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Daniel Schwarcz on the Evolution of Insurance Contracts

posted by Mitu Gulati

I shudder even as I write these words, but I’m increasingly fascinated by insurance contracts.  If you are interested in the processes by which standard form contracts evolve – which I am -- then you can’t help but be sucked into this world. Coming from the world of sovereign bonds, the insurance world strikes as bizarre. Among the wonderful authors whose worked has sucked me in are Michelle Boardman (here), Christopher French (here) and Daniel Schwarcz (here).

There are a handful of major players who dominate the insurance industry and everyone seems to use the same basic boilerplate terms tied a core industry-wide form. Further, courts aggressively use an obscure doctrine, contra proferentem (basically, construing terms against the drafter/big bad wolf), that is often ignored in other areas such as the bond world where figuring out who did the actual drafting is a near impossible task.  Finally, while contracts in this world are often sticky and full of long buried flaws, they are also sometimes highly responsive to court decisions. In other words, there is much to be learned about the how and why of contract language evolution as a function of court decisions (a process about which most law school contracts classes make utterly unrealistic assumptions and assertions) by examining insurance contract evolution and comparing it to contract evolution in other areas that don’t share the same characteristics.

My reason for this post, is to flag a wonderful new paper by Daniel Schwarcz of U. Minnesota Law. The paper, “The Role of Courts in the Evolution of Standard Form Contracts” (here) is on the evolution of insurance contract terms in response to court decisions.  Unlike much of the prior literature on standard form contracts where each paper examines no more than a handful of terms and often finds that contracts are not very responsive to particular court decisions, Daniel examines a wide range of terms (basically, everything) over a long period of time (a half century) and finds a great deal of responsiveness to court decisions.  The question that raises is whether there are features of the insurance industry that are different from, for example, the bond world.  Or whether Dan just studied a lot more changes than anyone before this had done; and, therefore, he was able to see further than prior scholars.

I am in awe of the mammoth amount of work Dan and his research assistants did for this paper.  Plus, the paper manages to be theoretical, empirical and grounded in the realities of practice, all at the same time.  This is legal realist research in the truest sense.  It reminds me of another wonderful recent paper on contract evolution, by John Coyle, that I’m also jealous of (here).

Dan’s abstract, from ssrn, says:

Standard form contracts are a pervasive feature of modern commercial life, for ordinary consumers and big businesses alike. Yet remarkably little is currently known about how and when these contracts evolve in response to judicial decisions that interpret and apply them in individual disputes. Homeowners insurance policies offer a particularly fertile ground for studying this issue due to the prominence of the insurance law doctrine that ambiguities are interpreted against the drafter and the historic standardization of insurance policies across different insurers.

Utilizing a unique hand-collected dataset, this Article empirically investigates the links between innovation in the dominant “ISO HO3” homeowners policy and published caselaw interpreting that contract. The results demonstrate that judicial caselaw has indeed played a vital role in the evolution of homeowners insurance policies over the last fifty years, forcing insurers to spell out their obligations more precisely and clearly. Notably, judicially-prompted changes to policy language have often expanded coverage, suggesting that judicial scrutiny can empower regulators and market intermediaries to secure drafting concessions in revisions to homeowners policies.

Normatively, these results provide strong support for insurance law’s central doctrine that ambiguities are interpreted against the drafter. When considered in light of prior research demonstrating that some homeowners insurers have recently begun departing from the ISO HO3 policy in ways that systematically restrict coverage, this Article’s results also suggest that states should strongly consider requiring homeowners policies to provide coverage that is no less generous than the ISO HO3 policy. With respect to contract law more generally, the Article’s findings suggest that contractual innovation, particularly when prompted by caselaw, operates quite differently in different market and regulatory settings.

Final note though: I still have no idea what my own homeowners policy says.  But I am happy to know that the terms will be construed against the big bad insurance company if I ever have occasion to sue it.


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