Punishing Who’ The Debate Over Insuring Punitive Damages

Two recent Texas opinions have re-opened an issue of public policy. For many years now, the question as to whether punitive damages are covered under general liability policies has been one of much debate. In Texas, much of the debate in earlier years focused on the fact that it was not clear exactly what punitive damages were supposed to do. That is, were punitive damages designed to punish, or were there other public policy rationales for their imposition, such as compensation of victims? If so, it might make at least some sense to allow insurance against the risk of punitive damages.

Then, in a moment of great clarity, the Texas Supreme Court in Transportation Ins. Co. v. Moriel, 879 S.W.2d 10 (Tex. 1994), held forth that “the legal justification for punitive damages is similar to that for criminal punishment” and that “punitive damages are levied for the public purpose of punishment and deterrence.” Id. at 16-17. Viola! If the rationale for punitive damages in Texas is solely punishment and deterrence, it would seem that the question of insurability is simple.

Let me explain. If punitive damages are designed to punish and deter the bad behavior of tortfeasor’s, the insured’s ability to get insurance coverage to cover punitive damages would undermine their very purpose. It is as if a criminal could get jail insurance so that someone else would serve his time or pay his fine (which courts have rejected as against public policy). Okay, I guess it is possible that the criminal would have to pay a very high premium if such insurance was available, but what prudent criminal would not fork over serious dollars in order to avoid the risk of punishment for his crime. Likewise, if a corporation, in buying insurance, knows that it will not be “punished” for its gross negligence if punitive damages are awarded, since insurance will pay, then the normal function of punishment and deterrence are gone (obviously this does not apply to intentional acts which are not fortuitous, and therefore not covered under any policy of insurance—again as a matter of public policy).

Courts have long recognized this fact. The Fifth Circuit, in Northwestern National Cas. Co. v. McNulty, explains this simple reasoning in terms better than I ever could:

“Where a person is able to insure himself against punishment he gains a freedom of misconduct inconsistent with the establishment of sanctions against such misconduct. It is not disputed that insurance against criminal fines or penalties would be void as violative of public policy. The same public policy should invalidate any contract of insurance against the civil punishment that punitive damages represent.

“The policy considerations in a state where … punitive damages are awarded for punishment and deterrence would seem to require that the damages rest ultimately as well [as] nominally on the party actually responsible for the wrong. If that person were permitted to shift the burden to an insurance company, punitive damages would serve no useful purpose. Such damages do not compensate the plaintiff for his injury, since compensatory damages already have made the plaintiff whole. And there is no point in punishing the insurance company; it has done no wrong. In actual fact, of course, and considering the extent to which the public is insured, the burden would ultimately come to rest not on the insurance companies but on the public, since the added liability to the insurance companies would be passed along to premium payers. Society would then be punishing itself for the wrong committed by the insured.”
307 F.2d 432, 440-41 (5th Cir. 1962).

Exactly. I submit to you that the Fifth Circuit’s reasoning is ironclad and ultimately reasonable. However, the Fort Worth Court of Appeals disagrees.

On June 26, 2003, the Forth Worth Court of Appeals issued Westchester Fire Ins. Co. v. Admiral Ins. Co., 2003 WL 21475423 (Tex.App.-Ft. Worth, June 26, 2003), finding that punitive damages are insurable. What I find most remarkable is that the Court was not only aware of the arguments described above, it actually cited the same language from the Fifth Circuit McNulty case. Even so, the Westchester Court, committing a blatant act of economics, decided that if you punish the insurance company enough, it will raise premiums on the insured, thereby preventing the tortfeasor insured from getting insurance or punishing the insured indirectly by increased premiums. Do you see the problem here? In other words, if a jury decides to punish a corporation to the tune of a $1 million punitive award, the insured, if it has sufficient insurance, may be covered by insurance for the full amount, but will have to pay a higher premium later. Maybe. In the meantime, the real and immediate blow falls on the (innocent) insurance company and the tortfeaser walks away unscathed.

To justify this absurd result, the Westchester Court engages in further economics by arguing that the insurance company is free to deny coverage of punitive damages altogether (presumably by exclusion) and also noting that the insured’s costs from “inability to obtain such coverage [for punitive damages] will inevitably be passed on by the tortfeasor to consumers of its products—who are also innocent.” Id. at page 5. That, of course, is not inevitable. Anyone who has operated a business knows that at some point prices are no longer elastic; that is, if I try to pass certain costs on to my customer, he may be able to obtain the same good or service from some other source at a cheaper price and I lose the business. So the loss is not always passed on to the customer, but is passed on to shareholders or owners of the tortfeasing company either in the form of decreased profits or actual losses.

Ultimately, the Westchester Court reasoned that since the insurance policies in the case did not expressly bar punitive damages, and since the Texas Legislature and the Texas Supreme Court have not specifically addressed whether insurance coverage for punitive damages violates public policy, that they have to rule in favor of coverage in order to uphold the language of the policy. This reasoning, however, simply ignores the issue. Punishing tortfeasors, not insurance companies, is the purpose of punitive damages.

Not surprisingly, just a few weeks later, the Fort Worth Court of Appeals upheld an award of insurance for punitive damages in Waffle House Inc. v. The Travelers Indemnity, 2003 WL 2166438 (Tex.App.-Ft. Worth, July 17, 2003), without any further discussion or analysis of the issue.

Pardon my cynicism, but these rulings seem like results-oriented jurisprudence. If the sole public policy rationale is punishment, how can punitive damages paid by an insurance company serve any public policy purpose? Remember, these are not actual damages meant to recompense a victim’s injuries. These are damages simply meant to punish the tortfeasor/insured and deter the proscribed behavior. Punishing the carrier, unfortunately, represents the logic of “Alice In Wonderland” rather than a court of law.

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and products cases. Martin is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.

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