- Introduction
The primary objective of insurance law across jurisdictions is to balance the interests of policyholders, insureds, and insurers. However, the inherent complexity and standardization of insurance contracts, often drafted unilaterally by insurers, pose challenges for policyholders who may lack the expertise to fully comprehend their terms.
Insurance contracts are typically contracts of adhesion, where the policyholders are left with little choice beyond electing among standardized provisions offered by insurers. Despite regulatory efforts to mandate certain provisions and prohibit others, insurers retain significant drafting autonomy. This imbalance often leads to unfair outcomes, even when insurers fulfill their disclosure obligations, it also underscores the necessity of a legal mechanism to protect policyholders from unjust exclusions and limitations embedded in insurance policies.
The principle of Reasonable Expectations addresses this issue by prioritizing the objectively reasonable understanding of the policyholders, ensuring that insurance contracts are interpreted in a manner that aligns with what an average policyholder would reasonably expect, even if strict policy wording might suggest otherwise. This principle is crucial in mitigating the imbalance of power between insurers and insureds and promoting fairness in contractual interpretations. While not explicitly codified in Chinese law, Chinese courts have increasingly applied this principle in judicial practice. This article explores the development, judicial application, and comparative analysis of PRE in U.S. and PRC jurisdictions.
- Definition and Development of the Principle
The Principle of Reasonable Expectations was formally articulated by Judge Robert E. Keeton in his seminal 1970 article, Insurance Law Rights at Variance with Policy Provision, published in the Harvard Law Review:
“The objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.”
This principle ensures that policyholders are not bound by unexpected exclusions or limitations hidden within complex insurance contracts. Keeton emphasized that “An important corollary of the expectations principle is that insurers ought not to be allowed to use qualifications and exceptions from coverage that are inconsistent with the reasonable expectations of a policyholder having an ordinary degree of familiarity with the type of coverage involved.” Over time, this principle has been adopted in various forms by jurisdictions in the United States and other common law countries, gradually evolving into a brand-new principle for interpreting insurance contracts.
While various doctrines share common goals with the principle of Reasonable Expectations, it is distinct. Contra Proferentem dictates that ambiguities in a contract should be interpreted against the drafter – typically the insurer. While both principles address protection mainly for insurers amid the ambiguities, the Reasonable Expectations extends further by protecting insureds even in the absence of ambiguity, focusing on their understanding of the policy. The Doctrine of Utmost Good Faith emphasizes the mutual duty of honesty and full disclosure between the insurer and the insured. Unlike Contra Proferentem, Utmost Good Faith is an ongoing obligation that applies from the pre-contractual stage throughout the life of the policy.
- Development of the Principle in U.S. Judicial Practice
According to Roger C. Henderson the Principle of Reasonable Expectations has been influential, while its adoption across U.S. jurisdiction has been inconsistent. Some jurisdictions have embraced the principle broadly, prioritizing policyholders’ expectations over strict policy wordings while others have limited its application to cases involving ambiguous terms or misleading practices by insurers. Critics argue that overly liberal application of the principle could undermine contractual freedom and create uncertainty in contract enforcement.
In the U.S., courts have adopted varied approaches to the Principle of Reasonable Expectations, falling into three main categories:
| Position One: Interpreting Ambiguous Terms in Favor of the Insured | ||
| Case | Background Facts & Key Issues | Judgment |
| Eli Lilly& Co. V. Home Ins. Co (Indiana Supreme Court) | Eli Lilly & Co., a prominent pharmaceutical company, faced environmental contamination liabilities related to diethylstilbestrol (DES), a drug later found to cause long-term health issues in the daughters of women who had taken it during pregnancy. Eli Lilly had purchased various Commercial General Liability (CGL) policies from Home Insurance Company. When the company sought compensation, the insurers denied coverage, arguing that the pollution incidents did not constitute an “occurrence” under the policy terms. A key issue was the determination of when the “occurrence” of injury took place under the terms of the policies—whether at the time of drug ingestion (policy coverage at the time of exposure or first sold, insurers’ position) or at the time when injuries manifested (policy coverage at the time of discovery, Eli Lilly’s position). | The Indiana Supreme Court ruled in favor of Eli Lilly, determining that the policy wording was ambiguous concerning when an “occurrence” should be recognized in cases of long-latency injuries. Applying the multiple trigger interpretation, the court held that each insurer on the risk between ingestion of DES and the manifestation of a DES-related illness would be liable for indemnification, ensuring broader protection for policyholders facing delayed injury consequences. |
| Position Two: Rejecting Contract Terms That Conflict with Reasonable Expectations, usually referring to additional clauses | ||
| Case | Background Facts & Key Issues | Judgment |
| Woodson v. Manhattan Life Insurance Co. of New York (Kentucky Supreme Court) | On February 8, 1982, the policyholder, Woodson, was called before the Executive Committee of Kentucky Finance Company and was told to resign from his position. He signed a resignation letter on February 26, resigning from all officer and director positions but not from his employment or other duties as an employee. The company continued to pay his regular salary, including deductions for taxes and life insurance premiums, for six months following his resignation. Woodson was killed by his estranged wife on May 19, 1982. At the time of his death, the company was still remitting his life insurance premiums to Manhattan Life Insurance Company. After his death, the company ceased salary payments. Woodson’s estate filed a claim for life insurance benefits under the group policy, arguing that the policy had already been approved before his death, however, the insurer denied the claim, asserting that Woodson’s coverage had terminated upon his resignation. The core issue was whether Woodson was still a covered individual under the group life insurance policy at the time of his death. Specifically, the phrase “leave of absence” in the policy was key to whether Davis was covered at the time of his death. | The Kentucky Supreme Court held that the policy wording was ambiguous. The phrase “leave of absence” was not qualified as “temporary” and the court found that the policy did not clearly exclude terminal leave. Therefore, the ambiguity should be resolved in favor of the insured.The court also applied the doctrine of reasonable expectations, finding that both Woodson and the company officials had treated him as a covered employee on leave until his death. The continuation of salary payments and life insurance premiums made it reasonable for Woodson to expect that his life insurance coverage remained in effect during the leave period. |
| Position three: Overriding Explicit Policy Terms Based on Reasonable Expectations | ||
| Case | Background Facts & Key Issues | Judgment |
| C&J Fertilizer, Inc. v. Allied Mutual Insurance Co. (Iowa Supreme Court) | C&J Fertilizer, Inc. purchased a burglary insurance policy from Allied Mutual Insurance Co. to protect its property. The policy defined “burglary” as requiring visible signs of forcible entry into a locked building. C&J Fertilizer experienced a theft where the burglars entered without visible signs of forced entry but stole property from inside the building. Allied Mutual denied the claim, citing the policy’s definition of burglary and the lack of visible marks indicating forced entry. C&J Fertilizer sued, arguing the policy terms were ambiguous and that the denial contradicted its reasonable expectations of coverage. The key issue was whether the insured’s reasonable expectations of coverage should override the policy’s explicit terms, especially when those terms were not clearly communicated or understood. | The Iowa Supreme Court held that the policy’s definition of “burglary” was not consistent with the reasonable expectations of the insured, and a layperson purchasing burglary insurance would reasonably expect coverage for theft, regardless of visible signs of forced entry. Insurance contracts, especially adhesion contracts, should be interpreted in line with what an average policyholder would reasonably expect. The court applied the doctrine of reasonable expectations, holding that an insured’s reasonable understanding of the policy terms should prevail, even when the wording might technically limit coverage. |
- The Principle’s Application in China
Although the Principle of Reasonable Expectations is not formally codified in PRC Law, courts have already consciously applied this principle in judicial decisions. Two cases are presented hereby for reference.
| Case | Background Facts & Key Issues | Judgment |
| (2019) Xiang 13 Minzhong No. 986 | There is a health insurance dispute between the insureds, Zeng and his husband Zou, and the insurer. Zeng purchased a “360 Family Happiness Card Insurance” which provides coverage over accidental injury and hospitalization. Zeng claimed insurance compensation after her husband was injured by falling from a makeshift staircase, suffered severe injuries, and was later diagnosed with an 8th-grade disability.The insurer denied coverage by arguing that the insurance card was not activated and therefore the policy was not valid. The plaintiffs sued for the insurance payout. The main issue lies over the effectiveness of the clause in the insurance contract stating, “It is necessary to insure (activate) before the last insurance (activation) date stipulated on this card, in the manner provided by this card, and the insurance contract will only take effect after which the insured can enjoy insurance coverage.” | The court determined the “activation” as a condition precedent for the policy’s effectiveness. Although such a condition is not an absolute exemption or limitation of the insurer’s liability, it creates a gap between the formation of the contract and the activation of coverage, effectively delaying the insurer’s liability. This delay, the court found, imposed additional obligations on the insured and was inconsistent with the insured’s reasonable expectations. The court emphasized that the insurer had a duty to clearly explain the activation requirement to the insured. Since the insurer failed to fulfill this obligation, the activation clause was deemed invalid. As a result, the court ruled that the policy became effective upon the purchase and payment of the premium, and the insurer was obligated to provide coverage for Zou’s injuries. |
| (2020) Su Minzhong No. 372 | There is an accident insurance dispute between the insureds, Wang and her son, and the insurer. Wang’s husband purchased an “Anxin Card H” insurance policy, which covered accidental death and accidental medical expenses.On October 13, 2017, Wang’s husband was involved in a traffic accident and died on May 25, 2018, due to complications from the injuries.The insurer denied paying the insurance indemnities, arguing that Wang’s husband died more than 180 days after the accident, which was outside the policy’s coverage period. The plaintiffs sued for insurance indemnities. The main issue was the effectiveness of the standard clause, stating, “If the insured dies within 180 days from the date of the accidental injury due to the same cause, the company shall pay the death benefit according to the insurance amount of this contract”. | The court ruled in favor of the insured, holding that the 180-day time limitation clause violated the Principle of Reasonable Expectations. The court reasoned that, from the perspective of a layperson, the insurer should pay death benefits if the insured dies as a result of an accidental injury, regardless of the time elapsed between the accident and the death. The 180-day limitation, the court found, was inconsistent with the reasonable expectations of the general public and contravened the principle of good faith.Furthermore, the court highlighted that the clause violated the principle of public policy and good morals, which could lead to moral hazards, such as incentivizing the insured’s relatives to hasten death to ensure coverage within the 180-day window or discouraging them from providing timely medical treatment. |
In addition, in certain circumstances, PRC courts also attempt to meet the insured’s reasonable expectations of the insurance contract by denying the effectiveness of exclusion clauses. According to Article 17 of the PRC Insurance Law, when entering into an insurance contract using standard terms provided by the insurer, the proposal form provided by the insurer to the policyholder shall be accompanied by the standard terms, and the insurer shall explain the content of the contract to the policyholder. For any clauses in the insurance contract that exempt the insurer from liability, the insurer shall, at the time of contract conclusion, provide a clear prompt on the proposal form, insurance policy, or other insurance vouchers that is sufficient to draw the policyholder’s attention, and shall clearly explain the content of such clauses in writing or orally to the policyholder; if no prompt or clear explanation is given, such clauses shall not be effective.
In practice, if an insurer cannot provide sufficient and compelling evidence to demonstrate that it has given clear and explicit explanations regarding the standard clauses that exclude its liabilities, the PRC courts are inclined to reject the validity of such exclusion clauses. This ensures that the policy coverage meets the expectations of the policyholders.
- Conclusion
The principle of Reasonable Expectations plays a critical role in addressing the inherent complexities and imbalances in insurance contracts. In the U.S., its application has been influential, though inconsistent, with courts prioritizing the reasonable understanding of policyholders in cases involving ambiguous terms or misleading practices. PRC courts are aligning insurance practices with the needs and expectations of policyholders. This judicial approach continues to serve as a vital tool for balancing the interests of insurers and insured parties, promoting fairness, and ensuring the integrity of insurance contracts. As the principle continues to evolve in Chinese jurisprudence, the Principle of Reasonable Expectations will likely remain a cornerstone of judicial reasoning, adapting to new challenges and contexts in the global insurance landscape.
*The contribution of our intern, Chen Mengjun, to this article is also acknowledged with thanks.
For further information, please contact:
Wan Jia, Partner, Anjie Broad
wanjia@anjielaw.com
- Roger C. Henderson, The Doctrine of Reasonable Expectations in Insurance Law after Two decades, 51 OHIO ST. L.J
- Eli Lilly & Co. v. Home Insurance Co., 482 N.E.2d 467 (Ind. 1985). https://law.justia.com/cases/indiana/supreme-court/1985/685s243-2.html
- Woodson v. Manhattan Life Insurance Co. of New York, 743 S.W.2d 835 (Ky. 1987). https://law.justia.com/cases/kentucky/supreme-court/1987/87-sc-247-dg-1.html
- C&J Fertilizer, Inc. v. Allied Mutual Insurance Co., 227 N.W.2d 169 (Iowa 1975). https://law.justia.com/cases/iowa/supreme-court/1975/2-56355-0.html
