RISK BITES ARCHIV

Insurance Coverage for Rental Cars:
Who Pays First?

By Peter Dworjanyn

Significant coverage disputes can arise out of accidents involving rental cars. This is doubly so when a rental car is rented in one state and involved in an accident in another, as a court asked to issue a declaratory judgment may have to decide which states’ law applies. The disputes often arise out of insurers’ efforts to limit exposure for these accidents.

In order to comply with financial responsibility laws and to protect themselves from liability, automobile rental companies ensure that their customers either have liability insurance, or sell them insurance or a damage waiver. The rental companies and their insurers strive to make their insurance secondary to their renters’ personal automobile insurance by inserting what are known as super-escape clauses. Meanwhile, personal insurance carriers try to avoid coverage for accidents in which their insured drivers are in rental cars. The personal insurers do this through the use of “other insurance” or “excess insurance” clauses. Courts are divided on how to resolve the conflict between a super-escape clause and an excess clause. Some courts give effect to the specific language of a super-escape clause over that of an excess or other insurance clause. Some jurisdictions have held that the policy with the super-escape clause is primary. Other states have found the clauses to be mutually repugnant and have decided that damages should be shared proportionately. The scope of this article is limited to discussing one of these cases, Clarendon Nat. Ins. Co. v. Arbella Mut. Ins. Co., 803 N.E.2d 750 (Mass.App.Ct. 2004).

The first step in coverage analysis of any insurance dispute is the determination of which state’s law will apply; the same holds true in disputes involving coverage for rental cars that have been involved in an accident. However, the very nature of the manner in which rental cars are used creates some complications. In many claims the driver of the rental vehicle will not be in his home state, but will be in either the state he rented the vehicle or in another state to which he has traveled. Before any coverage dispute can be resolved, a court must determine which state’s law will apply.

In general, the law of the place where a contract is entered into determines the rights of the parties to an insurance contract. One exception is where a court recognizes a paramount interest in protecting that state’s residents from a policy term that is repugnant to the public policy of the state. In determining where the contract was made, the court may look to factors including (1) where the contract was formed, (2) the place where the contract was delivered, (3) the place where the claim is to be paid, and (4) the state where the insured or insurer is located.

In addition to that rule, most states have a choice-of-law statute which provides that all contracts of insurance on property, lives, or interests in that state are considered to be made in the state and all contracts of insurance applied for within the state are considered to have been made within the state and subject to the laws of the state. That choice-of-law provision does not necessarily apply to preempt the law of the place of contracting in a rental coverage claim.

Because states do not agree on how to resolve the conflict between a super-escape clause and an excess clause, a complex problem can arise where a personal insurance policy was issued in one state and a rental policy in another state. The facts discussed hereafter are true but have been simplified. A Massachusetts driver, Mary, owned a car insured by a Massachusetts insurance company. Mary took her car to a dealership in Rhode Island for service and borrowed a loaner from the dealer. While driving the loaner in Massachusetts, Mary caused a four-car accident. One of the drivers sued Mary for personal injury.

The dealer’s insurer filed for declaratory judgment, seeking a court ruling that Mary’s insurance company was the primary insurer for the accident and that it did not have any duty to defend Mary or pay for the damages unless Mary’s policy was exhausted. Mary’s insurer counterclaimed, asking the court to rule that the dealer’s insurer had a concurrent duty to defend Mary and to make a pro rata contribution toward the settlement of the case.

Mary’s insurance policy contained an excess clause providing that if the insured was operating a car she did not own at the time of the accident, “…the owner’s auto insurance must pay its limits before we pay.” On the other hand, the dealer’s policy contained a super-escape clause which provided that a customer driving a loaner car did not qualify as an insured under the policy unless the customer had no other available insurance, whether primary, excess, or contingent. In other words, the excess clause in Mary’s policy withheld coverage from Mary until the other vehicle owner’s insurance paid to its limits, while the super-escape clause in the dealer’s policy denied coverage where other insurance, including excess insurance, was available.

The courts in Rhode Island and Massachusetts differed in their approach to conflicts between the super-escape clause and the excess clause. Therefore, the choice of law to apply to the case was important, and the Massachusetts court in which the declaratory judgment was filed had to decide whether Massachusetts law or Rhode Island law should be applied to determine the outcome of the conflict between the excess insurance clause in Mary’s policy and the super-escape clause in the dealer’s policy. Rhode Island would require both insurers to share the loss on a pro rata basis. Thus, Mary’s insurer would receive contribution from the dealer’s policy. Massachusetts would rule that the super-escape clause in the dealer’s policy brought into effect the excess coverage in Mary’s policy, and therefore Mary’s policy would have to pay its limits before the dealer’s policy would have to pay anything.

To determine the choice of law to apply, the Massachusetts court first considered the fact that the rights created by an insurance policy are normally determined by the law of the state that the parties understood would be the principal location of the risk. The location of the risk is important because location often has a close bearing on the nature of the risk and policy terms and rates. In the case of an automobile liability policy, the parties ordinarily know where the car will be garaged and that the garaged location is the principal location of the insured risk. The Rhode Island dealer and its insurer knew that the loaner would be principally garaged in Rhode Island. On the other hand, Mary and her insurer knew that Mary’s car was located principally in Massachusetts. Therefore, the risk could not be said to be located principally in one state, and the court had to go to the next step in the choice-of-law analysis.

The court next considered which state had the most significant relationship to the issue. In its analysis the court considered (1) the protection of the parties’ justified expectations, and (2) the purpose sought to be achieved by the law of the each state and the relation of each state to the parties and the event. The court decided that the parties’ expectations were best served by applying Massachusetts law. The court reasoned that Mary’s insurer should expect to be liable if a driver, whose car was insured under one of its Massachusetts policies containing an excess clause, caused an accident while driving a loaner insured under another Massachusetts insurance policy that containing a super-escape clause, because a super-escape clause defeats an excess coverage clause under Massachusetts law. The court held that the dealer’s insurer’s expectations were not as certain. Although the dealer’s insurer may have expected that the super-escape provision of its Rhode Island policy would overrule an escape clause in some cases, it could not expect that to happen against another Rhode Island policy with an excess clause because Rhode Island law nullifies such provisions.

The second factor considered to determine which state had the most significant relationship to the issue was the purpose each state’s laws sought to achieve. The purpose of the Massachusetts rule was to give effect to the language of both insurance policies. The purpose of the Rhode Island rule was to prevent a total absence of insurance coverage and to avoid encouraging the battle between insurance policy writers. The Appeals Court of Massachusetts held that the purposes underlying both goals would best be furthered by applying Massachusetts law, as this would effectuate the language of both contracts while avoiding an absence of insurance coverage. In contrast, the only purpose served by applying Rhode Island law would “applying Rhode Island law” since the language of both policies’ clauses would not be given effect. There would be no absence of coverage. Therefore, the court applied Massachusetts law. Since Massachusetts gives effect to super-escape clauses such as those in the dealer’s policy and causes the insurer whose policy contains the excess clause to bear liability, the Mary’s insurer had to pay the claim up to the policy limits.

ABOUT THE AUTHOR

Peter Dworjanyn is a shareholder with Collins & Lacy, P.C. in Columbia, South Carolina. He practices in the area of insurance coverage and can be reached by e-mail at pdworjanyn@collinsandlacy.com.

This article is only a general summary for informational purposes and does not constitute legal advice. Consult a qualified and experienced insurance advisor for your specific situation or particular questions.

riskVue | The webzine for risk management professionals
August 2005