Insurability of Punitive Damages — Texas Style

It’s not as if the only cases I read these days are from the former independent nation of Texas, but the Texas Supreme Court is on a roll in clearing out its backlog of important insurance cases, some involving additional insured coverage (and here), and a new important decision on the insurability of punitive damages.
One of the great myths in the insurance industry is that punitive damages are not insurable. This is false, particularly considering that the majority of US jurisdictions allow coverage for punitive damages at least in some circumstances. The argument against coverage in premised on the notion that it would undermine the deterrent effect of imposing punitive damages were the defendant able to in turn seek insurance recovery. A century ago the same debate in the same terms was had over whether liability insurance policies were themselves contracts violative of public policy, since it would undermine the deterrent effect of imposing tort liabiltiy were the defendant able to in turn seek insurance recovery. See Mary McNeely, Illegality as a Factor in Liability Insurance, 41 Col. L. Rev. 26 (1941) (an excellent early analysis of some of these questions). As McNeely wrote three score years ago, “Throughout its history the insurance device has been alternatively hailed as a promoter of communal welfare and damned as a generator of evil.”
So too is framed the interesting recapitulation of these familiar polarities from the majority and (main) concurring opinions in Texas. Fairfield Ins. Co. v. Stephens Martin Paving LP (Texas Feb. 15, 2008).
What I would add is that the data and more rigorous theoretical analyses do not suggest there is a major “moral hazard” problem in liability insurance, see C. Heimer, Reactive Risk and Rational Action: Managing Moral Hazard in Insurance Contracts (1985). And courts should not assume a set of governing facts without evidence (for given the data here the easy assumption that allowing indemnification “encourages” misconduct is surely problematic and not a proper subject for judicial notice). This is not to suggest that there isn’t lazy underwriting — insurers should vet their potential insureds to see if they might be the kind of of folks or companies to engage in misdeeds. But as the Texas majority holds, the principle of freedom of contract should allow whatever coverage is provided by the contract terms — and if insurers do not want to cover punitive damages in their policies, they can say that.

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