10.  Exclusions

10.1   The Nature of Exclusions

Exclusions define the scope of the cover, however, in negative terms: an exclusion qualifies the ordinary and literal reading of one or more of the insuring clauses637 and limits the extent of the cover provided by them. Exclusions are usually set out in a separate section of liability policies headed “Exclusions”; this is usually sufficient to distinguish them from what insurance law calls “warranties,” which are usually found in a section of policies headed “Conditions.”638

Exclusions are of two kinds. First, descriptive exclusions concern the subject-matter of the exclusion, for example, claims for bodily injury639 or damage to property.640 Second, circumstantial exclusions concern certain circumstance, which gives rise to the liability of the insured and thus prima facie to cover, but which the insurer does not intend to cover. For example, a profession indemnity (PI) insurer is likely to cover the default of a conveyancing solicitor to a client buyer in the course of conveyancing but not that of one selling property to a client.641 The distinction between circumstantial exclusions and warranties is discussed further in connection with warranties.642

10.2   Human Fallibility: Moral Hazard

Certain exclusions reflect and reinforce the insurer’s concern with moral hazard: an aspect of general human behavioral weakness, the risk of which the insurer is unable or unwilling to assume. For example, the policy may exclude cover of liability arising out of conduct that is fraudulent or otherwise criminal,643 or of fines, penalties, or exemplary damages,644 whatever the reason for their imposition or award. Another example is that of medical malpractice policies that exclude cover for claims arising out of the performance of a service while the insured is under the influence of drugs. In such cases the insurer is concerned with any aspect of the policyholder or the group, to which the policyholder belongs, which increases the risk of liability to a degree that the insurer is unwilling to cover.

10.2.1   Precautions

A particular concern about moral hazard is the danger that, knowing that cover is in place, the policyholder, being “only” human will “relax his (or her) guard.” This concern has led to terms (often described as conditions but operating usually as exclusions) such as that which requires the insured to “take reasonable precautions to prevent” loss. Read literally such terms would remove the cover for ordinary negligence that is central to liability policies; however, these terms are not read literally but construed narrowly: the term is broken only if the insured has been reckless. In a leading case,645 Diplock LJ said:

What, in my judgment, is reasonable as between the insured and the insurer, without being repugnant to the commercial purpose of the contract, is that the insured, where he does recognise a danger, should not deliberately court it by taking measures which he himself knows are inadequate to avert it. In other words, it is not enough that the employer’s omission to take any particular precautions to avoid accidents should be negligent; it must be at least reckless, that is to say, made with actual recognition by the insured himself that a danger exists, and not caring whether or not it is averted. The purpose of the condition is to ensure that the insured will not, because he is covered against loss by the policy, refrain from taking precautions which he knows ought to be taken.

10.2.2   Fidelity

Another concern about moral hazard is the possibility that a policyholder will be tempted to steal the money or property of clients and customers. Hence exclusion of cover for liability arising out of such theft is also found, but such exclusions are construed narrowly.646 Policies sometimes exclude cover specifically in these terms but, in any event, fraud by the insured employer personally is not covered, whether specifically excluded or not.647

10.3   Breach of Contract

If the claim against the insured is based on both negligence (covered) and breach of contract (neither expressly covered or excluded), the claim is covered.648 However, cover in respect of liability for breach of contract alone is commonly excluded,649 even if the circumstances also give rise to liability in tort.650

Indeed, in the United States, it has been presumed as a matter of interpretation that sums which, for example, the insured becomes “legally obligated to pay as damages” cover liability in tort but not liability for breach of contract;651 as the Wisconsin court put it, a general liability policy “is not a performance bond.”652 In England, too, insurance against “legal liability for damages in respect of … accidental loss of or damage to property” has been construed to provide “an indemnity in respect of certain types of tortious liability,”653 but not environmental clean-up costs that the policyholder was obliged to pay by statute at the insistence of the Environment Agency.654 Likewise “liability at law,” prima facie wide enough to cover both liability in tort and liability in contract, has been construed as confined to tort.655

Whether a policy covers breach of contract by the policyholder, which is possible, is a question of construction.656 However, if the breach is deliberate, the presumption is strong that it is not covered by the policy. To avoid doubt, breaches of this kind that the insurer does not intend to cover may be excluded in some detail. A policy, for example, has been known to exclude liability arising out of any “contract where the Assured acts as a Contractor whether in conjunction with his/their profession as stated in the Schedule or not.”657 Alternatively it may exclude “the cost of replacing or making good defective materials [or] goods.”658

Like any other exclusion, these will be construed in context and consistently with the purpose of the policy.659 For example, in Dominion Bridge Co Ltd v Toronto General, the firm responsible for the steel work in a bridge and liable for the collapse of part of the bridge caused by its negligence found that liability cover was excluded under its insurance because it was “liability … assumed by the insured under any contract.”660 Literally these words extended the exclusion to liability to any casual passer-by injured by what fell from the steel work that the firm had contracted to do. But this construction was not consonant with the purpose of the cover, so the exclusion was limited (by the Canadian Supreme Court) to a claim by a party to the contract on a matter reasonably closely connected to the insured’s contractual obligations.661

10.4   Specific Exclusions

10.4.1   Personal injury

Policies commonly exclude cover for liability for death, bodily injury, or sickness to other persons. The meaning of damage, such as injury, depends on how it is defined or described. For example, a leading case in the United States held that “bodily injury” meant “any localised abnormal condition of the living body,” so that, in cases of asbestosis, there was injury to persons affected when the very first tissue damage occurred as a result of inhaling asbestos fibres.662 In England it has been accepted that injury may involve trauma either outside or inside the body,663 although some doubt was expressed over whether the interpretation will be quite the same in different kinds of cover.664 However, the absence of a direct external source is unlikely to be a point of significance in liability cover. To avoid doubt the policy may specify that the cover includes liability for “mental stress” or “distress” suffered by those persons injured.

10.4.2   Distress

In Australia, it has been held that “accidental bodily injury” in a liability policy includes nervous shock.665 However, prima facie bodily injury does not include such matters unless in some sense they are apparent, and today the question is the degree of bodily manifestation that is required. On the one hand, an English decision of the 1960s suggested that it is “a strained and unusual use of words to call the anxiety or the [consequent] change in the blood or the clot itself ‘a bodily injury sustained in the accident’.”666 On the other hand, American authority has accepted for some time that emotional distress can and often does have a direct effect on other bodily functions,667 such as weight loss, headaches, and muscle spasms. That is bodily injury. Now it seems that English law might be moving in that direction. In a 1996 tort case 5 Lord Lloyd, speaking of “personal injury,” observed that in “an age when medical knowledge is expanding fast, and psychiatric knowledge with it, it would not be sensible to commit the law to a distinction between physical and psychiatric injury, which may already seem somewhat artificial, and may soon be altogether outmoded.” This seems to be equally true of “bodily injury.”668