Insurance Exclusion Clauses: Excluding War Risks and Terror Risks from Insurance Contracts

Congressional research reportJun 14, 2001

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Order Code RL31166

Report for Congress

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Insurance Exclusion Clauses:

Excluding War Risks and Terror Risks

from Insurance Contracts

Updated June 14, 2001

Christopher A. Jennings

Legislative Attorney

American Law Division

Congressional Research Service ˜ The Library of Congress

Insurance Exclusion Clauses: Excluding War Risks and

Terror Risks from Insurance Contracts

Summary

An insurance policy is only as good as the losses it covers. Most insurance and

reinsurance policies exclude classes of risks, perils, and exposures from coverage.

Common exclusions include war risks, nuclear risks, political risks, and risks on

property exceeding a certain value. After September 11, “it may be that terrorism

risk is no longer insurable,” according to Dean R. O’Hare, Chairman and CEO of

Chubb, Inc., a major insurer.

“The Terrorism Protection Act,” H.R. 3210, placed on the Senate Legislative

Calender on December 3, 2001, and “The Terrorism Risk Insurance Act,” S. 2600,

laid before the Senate by unanimous consent on June 13, 2002, respond to the

widespread exclusion of terrorism risks from insurance contracts.

This report provides background on exclusion clauses generally. In particular,

it discusses how “terrorism” risk clauses may be interpreted by the courts, and

examines how “war risk” exclusion clauses have been interpreted by New York (and

other) courts. This report also touches on issues unique to the interpretation of

reinsurance contracts. The review concludes with a discussion of potential

constitutional barriers to retroactive federal and state regulation impairing the private

enforcement of exclusion clauses.

Though constitutional barriers exist, Congress enjoys Article I power to regulate

the business of insurance under the commerce clause. However, the regulation of

insurance is generally left to the states. While Congress has constitutional power to

act, legislation impairing insurance contracts covering losses arising out of the

destruction of the World Trade Center would involve, to some degree, the

federalization of insurance law.

Commercial law is made in the private markets, not the courts. Under the law

of contracts, state courts are likely to reflect business reality, so long as the exclusion

clause language unambiguously excludes the relevant loss from coverage. As such,

a business judgment to exclude “terrorism risk” from the conventional basket of

insurable risks will force the hand of market forces or legislators to put it back, not

state courts.

After the events of September 11, it has been noted that “the line between war

and terrorism is increasingly ambiguous.” The complication surrounding the popular

understanding of “war” will likely render future negotiations over the scope of “war

risk” exclusions more contentious. Moreover, the background culture’s ambiguous

understanding of “war” also raises the issue as to whether the events of September

11 were “acts of war” for the purposes of exclusion clauses.

Contents

I. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

II. Choice of Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

III. Some Procedural and Interpretive Norms Governing the

Invocation, Application, and Construction of Exclusion Clauses. . . . . 4

IV. War Risk Exclusion Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

A. Reports from the Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

B. The Public’s Interpretation Versus the Court’s Interpretation of

“Act of War . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

C. The Pan American Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

D. New York Statutory Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

V. Interpretation and Construction of Reinsurance Contracts . . . . . . . . . . . 11

VI. Constitutional Impediments to State and Federal Legislation . . . . . . . . 13

A. Federal Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

B. State Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

VII Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Insurance Exclusion Clauses: Excluding

War Risks and Terror Risks from Insurance

Contracts

I. Overview

The events of September 11, 2001 raise issues relevant to private interests in

property and life under the law of contracts, in general, and insurance law, in

particular. Insurance is only as good as the losses it covers. Insurance contracts,

even “all-risk” insurance contracts, generally exclude certain classes of risk from

coverage. Common exclusions include losses due to political risks, war risks, and

nuclear risks. On September 26, a panel of industry professionals before the House

Financial Services Committee suggested that “terrorism risk” may join the list.1

“The Terrorism Protection Act,” H.R. 3210, placed on the Senate Legislative

Calender on December 3, 2001, and “The Terrorism Risk Insurance Act,” S. 2600,

laid before the Senate by unanimous consent on June 13, 2002, respond to the

widespread exclusion of terrorism risks from insurance contracts.

This report examines the judicial interpretation and private enforcement of

exclusion clauses. It pays attention to how courts may interpret potential “terrorism

risk” exclusion clauses, and reviews case law interpreting “war risk” exclusion

clauses. The report highlights issues relevant to the reinsurance industry. It

concludes by discussing constitutional issues regarding possible federal and state

legislation.

Congress enjoys Article I authority to regulate the business of insurance under

the commerce clause.2 However, pursuant to the McCarran-Ferguson Act, Congress

generally leaves such regulation up to the states, declaring “that the continued

regulation and taxation by the several States of the business of insurance is in the

See, e.g. statement of Dean R. O’Hare, Chairman and CEO of Chubb, Inc., before the

House Financial Services Committee, “America’s Insurance Industry: Keeping the Promise,”

September 26, 2001. [http://www.house.gov/financialservices/092601oh.pdf], visited

October 9, 2001. See also, Ronald E. Ferguson, “The Impact of the September 11, 2001

Terrorist Attack on America’s Insurance and Reinsurance Industry,”

[http://www.house.gov/financialservices/092601fe.pdf], visited October 9, 2001.

U.S. Const., Art. I, § 8, cl. 3 (giving Congress the power “to regulate Commerce . . . among

the several states.”) See also, United States v. South-Eastern Underwriters Assoc., 322 U.S.

533 (1944)(holding that “insurance” is “commerce” for the purposes of the commerce

clause.)

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public interest.”3 While Congress has constitutional power to act, legislation

impairing insurance contracts covering losses arising out of the destruction of the

World Trade Center would involve, to some degree, the federalization of insurance

law. Inasmuch as insurance regulation is primarily a matter of state regulation and

state contract law, this report predominately covers state law themes.

The examination proceeds on four related levels:

First, insight into how courts interpret exclusion clauses heightens the

significance of “terrorism risk” exclusions becoming common fixtures in private

insurance policies. An enduring truth of Anglo-American contract law is that

commercial law is made in private markets, not courtrooms.4 Norms of contract

construction compel the courts to vindicate the parties’ mutual understanding at the

time of contract, not to intervene and decide how the parties “ought to have agreed.”

When a clause is ambiguous, the courts entertain extrinsic evidence to ascertain

meaning, where market norms and mores carry heightened weight. Thus, once

industry excludes “terrorism risk” from the conventional basket of insurable risks,

it can only be put back or mitigated by market forces or democratic institutions.5

However, in the case of an ambiguous exclusion clause, norms of interpretation and

procedure tend to favor the insured.6

Second, when public officials, such as Members of Congress, characterized the

events of September 11 as an “act of war,” many feared that insurance companies

might invoke “war risk” exclusion clauses in seeking to deny coverage.

Widespread invocation of war risk exclusion clauses appears to be unlikely,

however:

•

As a matter of business judgment, industry leaders pledged to honor

claims for losses arising out of the events of September 11.7

•

The understanding of the parties at the time of contract, not the public’s

understanding, constitutes the benchmark of meaning for categorizing a

risk as a “war risk.”

•

Characterizations by public officials, even an official declaration of war

by Congress, will not have a dispositive effect upon the interpretation of

15 U.S.C. § 1011. See also, 15 U.S.C. § 1012(b)(“No Act of Congress shall be construed

to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating

the business of insurance, or which imposes a fee or tax upon such business, unless such Act

specifically relates to the business of insurance.”)

See, Insurance Co. of the State of Pennsylvania. v. Grand Union Ins. Co., (1990) 1 Lloyd’s

Rep 208 (HK CA 1989), cited in Graydon S. Staring, LAW OF REINSURANCE § 13:1 (1993).

See e.g. “Bush Details Plan to Help Insurers on Future Terror Claims,” NY TIMES A-1

(October 16, 2001).

See section III, infra.

See section IV(A), infra.

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•

war risk exclusion clauses, though it could inform the judicial viewpoint

and legal arguments by the insurance industry.8

The leading New York case in this area, Pan American World Airways,

Incorporated v. Aetna Casualty and Surety Company,9 suggests that the

losses to life and property on September 11 could not aptly be attributed

to a “military or usurped power” for the purposes of triggering a “war risk”

exclusion clause.10

New York statutory law appears, in some instances, to favor the insured.

Statutory law defines “war” or “acts of war” for the purposes of life

insurance, disability insurance, worker’s compensation, and health

insurance for state and retired state employees. These definitions, on their

face, appear favorable to the policyholder, but have important differences.

There is an authoritative interpretation of the life insurance policy;

however, the other provisions do not appear to have one.11

Third, this report highlights some important similarities and differences among

legal issues affecting reinsurance policies and consumer policies.12

The examination concludes with a discussion of constitutional constraints that

may impede federal and state legislation designed to suspend the enforcement of

these clauses.13

II. Choice of Law

In general, state statutory and common law governs the interpretation and

application of insurance contracts. This Report attempts to balance the weight of

authority pertaining to the interpretation of exclusion clauses, in general, and war

risk exclusion clauses, in particular. It does not provide an exhaustive survey of the

issue. To convey a sense of the common law’s trajectory in light of the events of

September 11, this Report focuses on New York law, primarily, and examines basic

contract principles as addressed by various common law systems, including that of

England.14

Emphasis on New York law is based on two grounds: (1) in the area of

evaluating the application of “war risk” exclusion clauses in cases involving a nonsovereign entity, New York has the most developed jurisprudence, and (2)

heightened Congressional attention to losses stemming from the destruction of the

See section IV(B), infra.

505 F.2d 989 (2nd Cir. 1974)(applying New York law).

See section IV(C), infra.

See section IV(D), infra.

See section V, infra.

See section VI, infra.

In the insurance context, citation to English authority appears to be common practice. Two

reasons explain this reliance. England and the United States share a common law system, and

English law displays an extensive and well developed insurance law jurisprudence.

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World Trade Center appear to be most efficiently addressed through New York law.

A focus on New York law is self limiting, not only in light of possible claims

arising in Virginia and Pennsylvania, but also in light of claims in other jurisdictions

that may arise due to choice of law provisions in insurance policies, or that may arise

due to future acts of terrorism in other states.

III. Some Procedural and Interpretive Norms Governing the

Invocation, Application, and Construction of Exclusion

Clauses.

Insurance policies are private agreements controlled primarily by state contract

law, not federal law. When enforcing an agreement, the task of the court is to

determine what the contract language means from the contracting parties’ point of

view. When interpreting contracts, courts strive to give words their ordinary

meaning, advance reasonable interpretations, avoid absurdities, “take the contract by

its four corners, consider all its terms, and examine meanings in light of the entire

transaction.”15

Generally, when the court interprets an integrated, final agreement, it will not

go outside the four corners of the document, unless there is an ambiguity.16 In the

United States Court of Appeals for the Second Circuit, an ambiguous clause is one

that gives rise to multiple meanings when viewed “objectively by a reasonably

intelligent person who has examined the context of the entire integrated agreement

and who is cognizant of the customs, practices, usages and terminology as generally

understood in the particular trade or business.”17 The court generally opts for a

meaning most consistent with the underlying purpose and intent of the contract,18 but

if ambiguity persists, then the ambiguous clause will be strictly construed against the

party who wrote it.19

Regarding the judicial construction of “terrorism risk” exclusion clauses, the

relative lack of “industry standards” to define an “act of terrorism” will complicate

judicial inquiry. Moreover, the events of September 11 may likely inform

contracting parties as they bargain over the scope and meaning of common exclusion

clauses, such as “war risk” exclusion clauses or, less common “terrorism” exclusion

clauses. As the line between war and terrorism blurs, crafting language to categorize

Graydon S. Staring, LAW OF REINSURANCE, § 13:1.

Moreover, while the parol evidence rule requires the exclusion of evidence of

conversations, negotiations and agreements made prior to or contemporaneous with the

execution of a written contract which may tend to vary or contradict its terms such proof is

generally admissible to explain ambiguities therein. See e.g. Wall Street Co. v. Franklin

National Bank, 333 N.E.2d 184, 186-87 (N.Y. 1975).

U.S. Fire Ins. Co. v. General Reinsurance Corp., 949 F.2d 569 (2nd Cir. 1991)(applying

New York law).

See, Youell v. Bland Welch and Co, 2 Lloyd’s Rep 431, 440 (1990).

See Pan Am, 505 F.2d at 1000.

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potential risks as “acts of war” or “acts of terrorism” may prove to be a complicated

and subtle task even for the most sophisticated parties.

If ambiguity prevents a court from reaching the substance of the underlying

agreement, procedural issues like burdens of proof, interpretive canons, and

presumptions may resolve cases and controversies arising under the enforcement of

exclusion clauses. Towards these narrow issues, a brief survey of New York law

may be instructive.

Under New York law, various procedural and interpretive norms favor the

policy holder in the event an insurer denies coverage under an ambiguous exclusion

clause:

•

The insured establishes a prima facie case for recovery “merely by

showing the existence of the policy and a loss with respect to covered

property.”20

•

The burden of proof then shifts to the insurer to show that the event giving

rise to the claim falls within an exclusion clause under the policy.21

•

The court interprets exclusion clauses in a manner “which is most

beneficial to the insured.”22

•

Most importantly, under the rule of contra proferentem, an insurer does not

meet its burden when it merely offers “a reasonable interpretation under

which the loss is excluded,” but only when its interpretation “is the only

reasonable reading of [a relevant term] of exclusion.”23 Under this rule,

the insurer, as the party generally responsible for the ambiguity, usually

has the uncertainty enforced against it.

The bottom line in New York is that exclusion clauses “are not to be extended by

interpretation or implication, but are to be accorded a strict and narrow

construction.”24

Insurance Co. of North America v. Historic Cohoes II, 879 F.Supp. 222, 224-25 (N.D.N.Y.

1995), citing Pan Am, 505 F.2d at 999.

See, Allianz Ins. Co. v. RJR Nabisco Holdings Corp., 96 F.Supp.2d 253, 255 (S.D.N.Y.

2000). See also, Marino v. New York Telephone Co., 944 F.2d 109 (2nd Cir. 1991);

Seaboard Surety Co. v. Gillette Co., 476 N.E.2d 272, 285 (N.Y. Ct. App.1984); and Pan Am

505 F.2d at 999.

Pan Am, 505 F.2d at 999. Accord, Westchester Resco Co. v. New England Reinsurance

Corp, 818 F.2d 2, 3 (2nd Cir. 1987) (per curiam)(holding that under New York law, the

"general rule" is that "ambiguities in an insurance policy are to be construed strictly against

the insurer").

Pan Am, 505 F.2d at 1000 (emphasis added). See also, Holiday Inns Inc. v. Aetna

Insurance Co., 571 F. Supp. 1460, 1464 (S.D.N.Y. 1984). If a case presents facts

demonstrating that the insured is responsible for the ambiguity, then it is unlikely that the

court would invoke the rule against the insurer.

Id. See also, Island Lathing and Plastering, Inc. v. Travelers Indem. Co. 2001 WL

1006114 (S.D.N.Y, 2001); Seaboard Sur. Co. v. Gillette Co, 476 N.E.2d 272 (N.Y.

1984)(“whenever [the] insurer wishes to exclude certain coverage from its policy

obligations, it must do so in clear and unmistakable language”), id. at 275 (“any exclusions

or exceptions from insurance policy coverage must be specific and clear in order to be

enforced; they are not to be extended by interpretation or implication, but are to be accorded

(continued...)

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These norms distribute the relative burdens of litigation heavily on the insurer’s

side, which will inform industry when deciding whether to deny a claim under an

exclusion clause. As applied to potential claims arising out of September 11, a

sketch of the litigation process follows.

In the event that an insurer denies a policy holder coverage for a loss caused by

the events of September 11 based on a “war risk” or similar exclusion, the policy

holder appears to have some advantages, if the case proceeds to litigation. The

policy holder would merely have to assert a loss and the existence of a policy

covering that loss to sustain a cause of action through a preliminary motion to

dismiss by the insurer. The insurer, on the other hand, would bear the burden of

proving that the events of September 11 are “acts of war” or are “acts of terrorism”

or fall under some other pocket of risks excluded under the relevant policy. If the

exclusion clause is ambiguous the insurer would have to demonstrate that its

interpretation of the exclusion clause is the only reasonable interpretation. The

relative burdens between the insured and the insurer may deter the insurance industry

from denying coverage under, for example, a “war risk” exclusion clause,25 but not

necessarily another exclusion clause, like a terrorism exclusion clause.

Other than inferring from early statements by industry, it is difficult to predict

the scope and depth of litigation stemming from claim denials under exclusion

clauses.26

IV. War Risk Exclusion Clauses

Almost always,27 insurance policies contain terms that exclude from coverage

“war risks”28 – losses of property or life due to acts of war.29 When public officials

(...continued)

strict and narrow construction.”). Moreover, “a court may infer from an insurer's reliance

on a large number of exclusions that the insurer ‘recognize[s] that each of the exclusions is

ambiguous or has only uncertain application to the facts.’” Historic Cohoes II, 879 F.Supp.

at 224-25, quoting Pan American, 505 F.2d at 1005.

For a more detailed discussion of “war risks,” see section III, supra.

For instance, the reinsurance market, consisting primarily of foreign corporations

(primarily England), could place pressure on the primary insurance market to assert

exclusions under war exclusion clauses, inter alia. Indeed, the most contentious conflicts

may be between the reinsurance market and the primary insurance market, and not between

the insurance market and the policy holders. See section IV, supra.

Aviation insurance contracts generally extend coverage for “war risks.” See Jason Bibby,

War Risk Aviation Exclusion, 60 J. AIR L. AND COM. 609 (1995).

For example, basic commercial property policies generally exclude losses for “(1) war,

including undeclared war or civil war; and (2) warlike action by a military force, including

action in hindering or defending against an actual or expected attack, by any government,

sovereign, or other authority using military personnel or other agents.” Jefferey W.

Stempel, LAW OF INSURANCE CONTRACT DISPUTES § 1.02[a] (2001)(emphasis added).

The purpose of excluding “war risks” from insurance policies is to prevent the insurer from

being bankrupted by shouldering countrywide losses from war, as these risks are of a large

(continued...)

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characterize the events of September 11 as “acts of war,” an issue arises as to the

potential effect of such a characterization on the judicial interpretation of these

clauses. However, “even [a] broadly drafted war exclusion [clause] that seek[s] to

preclude coverage for anything that looks like armed conflict is not ironclad for the

insurer.”30

This section addresses the interpretation of these clauses under New York

contract and insurance law.31

A. Reports from the Industry.

It appears, as a matter of business judgment, that most insurance companies will

not invoke war risk clauses, at least initially. On September 25, a panel of American

insurance and reinsurance professionals testified before the House Financial Services

Committee and indicated that industry has the capacity and will to pay claims arising

out of the events of September 11.32 Conclusions concerning the industry’s overall

inclination to contest, arbitrate, or litigate may be premature, however, as

international reinsurance providers revise (and increase) their loss estimates.33 On

September 17, a Wall Street Journal article reported that “insurers intend to pay

claims stemming from [the attacks] on the World Trade Center, despite certain ‘act

of war’ policy exclusions.”34 The public statements by industry are not uniform, as

reports on September 19 suggest that certain segments of the industry have not ruled

out denying claims under a theory of war risk exclusion (or other exclusions).35

Even in the case of litigation, a survey of New York case law suggests that the

events of September 11 may not be sufficient to be categorized as acts of war under

insurance contracts. While the law is not categorical, the weight of authority appears

(...continued)

scale (e.g. the 1991 Gulf War, World War II) and may go on for years (e.g. insurgence

against the former Soviet Union’s occupation of Afghanistan). Jefferey W. Stempel, LAW

OF INSURANCE CONTRACT DISPUTES § 1.02[a] (2001).

Id. at § 15.02

This section focuses on New York law for the sake of brevity, clarity, and probability.

There are, no doubt, “choice of law” issues which may preclude the application of New York

law to particular insurance policies. However, even in these circumstances, New York

jurisprudence is influential in the area of policy exclusions under “war risk” clauses. It is

likely that the Second Circuit’s decision in Pan Am, 505 F.2d 989, will serve as a template

in other jurisdictions addressing these issues. See III(C), infra.

See, “Hearing on America’s Insurance Industry: Keeping the Promise,” September 25,

2001; http://www.house.gov/financialservices/092601tc.htm <visited October 1, 2001>

See, “Insurers Revise Terrorist Attack Estimates” at http://www.lloyds.com/un/en/

article/0,1252,101020000|101119,00.html <visited September 21, 2001>

Christopher Oster, Insurers Pledge Act of War Won’t Block Claims, THE WALL STREET

JOURNAL, A-3 (Sept. 17, 2001).

See Christopher Oster, Insurers Weigh Invoking Act-of-War Clauses to Invalidate Policies,

THE WALL STREET JOURNAL, A-4 (Sept. 19, 2001).

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to favor the insured on this issue. However, the insurance industry enjoys recourse

to a battery of arguments in its favor.

B. The Public’s Interpretation Versus the Court’s Interpretation of

“Act of War.”

Though procedural and interpretive norms tend to favor the insured,36 the

pervasive characterization of the events of September 11 as an “act of war” by public

officials, sovereigns, international organizations, and the media could affect how the

courts interpret a war exclusion clause. However, even a declaration of war by

Congress will not have a dispositive effect on the construction of material terms

contained in private contracts. The intent of the parties, not the description of

Congress, controls whether the events of September 11 are “acts of war” within the

meaning of private contracts.37 The material issue, here, is whether the events of

September 11 were “proximately caused by an agency fairly described, for insurance

purposes, by an exclusion clause” in the relevant policy.38 Or, in similar terms, the

court will construe the “exclusions as the parties would reasonably have expected

them to be construed.”39 This is essentially a question of fact.40

To stress again, as the court is dealing with a question of fact, how the

background culture characterizes the events of September 11 may inform a court

when it categorizes what “warlike” action means under a policy’s exclusion clause,

if the court admits extrinsic evidence in giving the words their ordinary meaning.

Still, precedent suggests that characterizations of an event by public officials is not

dispositive of the issue.41

As these cases turn on the application of New York norms of construction in

individual cases, comprehensive analysis and prediction is not possible – such is the

See section II, supra.

Under New York law, insurance policies are to be interpreted in accordance with their

terms. See Continental Insurance Company v. Arkwright Mutual Insurance Company, 102

F.3d 30 (2nd Cir. 1996).

See, Holiday Inns Inc. v. Aetna Insurance Company, 571 F. Supp. 1460, 1464 (S.D.N.Y.

1983)(holding that interpretation of insurance policies does not turn on how political leaders

describe the events giving rise to a loss, but on how the policy describes the event), quoting

Spinney’s Ltd v. Royal Insurance Co., Ltd, 1 Lloyd’s L. Rep 406 (Q.B.). Holiday Inns

involved a claim for damage to a hotel shelled during a battle in Beirut, Lebanon. The issue

involved whether the three entities in conflict were “at war” for purposes of the insurance

contract. The insurer argued that three factions fighting in Lebanon had sovereign attributes.

The court focused only on the faction that did the damage and held that the faction was not

a sovereign entity, and even if it were, it was not fighting another sovereign when the

damage was done. As such, the “war” exclusion clause was not applied.

Pan Am, 505 F.2d. at 1003.

See id.

Id. See also 571 F. Supp at 1464.

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nature of contract law. However, the leading case in this area, Pan American World

Airways, Incorporated v. Aetna Casualty and Surety Company,42 may be instructive.

C. The Pan American Case.

In Pan Am, a jet was hijacked and destroyed by political dissidents in the

Middle East. “Notwithstanding the obvious political overtones of the event,” the

court ruled that “the hijacking was too contained to come under the war or

insurrection exclusion.”43 A rule of causation and a rule of identity informed this

conclusion.

According to the Pan Am decision, when the court interprets an insurance

policy excluding from coverage any injuries "caused by" a certain class of

conditions, “the causation inquiry stops at the efficient physical cause of the loss; it

does not trace events back to their metaphysical beginnings."44 With respect to

claims arising out of the September 11 incident, a court following this rule may

examine the naked act of a plane crashing into a building, stripping the event of its

political motivations and significance. The court will then likely ask whether this

naked act is the sort of instrumentality properly categorized as an “act of war” for

the purposes of the relevant war exclusion clause. This narrow inquiry into the cause

underpinning the events of September 11 cuts against an argument attributing losses

to property and life from theses events to an act of war.45

In the Pan Am case, the court examined contract language excluding from

coverage losses caused by a “military or usurped power.” Under Pan Am, an act

causing such a loss “must be at least that of a de facto government.”46 On the facts

of Pan Am, where the “military or usurped power” language was part of the

insurance policy, the court found that the terrorist organization that highjacked the

505 F.2d 989

Id. at 1009. Jefferey W. Stempel, LAW OF INSURANCE CONTRACT DISPUTES § 1.02[a]

(2001)

Pan Am, 505 F.2d at 1006. See also Kimmins Indus. Service Corp. v. Reliance Ins. Co.,

19 F.3d 78, 81 (2nd Cir. 1994), Album Realty Co. v. American Home Assurance Co., 176

A.D.2d 513, 514 (N.Y. Ct. Ap. 1991)(reversed on other grounds), quoting Home Insurance

Co. v. American Insurance Co., 147 A.D.2d 353, 354 (1989).

See also, Queen Insurance Company v. Globe and Rutgers Insurance Co., 263 U.S. 487

(1924)(applying a similarly narrow causation rule, holding that a collision of two merchant

ships traveling the Atlantic ocean in World War I was not caused by a “war risk.”) In Queen

Insurance, the ships were traveling at night, without lights, and one ship changed its course

into the direction of the other because of a submarine attack. The Supreme Court held that

the damage was due to a “collision” as such, which could have occurred at any time;

therefore, it was not the result of “war.” But see, TTR/FTC Communications, Inc. v.

Insurance Company of the State of Pennsylvania, 847 F. Supp 28 (D. Del. 1993)(finding that

looting of merchandise and equipment during the Panama conflict was sufficient to trigger

a war risk exclusion clause since the act was “enabled by the military hostilities occurring

between Panama and the United States.”) In dicta, the TTR/FTC court suggested that the

conclusion would follow, even if the looters were not an arm of the Panama government’s

forces.

Pan Am, 505 F.2d at 1006.

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Pan Am airplane “was not a de facto government in the sky over London when the

747 was taken.”47

D. New York Statutory Law.

State law governs the application of “war risk” exclusion clauses. While New

York’s common law controls the interpretation of many categories of insurance

contracts, statutory law controls the interpretation of war risk clauses in life and

disability insurance contracts, in health insurance contracts for state and retired state

employees, and in workers’ compensation programs. When parties agree to contract

terms, these statutes set the outer limits by which insurers may exclude coverage for

losses stemming from “acts of war.” New York statutory law only provides for

narrow exclusions in life insurance48 and disability insurance49 contracts. On the

other hand, broad exclusion language controls the interpretation of health insurance

contracts for state employees,50 as well as in worker’s compensation programs.51

The New York courts remain, for the most part, silent on the extension of these

statutory provisions.52

However, Shneiderman v. Metropolitan Casualty offers insight into how New

York courts interpret “war risk” exclusions in life insurance contracts.53

Shneiderman involved a photo-journalist who died in the Suez Canal vicinity during

a “cease fire” in the Arab-Israeli conflict of the 1950's.54 The issue there was

whether a death during an official cease fire was "caused by war or any act of war”

Id.

See, NY INS. § 3203(c)(1)(A) - (C)(2001)(defining “war” and “act of war” in narrow terms

for the purpose of general life insurance contracts); NY CIV SERV § 4510(b)(1)(A),(C) and

(b)(2)(A)-(C)(McKinney 2001)(defining “war” and “act of war” in narrow terms for the

purposes of life insurance contracts provided by fraternal benefit societies); and, 11 NYCRR

45.1 (May 15, 2001)(administrative regulation requiring that when life insurance contract

contain “act of war” exclusions, the insured must have separate, written notice of the

inclusion of such clauses in the contract. It is not clear whether the insured has to

acknowledge the separate notice.)

See, NY INS. § 3215(b)(1)(C)(McKinney 2001)(defining “an act of war” in broad terms,

but contemplates that such acts occur while “the insured is outside the geographical limits”

specified by the policy).

See, NY CIV. SERV. § 161(2)(McKinney 2000)(severe limits on benefits, excluding

payment for “services received for injury or sickness due to war or any act of war, whether

declared or undeclared, which war or act of war . . .”).

See, NY WORK. COMP. § 205 (McKinney 2001)(a very broad exclusion clause for “any

disability due to any act of war, declared or undeclared . . .”).

Note that Pan Am and Holiday Inns dealt with insurance contracts covering property

insurance.

14 A.D.2d 284 (N.Y. 1961)

See id. at 285.

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under a life insurance policy.55 The court answered no.56 The court’s interpretive

approach, not its holding under the facts, is relevant here.

The Shneiderman court read terms like “war” in a way consistent with

“everyday,” rather than “specialized,” language.57 Finding for the insured, the court

took “cognizance of the fact that an insurance policy is generally a contract with the

average man who presumably is unfamiliar with the existence of a state of war from

the strictly political, military and/or legal standpoint.”58 Common use of “war or act

of war” in “every day expression” controlled the court’s interpretation, rather than

the use that controls “international relations or military affairs.”59

V. Interpretation and Construction of Reinsurance Contracts

Reinsurance is insurance for the insurance industry. Generally, there are two

forms of reinsurance: facultative reinsurance and treaty reinsurance.60 Exclusion

clauses are found in both (though more commonly in facultative contracts.)

“There is no reason for reinsurance contracts not to be interpreted and construed

according to the rules for contracts generally.”61 However, as the business reality of

the reinsurance market is guided by a different set of market norms and mores than

the primary insurance market, the application of the court’s rules of construction may

differ. In this respect, it is possible that a claim may not fall under an exclusion

clause in a primary insurance policy, but may fall under one in a reinsurance policy.

So, it is possible that a primary insurer of the events of September 11 will have to

pay its policy holder, but not enjoy coverage under its reinsurance contract.

Understanding how reinsurance market norms and mores inform the judicial

construction of exclusion clauses is easier said than done, since reinsurance “is a

field in which differences have often been settled by handshakes and umpires, and

pertinent precedents . . . are few in number.”62 However, this in itself suggests that

any conflict between the insured and reinsurer will likely be handled, at least

initially, in arbitration. Though uncertainties abound, a few generalizations about

exclusion clauses in general may be made. Moreover, there are some relevant

similarities and distinctions between reinsurance and primary insurance.

See id.

See id. at 290.

Id. at 287.

Id.

Id..

Facultative reinsurance is policy specific – it underwrites particular risks, in whole or part,

on a single policy. Treaty reinsurance exhausts the remaining universe of reinsurance – it

is generally used to aggregate and thus simplify reinsurance transactions, as they cover

multiple contracts under one reinsurance policy. Facultative reinsurance, which requires

individual attention, is used less often, but is nonetheless important.

Graydon S. Staring, LAW OF REINSURANCE §13:1 (1993).

Sumitomo Marine and Fire Ins. Co. v. Cologne Reinsurance Co., 552 NE2d 139 (1990).

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For this report’s purposes, three points of similarity and difference are

noteworthy:

•

The burdens of proof are similar. The reinsured carries the burden of

proving the fact of a loss and a relevant policy covering that loss.63 The

reinsurer carries the burden of proving an exception to the policy.64

•

The reinsurance contract is distinct from the underlying policy.65 While

parties generally aim to make a reinsurance policy coextensive with an

underlying policy, reinsurance is not, as a matter of law, coextensive with

the underlying policy.66 Moreover, an exclusion clause in a reinsurance

contract may be enforced against the reinsured, even though the reinsured

paid out on the underlying policy without invoking a similar exclusion

clause.

•

While the canon of contra proferentem generally favors the policy holder

in the primary insurance market,67 the reinsured does not necessarily enjoy

the favorable rule as against its reinsurer. The courts are split on the

extent to which an insurance company may invoke the canon against its

reinsurer.68 Due to this splintered precedent, a commentator on

reinsurance law suggests that the “party who would avoid the rigor of the

canon or who wants to avoid it will have to prepare a good factual case on

negotiation, economic duress, drafting, and who proffered the contested

wording.”69

See, 19 COUCH ON INSURANCE 2d, §§79.345, 79:368 (Rev. ed. 1983), cited in LAW OF

REINSURANCE §12:2.

See id.

See, Imperial F. Ins. Co. v. Home Ins. Co., 68 F 698 (1895).

For example, extrinsic evidence could suggest that parties intend the reinsurance to cover

risks coextensive with the underlying policy, but under the court’s policy of limiting

interpretation to the four corners of the contract, a reinsurance policy that is unambiguous

may be interpreted to exclude, contrary to the party’s intent, loses from coverage. See e.g.

Youell v. Bland Welch and Co., 2 Lloyd’s Rep 423 (Q.B. 1990).

See footnote 23, supra, and accompanying text.

In New York, when the reinsured is responsible for the ambiguity, the rule of contra

proferentem is applied against the reinsured. See, London Assur. Corp. v. Thompson, 62

N.E. 1066 (N.Y. 1902)(holding that “the responsibility for the ambiguity should be borne

by the party who caused it,” even though in the normal run of cases, the insurer is

responsible.) The Second Circuit, applying Massachusetts law, has held contra proferentem

a nullity “when both [parties] are large insurance companies long engaged in far-flung

activities in that field.” Great American Insurance Co. v. Fireman’s Fund Ins., 481 F.2d

948, 954 (2nd Cir. 1973)(remanding to the lower court to apply parol evidence rules to the

contested contract language), quoting Boston insurance Company v. Fawcett, 258 N.E.2d

771 (1970). Still others apply the rule categorically against the reinsurer. See, e.g., Royal

Ins. Co. v. Vanderbilt Ins. Co, 52 SW 168 (Tenn. 1899).

Graydon Staring, LAW OF REINSURANCE §13:2.

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VI. Constitutional Impediments to State and Federal

Legislation

Various constitutional impediments may obstruct federal and state legislation

designed to retroactively frustrate the private enforcement of exclusion clauses.

A. Federal Legislation.

In the event that Congress considers legislation to suspend or obstruct the

enforcement of “war risk” or “terror wisk” clauses, various constitutional issues may

arise. Though Congress has the power under the commerce clause to regulate the

insurance industry, the Fifth Amendment’s due process and takings clauses may

frustrate certain legislative responses to the invocation of exclusion clauses.

Congress enjoys Article I authority to regulate the business of insurance under

the commerce clause.70 However, pursuant to the McCarran-Ferguson Act, Congress

generally leaves such regulation up to the states, declaring “that the continued

regulation and taxation by the several States of the business of insurance is in the

public interest.”71 While Congress has constitutional power to act, legislation

impairing insurance contracts covering the World Trade Center could involve, to a

certain extent, the federalization of insurance law.

If Congress retroactively affects the insurance industry’s private interests in

contract, constitutional proscriptions may frustrate the legislation. Federal

legislation that interdicts or interferes with private contracts triggers a person’s due

process rights.72 As a general rule, the courts will treat such legislation under the

lenient, rational basis test accorded to economic regulation (whether the legislation

operates retroactively or not).73 Regulation subjected to this test is generally upheld.

However, in the light of Eastern Enterprises v. Apfel,74 a majority of the

Supreme Court may subject such legislation to a higher standard of scrutiny. Eastern

U.S. Const., Art. I, § 8, cl. 3 (giving Congress the power “to regulate Commerce . . . among

the several states.”) See also, United States v. South-Eastern Underwriters Assoc., 322 U.S.

533 (1944)(holding that “insurance” is “commerce” for the purposes of the commerce

clause.)

15 U.S.C. § 1011. See also, 15 U.S.C. § 1012(b)(“No Act of Congress shall be construed

to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating

the business of insurance, or which imposes a fee or tax upon such business, unless such Act

specifically relates to the business of insurance.”)

U.S. Const. amend. V. (“No person shall . . . be deprived of life, liberty, or property,

without due process of law.”)

See Pension Ben. Guar. Corp. V. R.A. Gray and Co., 467 U.S. 717, 731 (1984)(finding that

“the enactment of retroactive statutes confined to short and limited periods required by the

practicalities of producing national legislation ... is a customary congressional practice. We

are loathe to reject such a common practice when conducting the limited judicial review

accorded economic legislation under the Fifth Amendment's Due Process Clause.”) Accord,

United States v. Sperry Corp., 493 U.S. 52, 65 (1989).

523 U.S. 498 (1998)(plurality).

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involved the constitutionality of a Federal statute requiring coal mining companies

to fund lifetime health benefits of miners they employed decades earlier, even when

some of the companies never promised under their employment contract to provide

such benefits.75 A company, Eastern Enterprises, which had not made such a

promise, challenged the statute when a former employee sued Eastern for benefits

under the statute.76 In a 4-1-4 plurality, the Court found the statute unconstitutional

as applied to Eastern.

Five justices held that the Fifth Amendment’s due process clause controls the

evaluation of regulation retroactively impairing a party’s contract rights. Four

justices held that the takings clause of the Fifth Amendment is the relevant clause.

Four dissenting justices voted to uphold the statute under due process. One justice

voted to strike it down under due process. The remaining four justices voted to

strike it down under the takings clause. The reason for the 4-1-4 split follows.

Under the due process clause, four members of the current Supreme Court –

Stevens, Souter, Breyer, and Ginsburg – appear willing to strike down retroactive

economic regulation only if it is “fundamentally unfair.”77 These justices apply the

traditional rational basis test accorded to economic regulation. For Breyer, who

wrote for the dissenters, Eastern Enterprises needed to “show a sufficiently

reasonable expectation that it would remain free of future health care cost liability

for the workers whom it employed.”78 Otherwise, it fails to “show that the law

unfairly upset its legitimately settled expectations.”79 From the dissent’s point of

view, the company failed to meet this burden. Thus, four members of the court

would have upheld the statute as applied to Eastern.

Relative to the dissent, Justice Kennedy takes a similar, but more rigorous

approach. Similar to the four dissenting justices, Justice Kennedy invoked due

process principles to settle the matter before the Court.80 However, he subjected the

regulation to a higher standard of scrutiny.81 For Kennedy, “if retroactive laws

change the legal consequences of transactions long closed, the change can destroy

the reasonable certainty and security which are the very objects of property

ownership.”82 “As a consequence,” Kennedy concludes, “due process protection for

property must be understood to incorporate our settled tradition against retroactive

laws of great severity.”83 In other words, Kennedy would apparently subject

regulations of “severe retroactivity” to “severe scrutiny,” but not necessarily “strict

Id. at 500.

Id.

See id. at 559 (Breyer, J., dissenting)(Justices Stevens, Souter and Ginsburg joined.)

Id. at 567.

Id. at 568.

Id. at 547 (Kennedy, J., concurring in the judgment, dissenting in part).

Id. at 549.

Id. at 548.

Id. at 549.

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scrutiny.”84 As such, Kennedy appears more likely than Justices Breyer, Stevens,

Ginsburg, and Souter to strike down, under due process, retroactive economic

regulation of private contracts.

The remaining four justices, Rehnquist, O’Connor, Scalia, and Thomas, take a

different approach.85 In Eastern, these justices applied the Court’s “regulatory

taking” jurisprudence under the Fifth Amendment.86 As a general rule, contract

impairment does not constitute a taking for the purposes of the Fifth Amendment.87

However, the weighing of three general factors cut the plurality’s analysis in the

other direction: (1) the economic impact of the regulation, (2) the extent to which the

regulation interferes with investment-backed expectations, and (3) the character of

the governmental action.88 The plurality found a taking in Eastern on two grounds:

(1) the statute imposed severe retroactive liability on a limited class of parties who

could not have anticipated the liability, and (2) the extent of liability was

substantially disproportionate to the company’s experience in the relevant market.89

Moreover, it should be noted that the plurality and the four dissenters appear to

operate under a different conception of “retroactive impairment,” the Breyer

dissenters being more likely to view such legislation as imposing a “future liability”

on the rational grounds of a preexisting relationship.90

The absence of a case or controversy under an existing legislative scheme limits

constitutional analysis and prediction. However, it appears is that a majority of the

Supreme Court may be willing to subject economic regulation that retroactively

impairs private interests in contract to a higher standard of scrutiny than rational

basis.

B. State Legislation.

Under the Fourteenth Amendment’s due process clause and the Fifth

Amendment’s takings clause (as incorporated by the Fourteenth Amendment), the

When the court applies the “strict scrutiny” standard, the regulation, in order to pass

constitutional muster, must be narrowly tailored to serve a compelling state interest. In

Eastern, Kennedy appears to apply a less strenuous standard of review than strict scrutiny,

but more severe than rational basis. Thus, “severe scrutiny” is an apt descriptor as it reflects

the tone of his opinion.

Id. at 529 (O’Connor, J., plurality)(“we reach [our] conclusion by applying [regulatory

takings analysis,] although Justice Kennedy and Justice Breyer would pursue a different

course . . .”).

U.S. Const. amend. V. (the amendment provides “. . . nor shall private property be taken

for public use, without just compensation.”)

See, e.g., Connolly v. Pension Benefit Guar. Corp., 475 U.S. 211 (1986).

See, Eastern Enterprises, 523 U.S. at 524 (O’Connor, J., plurality),

See id. at 529 - 537.

Compare id. at 555 with id. at 532.

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court will subject state regulation to a similar standard as federal regulation.91 As

such, the Court’s ambiguous jurisprudence, discussed above, will likewise cloud the

analysis of state regulation designed to retroactively impair the enforcement of

exclusion clauses. However, an additional constitutional hurdle faces the states – the

contracts clause.

Article I, § 10, cl. 1 forbids the States from passing laws impairing the

obligation of contracts.92 However, under Home Building and Loan Assn. v.

Blaisdell,93 the stricture is not daunting, unless the states are attempting to avoid their

own contractual obligations.94 Under Home Building, “obligations of a contract are

impaired by law which renders them invalid, or releases or extinguishes them.”95

However, a state’s economic interests may justify exercise of its protective power,

“notwithstanding interference with contracts.”96 Moreover, “where protective power

of the state is exercised in a manner otherwise appropriate in regulation of business,

it is no objection that performance of existing contracts may be frustrated by

prohibition of injurious practices.”97

In light of the events of September 11 and its rippling effect on New York’s

local economy (apart from the national and world economies), state legislation

designed to serve the state’s economic interests by retroactively impairing the

enforcement of private insurance contracts are not likely to be struck down under the

contracts clause. However, without a specific legislative scheme at hand, prediction

and analysis is limited.

VII Conclusion

State common and statutory law controls the interpretation and enforcement of

exclusion clauses. This Report offers a few generalities concerning the extension

and application of these provisions. It does not provide an exhaustive survey.

Reports from industry suggest that “war risk” exclusion clauses will not likely

be invoked against losses arising out of the events of September 11, in general, and

the destruction of the World Trade Center, in particular.

In the event insurers invoke war risk clauses, interpretive canons and norms of

procedure suggest that success is unlikely, if the exclusion clause is ambiguous and

the insurer is the party responsible for the uncertain language. However, when an

exclusion clause is unambiguous, norms of interpretation generally do not cut against

See, Chicago B. & Q.R.R. v. Chicago, 166 U.S. 226 (1897)(Harlan, J.)(applying the fifth

amendment’s takings clause against the states through the fourteenth amendment.)

“No State shall . . . make any . . . Law impairing the Obligation of Contracts . . .”

See, 290 U.S. 398 (1934).

See, United States Trust Co. v. New Jersey, 431 U.S. 1 (1977).

290 U.S. at 431.

Id. at 437.

Id. at 438.

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the insurer’s interests, and, therefore, courts are more likely to apply exclusion

clauses against the insured.

The intent of the parties, the commercial context in which they bargain, and the

type of insurance at issue play significant roles in anticipating how a court will

interpret and apply an exclusion clause. As such, precise analysis and prediction is

difficult. However, generalities about bedrock common law doctrine can be offered.

These generalities convey a flavor for how courts traditionally interpret exclusion

clauses, and thus provide background for appropriate regulation.

Direct regulation of the insurance industry by Congress will involve, to a certain

extent, the federalization of insurance law, a deviation from the policy underlying the

McCarran-Ferguson Act. Under the Commerce Clause, Congress enjoys plenary

authority to regulate the insurance industry, but remains limited by other provisions

of the Constitution, like the Due Process Clause and the Takings Clause.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.