Innocent Insured: Are You Protected?

Most of us are confident that when our business floods, or home burns down, that we have sufficient insurance coverage to ensure we can rebuild and provide for the future. Surely, if we have paid our premiums, given prompt notice, provided our insurers with all the necessary paperwork and cost estimates, and we had nothing to do with causing the loss, then we will be paid for the loss. Right? The answer is in truth, a very qualified "maybe" and in some cases "no." So what's the problem? Coverage for losses can be in jeopardy if another insured under your policy did play a role in causing the loss or otherwise gave misleading information to the insurer during the claim investigation -- even if its your policy and you are completely innocent.

Not surprisingly, most property insurance policies (whether they be homeowner or commercial general liability policies) contain broad definitions of who is considered an "insured" under the policy. In the case of your home, that can mean not only the married couple who own the home and who the policy is issued to ("the named insureds") but also relatives of the named insureds who reside in the home. All partners in a partnership or certain key officers in a corporation may be "insureds" under policies issued to those entities. On the plus side, that potentially expands the property and persons covered when a loss occurs.

But perhaps less well known is that most such insurance policies also contain what is referred to as a "joint obligation clause." When present, this type of clause mandates that the responsibilities, acts or failures to act on the part of any person defined as an "insured" under the policy will be binding upon any other "insured." What courts across the country have determined is that when one "insured" under the policy takes an action which reduces coverage, that act is binding on all other insureds.

What does all that mean? It means:

• The innocent homeowner cannot recover when the home is destroyed by arson committed by a spouse, or even a less than reputable relative who just happens to be staying with you for a few months. (See e.g., Bryant v. Allstate Ins. Co., 592 F.Supp. 39 (E.D. Ky. 1984)).

• There may not be coverage on the parent's homeowner policy for injuries to the victim shot by the parent's wayward son because the joint obligation clause in the policy "resulted in the son's intentional act of shooting victim becoming the act of the parents under the policy" (Hrynkiw v. Allstate Floridian Ins. Co., 844 So.2d 739 (Fla. Dist. Ct. App. 2003)).

• When one corporate officer commits an intentional act in causing the loss, that bad act is imputed to the corporation and the corporation cannot recover anything. (Iemma c. Adventure RV Rentals, Inc., 632 N.E.2d 1178 (Ind. Ct. App. 3d Dist. 1994)).

• When one partner leaves to another the chore of completing the proof of loss, and that one partner deliberately exaggerates the value of the property destroyed, the partnership may be barred from any recovery even if the other partners were unaware of the fraud. (Tenore v. American & Foreign Ins. Co. of N.Y., 256 F.2d 791 (7th Cir. 1958)).

Courts will err on the side of policyholders in most situations, but they will also uphold unambiguous policy language even when this leaves an otherwise sympathetic innocent insured in the lurch. In the words of the Bryant court, the provisions of the policy excluding coverage for bad acts by any insured were "as clear as spring water" and it did not see itself "as saddling the plaintiff with the consequences of a crime that she did not commit, but rather as only requiring the company to pay solely for those losses it insured and not for those which were clearly excluded by unambiguous language."

Some states have adopted "innocent co-insured" statutes to protect the innocent insured in these situations, but they are the minority. Kentucky is not one of them. There is one case in Kentucky which an innocent insured could rely upon. In that case, the court held that "an innocent spouse should not be denied coverage under any policy of insurance simply because of the marital relationship." (American Hardware Mut. Ins. Co. v. Mitchell, 870 S.W.2d 783 (Ky. 1994)). But the policy involved there did not contain a joint obligation clause, and the court even indicated that "the policy could have been written to negate the collection of insurance by a co-insured." But most property policies do contain joint obligation clauses, and Mitchell provides no support for the innocent co-insured who has such a policy.

The best advice to minimize your risk is to read your policy closely and ensure you have the coverage you think you do. Don't delegate the making of your claim to others. Be honest. Don't exaggerate the claim, the cause of the loss or the value of the property destroyed. And associate yourself with people who do the same. Because despite how innocent you are, it may not matter if your spouse, relative, fellow shareholder or partner is "not so innocent."