Pollution Exclusion Applies
The Seventh Circuit was called upon to resolve, using the law of Illinois, the proper interpretation of the pollution exclusion in a general liability insurance policy. The most common policy is the “commercial general liability policy” drafted by the Insurance Services Office and purchased by businesses to insure against losses arising out of general business operations. The policies at issue in Scottsdale Indemnity Co. and v. Village of Crestwood, et al, No. 11-2385, 11-2556, 11-2583 (7th Cir. 03/12/2012) were “public entity general liability policies,” which are issued to municipalities to cover analogous risks and contain the same pollution exclusion as the commercial general liability policy.
Two insurers sued for a declaration that they have no duty either to defend a series of tort suits brought against their insureds (the Village of Crestwood, Illinois, and past and present Village officials) or to indemnify the insureds should the plaintiffs in those suits prevail. The trial court found that the allegations in the tort complaints triggered the pollution exclusion, granted summary judgment for the insurers, and multiple appeals followed.
Crestwood is a small Chicago suburb that supplies its residents with water obtained from both Lake Michigan and wells that it owns, and bills the residents for the water. According to the tort complaints, in 1985 or 1986 Crestwood’s mayor and other Village officials learned from state environmental authorities that one of the wells was contaminated by perc (PCE- perchloroethylene, also known as tetrachloroethylene) a solvent widely used in dry cleaning. Perc is a common contaminant of soil and groundwater and is more difficult to clean up than oil spills and is a carcinogen.
Perc used by a nearby dry-cleaning establishment had leaked into the groundwater tapped by the well. Village officials promised the state authorities that the well would be used only in emergencies. But instead, for reasons of economy, the well continued to be used as a source of the daily Village water supply-without disclosure to the Village’s residents. The well remained in use until 2007, and not until 2009 was it sealed.
Hundreds of Crestwood residents, having learned of the contamination of their water supply from a series of articles in the Chicago Tribune, sued the Village and past and present Village officials in an Illinois state court seeking damages for injury to health. In a parallel suit the State of Illinois seeks an injunction requiring the Village to finance “a site inspection to determine the nature and extent of contamination” and take “all necessary steps to remediate the contamination.” All these suits are pending.
The defendants’ insurance policies (primary policies issued by Scottsdale and excess policies issued by National) exclude from coverage ” ‘bodily injury,’ ‘property damage,’ or ‘personal injury’ arising out of, or ‘wrongful act(s)’ which result in the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of ‘pollutants’ at any time,” and also exclude from coverage expenses arising from orders for “cleaning up . . . or in any way responding to, or assessing the effects of pollutants.” “Pollutants” are defined as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.” There are slight differences in the wording of the various policies but they are immaterial and we ignore them.
There is no doubt that perc is a “contaminant” within the meaning of the policies; and the tort plaintiffs are complaining about its “dispersal” by the Village from the contaminated well to their homes via the system of water mains that connects the well to the homes. The Seventh Circuit refused to stop there and affirm the trial court. It saw a problem from a literal reading of the pollution exclusion that could exclude coverage for acts remote from the ordinary understanding of pollution harms and unrelated to the concerns that gave rise to the exclusion.
The Seventh Circuit supposed a tanker truck filled with perc crashes into a bridge abutment, spilling its liquid cargo, and another vehicle skids on the wet surface of the highway into the abutment, injuring the driver. Perc is both a contaminant and a cause of the bodily injuries in this example. But it would be absurd to argue that a claim arising from such an accident would be within the pollution exclusion, since in no reasonable sense of the word “pollution” was the driver a victim of pollution.
There is nothing unusual about paint peeling off of a wall, asbestos particles escaping during the installation or removal of insulation, or paint drifting off the mark during a spray painting job. A reasonable policyholder, some courts believe, would not characterize such routine incidents as pollution.
The Supreme Court of Illinois has interpreted the pollution exclusion to be limited to harms arising from traditional environmental pollution. The Seventh Circuit believes that a more perspicuous formula than “traditional environmental pollution” would be “pollution harms as ordinarily understood.”
With such a definition in mind, the Seventh Circuit looked to the reasons for exclusions from insurance coverage. The reasons do not include fear by insurance executives of losses by insureds. The business of insurance is covering losses. The more policies written, the better from the insurance company’s standpoint – but this is provided the company can estimate within a reasonable range the size of the losses that it is likely to be required to reimburse the policyholders. Otherwise it can’t set premiums that will be high enough to compensate it for the risk of having to reimburse the losses it’s insuring, without being so high that no one will buy its polices.
Insurance companies use statistical methodologies (actuarial science) to calculate “expected losses” – the sum of the insured losses, if they occur, discounted (multiplied) by the probability of loss. The higher that probability or the greater the loss if it occurs, the steeper the insurance premium must be in order to be compensatory. Insurers do not write policies when they can’t calculate expected losses, since without such a calculation the determination of how high a premium to charge would be arbitrary. So for example they will not insure property against fire for more than the property is worth – overinsurance would induce property owners to be less careful about preventing fires, and how much less careful they would be and how that would affect fire losses would be very difficult to predict.
The effect of insurance on an insured’s behavior and hence on the risk is called “moral hazard.” A related problem, also illustrated by fire insurance, goes by the name of “adverse selection.” Insurers of pollution liability would encounter difficulty in estimating the expected loss from pollution and calculating the premium accordingly. Environmental damage is often very difficult to detect until it has become extensive, let alone to predict, or estimate its likely extent, in advance. The financial consequences can be horrific and are unpredictable. Most of those consequences are felt at the clean-up stage, and the insureds in this case would like us to confine the pollution exclusion to those costs, noting that the creation of expansive clean-up liability under federal law triggered the modern compendious pollution exclusion at issue in this case.
The exclusion was first introduced into general commercial liability policies in 1970. But it was the passage in 1980 of CERCLA (Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. §§ 9601 et seq.), the federal toxic-waste statute, and the threat and later the reality of government-ordered cleanup costs imposed by CERCLA, that prompted the industry to adopt the current, broader exclusion. When CERCLA was first enacted, insurers couldn’t calculate the costs it would impose on insureds, and while they could have dealt with this uncertainty by amending their liability policies to authorize retroactive calculation of premiums for pollution insurance, instead they limited their risk by excluding coverage of pollution harms in the broadest possible terms. To make assurance doubly sure they added an exclusion for clean-up costs that was separate from the exclusion for bodily-injury costs.
The insurers in this case invoke both exclusions because one of the plaintiffs in the suits against the insureds, the Illinois EPA, is seeking an injunction that would command the Village to take “all necessary steps to remediate the contamination,” and those steps would impose clean-up costs on the Village.
The main reason for the broad pollution exclusion is the adverse-selection problem. It is true that there is adverse selection only where the adverse factor, such as a pre-existing medical condition or the very low value placed by a property owner on his property, is invisible to the insurer, who therefore can’t adjust the insurance premium to the greater risk of loss from insuring those people – can’t in other words separate its high-risk customers from its low-risk ones and charge different premiums to the different groups.
But invisibility is a problem with pollution insurance too, as this case illustrates dramatically: deliberate concealment by the insureds of the pollution is alleged. If insurers can’t determine how likely a would-be buyer of insurance is to pollute, coverage would force enterprises that have a slight risk of liability for causing pollution damage to subsidize the premiums of high-risk potential polluters. Insurers could have excluded coverage just for knowing or deliberate polluting, which would have done the trick in this case but would not be a complete solution to the adverse-selection problem. A shopper for pollution insurance who knows that he has a high risk of accidentally polluting and being sued for it would, if able to buy the insurance at the normal premium, contribute to the premium spiral that we’ve described. Forcing him to self-identify as a potential polluter by buying a pollution-coverage rider to his general liability policy (as otherwise he will fall within the pollution exclusion) separates high- and low-risk polluters.
The Village “caused” the contamination of its water supply (it could have sealed the well a quarter of a century ago, when it discovered the well was contaminated) in a perfectly good sense of the word, the defendants did not introduce the contaminant into the soil or groundwater. The contamination had an infinity of authors, not only the Village and its officials but also the inventor of perc, the founder of Crestwood, and maybe Jean Baptiste Point du Sable, who built a farm at the mouth of the Chicago River in the 1780s and is thought to be the first permanent non-native settler of the Chicago area.
The pollution exclusion would mean little if the insured were required to have been the original author of the pollution in order to be within the exclusion. Groundwater contamination, with resulting contamination of drinking water, is extremely common and a fertile source of environmental litigation.
The insureds argue finally that this is not a pollution case at all, because the amount of perc in the Village’s water supply was below the maximum level permitted by environmental regulations. But either the perc caused injuries, maybe because the relevant regulations are too lax, or it did not and the tort suits will fail.
At issue is only that the suits are premised on a claim that the perc caused injuries for which the plaintiffs are seeking damages. If that claim triggers the pollution exclusion the insurers owe nothing.
Although an insurer’s duty to defend his insured depends on what the complaint alleges rather than on the facts that emerge over the course of the litigation and that might or might not give rise to a duty to indemnify, it is doubtful that the plaintiffs could have drafted complaints that did not reveal that this was a pollution case. The complaints actually filed describe in copious detail the conduct giving rise to the tort suits, and in doing so inadvertently but unmistakably acknowledge the applicability of the pollution exclusion.
The Seventh Circuit, showing an unusual and thorough knowledge of insurance, underwriting, the use of actuarial science to set premium and the reasons for exclusions concluded that allegations of damage caused by pollution deprives the insured of contract. The Seventh Circuit, as a result the eight corners rule, limited its analysis to the allegations of the complaint.
Insurance, as the court made clear, is a business where an insurer assumes a risk intelligently, based upon actuarial science. When the risk cannot be estimated by an actuary the insurer excludes the risk because it is impossible to calculate its exposure.
The case provides an excellent, short form, definition of the business of insurance and prevented an insured who, if the allegations are believed, intentionally poisoned the citizens of the insured community.
Barry Zalma, Esq., CFE, is a California attorney, insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud. Mr. Zalma serves as a consultant and expert, almost equally, for insurers and policyholders.
He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant. He recently published the e-books, “Zalma on Diminution in Value Damages – 2012,”“Zalma on Insurance,” “Heads I Win, Tails You Lose — 2011,” “Zalma on Rescission in California,” “Arson for Profit,” “Insurance Fraud,” and others that are available at www.zalma.com/zalmabooks.htm.
Mr. Zalma can also be seen on World Risk and Insurance News’ web based television program “Who Got Caught” with copies available at his website at http://www.zalma.com.