Policyholders Beware: The Known Loss Doctrine

Originally published in PropertyCasualty360 (July 16, 2014)

It is axiomatic that traditional insurance policies cannot be purchased to cover losses known to exist. A classic example is the homeowner standing in his basement, with water up to his ankles, who tries to order flood insurance for the first time.

Insurance companies attempt to expand this general rule by advocating for a "known loss" bar to coverage (the "Known Loss Doctrine"), asking courts to analyze whether circumstances known to the policyholder before the policy was sold portended a future loss and should have been disclosed to the insurance company. In other words, insurance companies argue, coverage should be excluded for any subsequent losses somehow arising from facts the policyholder knew about.

Policyholders can theoretically "contract around" the Known Loss Doctrine via policy language addressing situations insurance companies would otherwise argue are governed by the doctrine. The policyholder should negotiate clear prior circumstances/losses language specifying what information must be disclosed to the insurance company, and when. For example, what types of facts sufficiently indicate a potential future occurrence that they must be disclosed? What degree of conflict with a third party sufficiently portends a future claim that it must be disclosed? The clearer the language the better.

Even when the policyholder has negotiated for a policy that unambiguously covers a type of loss, however, the insurance company might invoke potentially more favorable common law by asserting the Known Loss Doctrine. Two leading state supreme court cases demonstrate how different results can be reached despite similar facts.

In Rohm & Haas Co. v. Continental Cas. Co., 781 A.2d 1172 (Pa. 2001), the Pennsylvania Supreme Court held that if the policyholder was aware or should have been aware of likely future losses triggering the policy, the insurance company can deny coverage in certain instances. The policyholder, a chemical company, knew of arsenic pollution at its facility since 1964, but did not tell its insurance company until 1988. On one hand, the company was never sued by private citizens and until 1980 was unhindered by modern regulations, suggesting future liability was unlikely. On the other hand, the policyholder was previously held liable for the arsenic pollution under a 1937 law and had voluntarily paid medical bills likely arising from the pollution for nearby residents...