of Insurance (8th edn, 2006); Malcolm A Clarke, The Law of Insurance Contracts (5th edn, 2006); Jürgen Basedow, ‘Der Gemeinsame Referenzrahmen und das Versicherungsvertragsrecht’ (2007) 15 ZEuP 280; Martin Fricke, ‘Das Internationale Privatrecht der Versicherungsverträge nach Inkrafttreten der Rom-I-Verordnung‘ Versicherungsrecht (VersR) (2008) 443; Jürgen Basedow and others, Principles of European Insurance Contract Law (PEICL) (2009).