Overview of U.S.

Insurance Law

National Economics University

March 29, 2023

Jeffrey E. Thomas
Daniel L. Brenner Faculty Scholar &
Professor of Law
University of Missouri – Kansas City
School of Law
 Roadmap – Main Points
• Common Law & Federalism Context
• Insurance Basics
• Regulatory Framework
• Insurance Policy Interpretation
• Liability for Bad Faith Conduct
Common Law Context

Theory

Doctrine

Case 1 Case 2 Case 3

 Implications of Common Law
1. Courts have substantial power
2. Flexibility to change legal rules and
adapt
3. Change comes slowly, incrementally
4. Theoretical incoherence
5. Insurance law has significant
common law component (Bad Faith
law)
 Federalism Context
• States have power independent of the
National government
• States have power independent from each
other
• The National government has authority over
the states in some areas, but is limited
• Insurance almost entirely regulated at the
state level
General Federalism Illustration
State
State State

State State

State
Federa State

State
l State

State State
State
Federalism for Insurance Law
Federal: Theorism, Flood
State
State: Cover most by State

State
State
Federal

State
State
 Implications of Federalism
1. Insurance law varies from state to
state
2. Heavy regulatory costs – to sell in
multiple states, must qualify in each
one
3. Variations allow for experimentation
4. Variations influence the insurance
market
 Insurance Theory
• Insurance defined: pooling and transference of
risk
• Function:
– Avoid catastrophic consequences of losses
– Encourage responsible risk-taking
• Example: risk of home being burned down
Insurance Pooling (250:1)
 Two Main Types of Insurance
First Party Insurance Third Party
Insurance
• Property • Commercial General
• Life Liability
• Disability • Errors & Omissions
• Health • Directors & Officers
 Role of Insurance in the Economy
• Pervasive use in US to manage risk
• Becoming fairly common in Vietnam –
property and life, some liability
• Availability of insurance promotes economic
growth – allows greater risk taking
• Accumulation of capital allows insurers to
play a major role with investments
 Insurance and the Legal System
• Insurers provide defense counsel and
manage the defense in many US cases
• Insurers manage settlement negotiations
in the US
• Insurers pay judgments in the US
 The Need for Regulation
• Consumer protection - they have less
money , information & expertise
• Insurer Solvency – due to contingent nature
of claims
• Moral Hazard – policyholders may take more
risks
• Adverse Selection – high risk people more
likely to buy insurance
 Insurance Regulation Overview
• State regulation began in 19th Century to
address solvency issues
• Predominately done by states
• Role of Federal government being expanded
• Role of the Courts significant in the US
• Complex, inefficient regulatory environment
in the US
 Types of Insurance Regulation
• Licensing of insurers and insurance
professionals
• Approval of policy forms (but easy to get)
• Pricing approval
• Solvency regulation (requirements and audits)
• Consumer protection – unfair practices
 Judicial Regulation (Common
Law)
• Very significant source of regulation in the US
• Policyholders have stronger incentives than
regulators
• Policyholders collectively have more resources
than regulators
• Precedents affect insurer behavior (forms &
practices)
• Enhanced damages (punitive damages, pain
and suffering) increase insurer incentives
 Insurance Policy Interpretation
• Insurance policy interpretation done by the
courts
• Key rules:
– Plain meaning will be followed
– Ambiguities will be interpreted in favor
policyholder
• Courts can invalidate plain provisions on the
grounds of public policy
 Why Favor Policyholders?
• Insurers draft the language
• Contracts of “adhesion”
• Asymmetrical information and
expertise
 Example 1: plain or ambiguous?
• Liability insurance policy says that coverage is
excluded for pollution
• The exclusion has an exception for “sudden
and accidental release”
• Underground storage tank leaks, owner is
sued; is coverage excluded or does the
exception apply?
 Common Law Tort of Bad Faith
• Starting in 1934, courts have imposed a duty
to act in good faith on insurers
• Justifications for the duty
– Implied duty in the insurance policy
– Unequal bargaining power (resources, info,
expertise)
– Policyholders put trust in insurers and rely on them
(quasi-fiduciary)
– Inadequate market incentives
 Tests for “Bad Faith”
• Overall the approach is one of reasonableness
• Third-party insurance
– Balancing of interest
– Disregard the limits
• First-party insurance – reasonable basis
 Example: Liability Insurance
Limits: $100,000
Exposure: $200,000
Proposed Settlement: $100,000
Insurer: Policyholder:
Why pay $100,000 when that Settle for $100,000, insurer
is the maximum? pays all

Judgement: $150,000
Who pays excess? ($50,000)
 Discussion Scenario
• Apply balancing and disregard the limits
• Settlement offer for $100,000; policyholder
demands insurer accept, but insurer refuses
• Scenarios to consider
o 80% chance that defendant will win ($40,000 value)
o 20% chance that defendant will win ($160,000
value)
 Conclusions
• Insurance beneficial to consumers and the
economy
• Combination of judicial and administrative
regulation is appropriate
• State system works, but has high costs
• Long-term trend will be to increase Federal
regulation
Questions?