Insurers must navigate legal challenges when doing business across state lines

By Brandon Clapp

Identifying and understanding the proper choice of law has significant consequences in insurance claims. While one state’s laws may apply to the interpretation of the insurance policy, another state’s laws could apply to the underlying claims against the insured.

Different states can have different laws impacting insurance claim decisions from beginning to end. These issues often appear when the insured does business in multiple states or owns property in multiple states. Here is some guidance on the importance of choice of law and why it should be considered at the outset of any insurance claim.

Most states follow a variation of one of two choices of law approaches. The traditional approach is the policy is governed by the state where the policy was issued to the insured.

The majority of states now follow some variation of the most significant relationship test. States following this approach consider several factors, which may include the place of contracting, the place the contract was negotiated, the place of performance, the location of the subject matter of the contract and the state affiliation of the parties. Thus, the applicable law could vary depending on the factors of the claim.

In a minority of states, such as North Carolina, the legislatures have adopted statutes requiring the application of their state’s laws to policies insuring property and people in their state.

In some circumstances, the laws of more than one state could apply, depending on where a lawsuit on the coverage issues is brought. This could determine the outcome for the relevant coverage issue based on the venue of the coverage lawsuit.

Important to follow the correct laws

While resolving choice-of-law issues can be a conundrum, it is important to determine them early so the insurer follows the proper state’s laws throughout the handling of the claim.

As mentioned previously, different states interpret the same policy language differently. Some often-litigated issues with varying results include when a claim for faulty construction work constitutes a covered occurrence under the general liability policy. Pollution exclusions are also subject to varying interpretations depending on the applicable state law. Some states, such as Wyoming, have held such exclusions only apply to traditional environmental pollution claims. Other states, including Colorado, have held that pollution exclusions apply more broadly to any claim involving an irritant.

Additionally, some states, including Texas, require the insurer to prove prejudice when attempting to decline coverage based on the insured’s failure to comply with a policy condition, such as providing timely notice of a claim. To prove prejudice, an insurer must show the untimely notice of the claim negatively impacted the insurer's ability to investigate and adjust the claim or impeded the insurer’s ability to defend the insured against the claim. However, other states, such as Alabama, do not require proof of prejudice so long as the insured fails to provide notice within a reasonable time.

Insurers may owe additional obligations

Depending on which state law applies, an insurer may owe additional obligations to the insured if it defends the insured under a reservation of rights. In Alabama, insurers owe an enhanced obligation of good faith if a defense is provided under a reservation of rights. This imposes certain obligations on the insurer, such as fully informing the insured of all settlement demands and offers and refraining from taking an action demonstrating a greater concern for the insurer’s monetary interest. In other states, such as Mississippi, the insured has the ability to select its counsel at the insurer’s expense when the defense is provided under a reservation of rights. In states such as Pennsylvania, an insured is only entitled to independent counsel when an actual conflict arises between the insured and insurer.

Further, states differ on an insurer’s extracontractual obligations. For example, Alabama recognizes a common law claim for bad faith and a common law claim for negligent or bad faith failure to settle. Michigan does not recognize an independent claim of bad faith. In Texas, insurers are subject to several potential extracontractual claims based on statutes and common law.

As described previously, the applicable state law may have a substantial impact on an insurer’s obligations to its insured when a claim is presented. Thus, it is important for insurers to get the information needed to assess the applicable law as soon as possible. This can be especially critical when the insured is headquartered in a state outside of the state where the claim occurred.