Scottsdale Indem. Co. v. Village of Crestwood, 2012 U.S. App. LEXIS 5069 (7th Cir. Mar. 12, 2012), the United States Court of Appeals for the Seventh Circuit, applying Illinois law, had occasion to consider the nature and purpose of the total pollution exclusion.
The underlying facts in Village of Crestwood involved traditional environmental pollution, and as such, did not appear to be the type of case that would require an extensive judicial opinion. A number of residents of the Village, a small suburb of Chicago, alleged in individual tort suits that the in the mid-1980s, the Village became aware of PCE or “perc” contamination of one of its municipal drinking wells, but nevertheless allowed the wells to be used for drinking water through 2007. In addition to these tort claims, the State of Illinois brought suit against the Village, seeking to require the Village to delineate and remediate any environmental contamination. The Village’s general liability insurer, Scottsdale, denied coverage for the suits on the basis of its policies’ pollution exclusions, and the United States District Court for the Northern District of Illinois ruled in Scottsdale’s favor on motion for summary judgment.
On appeal to the Seventh Circuit, Judge Posner agreed that perc qualified as a contaminant, and that there was a requisite discharge, dispersal, release, etc., of the perc such that the pollution exclusion applied. Judge Posner added, however, that “the problem with stopping there and affirming the district court in one sentence is that a literal reading of the pollution exclusion would exclude coverage for acts remote from the ordinary understanding of pollution harms and unrelated to the concerns that gave rise to the exclusion.” Instead of giving a one-sentence affirmance, Judge Posner followed with a multi-page disquisition on the history and purpose of the exclusion.
Judge Posner began his analysis by observing that the pollution exclusion should not apply each time an injury has a nexus to a contaminant. For instance, when a car spins out in an oil slick and results in injury to the driver, it cannot be said that the driver suffered bodily injury because of a pollutant. It is for this reason, explained Judge Posner, that Illinois courts have limited application of the exclusion to traditional environmental pollution, most notably in American States Ins. Co. v. Koloms, 687 N.E.2d 72 (Ill. 1997). Judge Posner agreed with this rationale, but nevertheless observed that:
A more perspicuous formula than "traditional environmental pollution" would be "pollution harms as ordinarily understood." That formula would also exclude the case of the leaking furnace; for think of what a misuse of language it would be to say that the workers had been injured by pollution. If one commits suicide by breathing in exhaust fumes, is that death by pollution?
Judge Posner followed this query by engaging in an analysis into the purpose of the exclusion. The exclusion did not come into prominence out of a “fear by insurance executives of losses by insureds.” Rather, the need for the exclusion arose out of general liability carriers’ inability to predict and calculate losses that can result from pollution. The inability to properly assess risk, he explained, results in arbitrary premiums and the potential for overinsurance. This, in turn, raises the potential for “adverse selection,” which could have negative societal consequences:
Overinsurance would attract people who valued their property at less than its insured value, and the addition of such people to the insurance pool would increase the probability of losses and so drive up premiums. Legitimate insurance purchasers would respond to the increased premiums by shifting their business to companies that refused to overinsure, and this would raise the probability of losses to the (shrunken) insurance pool of the first company and drive its premiums even higher. It would be a death spiral. The fear of such spirals explains the exclusion of pre-existing medical conditions from health insurance policies, the requirement in the federal health-reform law that in exchange for the elimination of that exclusion everyone be required to have health insurance, and laws requiring all motorists to have liability insurance as otherwise premiums would be driven to high levels by the most careless drivers, causing the safer ones to drop insurance, although that is not the only reason for such laws.
In other words, Judge Posner sees societal need and value in allowing insurers to have exclusions for risks that cannot be adequately valued. This is particular true for environmental contamination, which “is often very difficult to detect until it has become extensive, let alone to predict, or estimate its likely extent, in advance; and the financial consequences can be horrific but again are unpredictable.” This, he explained, created the adverse selection risk:
The main reason for the broad pollution exclusion is the adverse-selection problem of which we gave examples earlier. 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.
Judge Posner thus concluded that the pollution exclusion serves an important purpose in keeping insurance premiums in check, but that the exclusion must be narrowly restricted to harms that can reasonably understood to result from pollution.
In reaching this conclusion, Judge Posner considered but rejected the Village’s argument that application of the exclusion should be limited to instances where the insured actually caused the contamination. The language of the exclusion did not support such a narrow reading, and in any event, the Village bore responsibility for concealing the contamination from its residents for nearly a quarter of a century. Judge Posner further observed that identifying the cause of the contamination was a pointless exercise in reductive reasoning:
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, though [it] 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. None of the other authors could be thought to have caused the contamination and resulting injury in a sense of "cause" that is relevant to legal liability.
Thus, he concluded, limiting application of the exclusion to the actor responsible for the contamination would render it “largely nugatory” and frustrate its purpose. Judge Posner also rejected the Village’s argument that the exclusion should not apply to an insured involved in the distribution of a product (water) that could be contaminated, i.e., a “core business activity” application. This distinction, he noted, does not resolve the adverse-selection problem, since an insurer can no more easily predict the risk of contaminated products than it can predict the risk of environmental pollution.
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