Mind the Gap

By Matt Gartner, XL Specialty Insurance Co.

While today’s insurance policies are considered broader than they might have been in decades past, policies still include exclusions that are necessary to accurately define what is and what is not covered and help control the cost of insurance policies.

Exclusions serve a variety of purposes for both an insurer and its customer. For one, not every customer has the same exposures and, therefore, it is not fair to charge someone needlessly for exposures they don’t have. Exclusions also prevent coverage under one policy when it should be covered elsewhere. For instance, the commercial general liability (CGL) policy has an automobile exclusion. If it didn’t, liability arising from automobiles would be covered under that policy.

Policies also have exclusions because some exposures just aren’t or shouldn’t be insurable. For instance, war, nuclear reaction and pollution can result in losses so serious that most policies don’t cover them. In another example, if an insurance policy could insure against faulty workmanship, would businesses use adequate care in their work or just turn faulty workmanship claims over to be paid by insurers? Hence, faulty workmanship is also not covered in standard commercial liability policies.

Quite simply, while most businesses need to set limits and controls in their business activities, so do insurers, allowing them to protect their profitability and assets in order to provide the financial protection their customers rely on. Policy exclusions help them do so. An insurance policy is very much a contract and, like a contract, has various terms and limits that define the scope of the insurance coverage as well as circumstance that would result in excluded coverage. Exclusions vary widely from policy to policy. Therefore, it is very important to understand them in order to understand potential gaps in insurance coverage.

For the recycling and waste industries, the exclusion that is often overlooked and can result in significant uninsured losses is the “pollution exclusion.” This eliminates coverage for injuries or damages to a third party resulting from a pollution event arising from your business operations. The exclusion applies to the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of pollutants.

Typically, a pollutant is defined as any solid, liquid, gaseous, or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. For these purposes, waste is most commonly defined as materials to be recycled, reconditioned or reclaimed.

A Chicago-based recycler learned the hard way that its CGL policy included a pollution exclusion. Vandals set fire to an unknown amount of cardboard at its recycling facility. The fire burned for several days, sending clouds of smoke and toxic substances into the surrounding neighborhood. Residents of that neighborhood filed suit against the recycler, asserting claims for strict liability and negligence. The residents alleged that they were exposed to the hazardous and toxic substances. They sought damages for medical diagnosis, testing and monitoring.

The recycler turned to its CGL insurer for coverage and was denied because the policy contained a “total pollution exclusion” in its bodily injury and property damage liability coverage. But the recycler fought back, claiming that the exclusion contained an exception that reinstated coverage if the bodily injury was attributable to heat, smoke or fumes from a “hostile fire.” The exclusion defined a “hostile fire” as a fire which becomes uncontrollable or breaks out from where it was intended to burn.

Unfortunately for the recycler, however, the exception did not apply if that hostile fire occurred or originated at a location where the insured “handled, stored, disposed, processed or treated waste.” The recycler’s policy also stated that waste included material to be recycled, reconditioned, or reclaimed, and the policy also contained an “absolute pollution exclusion” in its personal injury and advertising liability coverage, meaning any injury that occurred as a result of pollution was excluded from personal injury coverage.

Inevitably, a coverage dispute like this ends up in court. The recycler’s CGL insurer filed a complaint for declaratory judgment arguing that no coverage existed. The trial court granted the insurer’s motion for summary judgment, finding that while the underlying plaintiffs sufficiently alleged that they suffered bodily injury as defined in the policy, there was no coverage due to the policy’s total pollution exclusion.

The appellate court affirmed the judgment of the trial court. The issue for the court was whether, based on the allegations contained in the underlying plaintiffs’ complaint, the exception to the total pollution exclusion applied, i.e., whether the complaint sufficiently alleged that the recycler was handling, storing, disposing, processing, or treating waste at its facility when the fire occurred. The trial court found that the total pollution exclusion barred coverage. Thus, the recycler did not have insurance coverage to cover the neighbor’s claims.

In this case, a business with a significant pollution exposure would have benefited from available stand-alone pollution coverage, along with the risk control guidance and legal defense such coverage often provides.

As with every business contract, it’s important for a firm to carefully understand the terms and conditions of its insurance policies to know what its insurance will and will not cover so that gaps in insurance coverage can be addressed appropriately.