What to Reasonably Expect in the Coming Years from the Reasonable Expectations of the Insured Doctrine

Arthur J. Park, apark@mfllaw.com

I. Origin of the REI Doctrine

The modern REI doctrine can be traced back to law journal article Insurance Law Rights at Variance with Policy Provisions, 83 Harv. L. Rev. 961 (1970), written by Professor Robert Keeton

“Insurance contracts continue to be contracts of adhesion, under which the insured is left little choice beyond electing among standardized provisions offered to him.”

“The objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.”

Origins cont.

The Keeton formulation was meant to extend beyond the contra proferentem doctrine: “protecting the policyholder’s expectations as long as they are objectively reasonable from the layman’s point of view, in spite of the fact that had he made a painstaking study of the contract, he would have understood the limitation that defeats the expectations at issue.”

Vast majority of insureds do not actually read their policy, much less have the opportunity to negotiate the policy terms: “qualifications and exceptions from coverage that are inconsistent with the reasonable expectations of a policyholder . . . should not be allowed even though the insurer’s form is very explicit and unambiguous, because insurers know that ordinarily policyholders will not in fact read their policies.”

Origins cont.

Based on an objective standard rather than a subjective standard

While the REI doctrine could apply to unambiguous language, it “does not deny the insurer the opportunity to make an explicit qualification effective by calling it to the attention of a policyholder at the time of contracting, thereby negating surprise to him.”

II. How the States Have Interpreted and Applied the REI Doctrine

The state courts have essentially developed four variations on the REI doctrine: (1) the unqualified version, (2) the prominence-based version, (3) the ambiguity-based version, and (4) the hybrid version.

1) The unqualified or “pure” version Can apply to any policy language regardless of

ambiguity Criticized as rewriting the contract

States cont.

2) Prominence-based version the court “will not invalidate an

otherwise clear and unambiguous policy provision unless it is ‘hidden’ in some manner, such as by fine print or inconspicuous placement in the policy.”

“a casual inspection of the policy would not have alerted the insured to the provision at issue.”

States cont.

3) The ambiguity-based version “virtually indistinguishable from--the

contra proferentem doctrine.” “fundamentally at odds with Professor

Keeton’s basic conception.” 4) The hybrid version

A contract provision is either hidden or ambiguous

State-by-State Review

Any attempt to categorize the states remains difficult as even the same state may not apply REI principles consistently over time. See, e.g., C & J Fertilizer, Inc. v. Allied Mut. Ins. Co.,

227 N.W.2d 169, 177 (Iowa 1975) (finding coverage based on the doctrine of reasonable expectations despite unambiguous policy language); Farm Bureau Mut. Ins. Co. v. Sandbulte, 302 N.W.2d 104, 112 (Iowa 1981) (requiring ambiguous, bizarre, or oppressive policy language to apply the doctrine of reasonable expectations)

Please see the attached chart for illustration and a research starting point

Different approaches can be case-determinative, leading to forum shopping by the insured

III. Justifications and Rationale in Support of the REI Doctrine

1) Insurance policies are contracts of adhesion “Insurance contracts continue to be contracts of

adhesion, under which the insured is left little choice beyond electing among standardized provisions offered to him.”

Wide disparities of expertise and bargaining power “Most policyholders do not see their policies until

long after they have purchased insurance coverage.”

Nearly all insurance companies use identical standard form language drafted by the Insurance Services Office; “except for perhaps negotiating the premium to be paid, ‘shopping around’ for different insurance coverage is futile.”

Support cont.

2) The vast majority of insureds don’t read the policy The “insurers know that ordinarily

policyholders will not in fact read their policies.”

“That most policyholders do not read their policies after they receive them is nearly universally accepted.”

Support cont.

3) If the average insured tried to read the policy, he probably wouldn’t be able to understand it

“Although insurers have had over a hundred years to hone their policies into forms that would not ferry the unwary reader on a trip through Wonderland, they regrettably have not seen fit to do so.”

Insurance policies “are a virtually impenetrable thicket of incomprehensible verbosity. It seems that insurers generally are attempting to convince the customer when selling the policy that everything is covered and convince the court when a claim is made that nothing is covered.”

Are easy-to-read policies the answer? Summary: the REI doctrine relieves an insured from

certain clauses of an insurance agreement which he did not negotiate, probably did not read, and probably would not have understood had he read them.

Support cont.

4) Advertising can create reasonable expectations of coverage

The whole transaction version considers advertisements, marketing patterns, and general practices.

“That insurers sell their product as being not only an agreement to indemnify the insured for certain kinds of loss but also to relieve the purchaser from anxiety concerning all aspects of claims is readily apparent in our society. One cannot watch televised entertainment for very long without being exposed to commercials for the sale of insurance which, for example, indicate that the purchaser will be in ‘good hands,’ that he will have the assistance of a troop of mounted cavalry, that he [will have] ‘a piece of the rock,’ or that ‘like a good neighbor’ the insurer will be there.”

State Farm’s Magic Jingle and Something’s Missing ads

IV. Continued Criticism of the REI Doctrine Over Forty Years

1) Effect on all consumers in the marketplace through increased premiums Insurer calculated premium based on no coverage,

so the new cost is inevitably spread to other insureds

“insurers must be able to predict in advance and with reasonable certainty how the policy terms will be interpreted.”

Especially when the insurer uses clear and unambiguous language

Unless the insurer or its agent promoted the different understanding or text is unconscionable

Inconsistent and unpredictable results Litigation expenses: can be fact-specific issue (no

summary judgment) and can apply to every provision

Criticism cont.

2) Leads to further attempts by insurers to limit coverage Insurers must return to the drawing

board every time a court construes a policy to find unintended coverage

The drafters’ new attempt to strictly confine coverage can result in even longer and more complex policies

Criticism cont.

3) REI doctrine constitutes judicial lawmaking REI doctrine “turns every court into a

mini-legislature, with the power to fashion public policy by invalidating contract terms it believes to be unfair or inappropriate.”

REI doctrine can be used as a tool to reach a desired result, such as assisting victims of tragic circumstances

Criticism cont.

4) Existing rules of contract interpretation are sufficient Waiver, estoppel, unconscionability,

reformation, public policy, and contra proferentem

Waiver and estoppel are available if insurer actively misled the insured

V. Where We’re Headed – Recent Trends in States Applying the REI Doctrine

Three recent cases have expressly rejected the REI doctrine, finding the criticisms outweigh the support

A) Allen v. Prudential Property & Casualty Ins. Co., 839 P.2d 798 (Utah 1992) Facts: insureds sought to invalidate the household

exclusion in their homeowner’s insurance policy that barred coverage for their two year old son

Simply being a contract of adhesion is not sufficient Noted “our unwillingness to alter fundamentally the

terms of insurance policies in the absence of legislative direction”

“It is not clear why estoppel, waiver, unconscionability, breach of the implied duty of good faith and fair dealing, and the rule that ambiguous language is to be resolved against the drafter are insufficient”

Trends cont.

B) Deni Associates of Florida, Inc. v. State Farm Fire & Casualty Insurance Co., 711 So. 2d 1135 (Fla. 1998)

Certified question from two underlying cases Inhalation of ammonia that was spilled while moving a

blueprint machine Exposure to chemical insecticide when helicopter

sprayed adjacent property The court noted the “great uncertainty as to the

theoretical underpinnings of the doctrine, its scope, and the details of its application” that continues to linger despite years of analysis

The court further provided that “[a]mong those courts which have adopted the doctrine, most only apply it when it can be said that the policy language is ambiguous.”

Held: “We decline to adopt the doctrine of reasonable expectations. There is no need for it if the policy provisions are ambiguous because in Florida ambiguities are construed against the insurer. To apply the doctrine to an unambiguous provision would be to rewrite the contract and the basis upon which the premiums are charged.”

Trends cont.

C) Wilkie v. Auto-Owners Insurance Company, 664 N.W.2d 776 (Mich. 2003)

Issue: applicable policy limits of underinsured motorist coverage when there are two claimants that split tortfeasor’s liability insurance

The REI doctrine, “where judges divine the parties’ reasonable expectations and then rewrite the contract accordingly, is contrary to the bedrock principle of American contract law that parties are free to contract as they see fit, and the courts are to enforce the agreement as written absent some highly unusual circumstance, such as a contract in violation of law or public policy.”

“The rule of reasonable expectations clearly has no application to unambiguous contracts. That is, one’s alleged ‘reasonable expectations’ cannot supersede the clear language of a contract.”

“stating that ambiguous language should be interpreted in favor of the policyholder's reasonable expectations adds nothing to the way in which Michigan courts construe contracts, and thus the rule of reasonable expectations should be abolished.”

VI. Where We Should Be Headed – REI Doctrine as a Limit on Contra Proferentem

A. The worst REI case of all time: Rusthoven v. Commercial Standard Insurance Company, 387 N.W.2d 642 (Minn. 1986)

Insured was forced off the road by an unknown or “phantom” driver and attempted to stack uninsured motorist coverage

Is there an ambiguity in these two policy provisions: (1) uninsured motorist coverage of $25,000 for “each person,” and (2) a provision stating that “[i]f there is more than one covered auto our limit of liability for any one accident is the sum of the limits applicable to each covered auto.”

Insured was a business with a fleet of 67 trucks Under contra proferentem, there simply is an ambiguity

($1.675 million under 67 policies) or there is not ($25,000 under one policy). No middle ground available

Court found an ambiguity, cited Keeton, and quickly found that stacking the 67 policies for $1.675m in UM coverage was (somehow) reasonable

How the REI doctrine can survive

The REI doctrine can survive as a limitation on the contra proferentum doctrine.

Three approaches to the ambiguity-based version of REI The penalty standard: any ambiguity triggers

coverage regardless of expectation or windfall Would a reasonable insured have expected

coverage? The majoritarian standard: would a majority of

policyholders have chosen to purchase such coverage if it were offered at an actuarially fair price; requires expert testimony, market studies, and actuarial studies

The REI doctrine as a middle ground

Avoids nonsensical and absurd results More than just a two-step approach of (1)

consulting the dictionary and (2) invoking contra proferentum when the dictionary definitions are deemed ambiguous

Apply the reasonable expectations analysis as a prerequisite to determining the meaning of words and the possible ambiguity of words