This week I received an email about a Colorado appellate court case involving a very broad residential construction exclusion in a policy. The property that was damaged was not habitational in nature, but rather a retaining wall. However, the court ruled that the exclusion applied even though there was no actual “residential’ construction involved.

The problem is, why was the contractor sold a policy that excluded virtually anything and everything related to residential construction since that’s the only kind of work he actually does. Doesn’t that make the policy, for all practical purposes, illusory? Not according to most court decisions. Here is an excerpt from my book When Words Collide: Resolving Insurance Coverage and Claims Disputes:

What if, following a claim, it is discovered that a policy not only excludes what happened, but it likely covers almost nothing the insured does? Don Malecki wrote about this in his monthly Rough Notes magazine column in an article entitled “Worthless Pieces of Paper” (do a web search of Don’s name and the article title). A roofing contractor was sued and the claim was denied because the policy had an exclusion for…roofing operations.

In the last chapter, I told my story about a tree service company bidding on taking down 19 trees on my residence premises. Their ISO CGL policy was endorsed with two onerous forms that excluded their “ongoing operations” and “your work.” In other words, they had no coverage for their off-premises work activities.

So, do policies that cover, at best, only premises exposures constitute “illusory” coverage for a business whose operations are conducted almost exclusively off premises? When you consider the coverage in the context of their business operations, one would think so, but the reality is that many, if not most, courts do not consider such onerous policy provisions to constitute illusory coverage. Some courts will not deem a policy illusory unless it does not cover ANY loss at all. As a result, the “illusory” argument is usually very, very difficult to win. A better tact in some jurisdictions might be a public policy (see below) or reasonable expectations approach.

In the case of my tree service company, when I examined his policy documents, all I needed to do was see the $707 CGL premium to know from experience that his policy must be replete with exclusions. I was also familiar with the surplus lines (E&S) insurer and had often come across their policy forms and noted how restrictive they could be. Did the insured understand that he essentially had no coverage for his ongoing and completed operations but elected to buy the policy just to get work? Perhaps, but in talking to him, I’m pretty convinced he had no idea how worthless this policy was. He was thrilled, as a startup doing dangerous work, that he got coverage and astonished at how “cheap” it was (which should have been a tip-off but apparently wasn’t).

Did the E&S broker know about the very limited coverage the insured bought? One would think that any experienced insurance professional could tell from the premium alone that it contemplated minimal risk. Frankly, if I can step on my soapbox for a moment, I considered the sale of this product to this business owner to approach insurance fraud. In my mind, it certainly was not ethical nor did it embody the principle that the purpose of insurance is to insure and that insurance is a product couched in utmost good faith.

And, in this case, another point is that, not only is the insured’s financial solvency imperiled, so is that of those that hire him based on a belief that he is insured, only to find out that he has no insurance or assets to compensate injured or damaged victims. Since this was an E&S product, the state insurance department had very little oversight, so such sales are truly caveat emptor. That being said, keep in mind that restrictive policies are not limited to the E&S marketplace. As a matter of public policy, insurance departments must do a better job of vetting policy form filings.

Is selling someone an insurance policy you know doesn’t cover 99%+ of what they do a fraudulent act and subject to regulatory action? If not, why? If not, should it be? If not, is it ethical? If it’s ethical, why?

Or could it be that the agent, broker, and/or underwriter did not know what was or wasn’t covered? If so, would an insurance law like this one from Florida be appropriate and applicable:

626.611  Grounds for compulsory refusal, suspension, or revocation of agent’s, title agency’s, adjuster’s, customer representative’s, service representative’s, or managing general agent’s license or appointment. The department shall deny an application for, suspend, revoke, or refuse to renew or continue the license or appointment of any applicant, agent, title agency, adjuster, customer representative, service representative, or managing general agent, and it shall suspend or revoke the eligibility to hold a license or appointment of any such person, if it finds that as to the applicant, licensee, or appointee any one or more of the following applicable grounds exist:

(8) Demonstrated lack of reasonably adequate knowledge and technical competence to engage in the transaction authorized by the license or appointment.

What do you think?

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Bill Wilson

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One of the premier insurance educators in America on form, coverage, and technical issues; Founder and director of the Big “I” Virtual University; Retired Assoc. VP of Education and Research from Independent Insurance Agents & Brokers of America. Reprint Request Information