liability insurance & the regulation of firearms · insurance, bid on a government contract...

CHAPTER 12Liability Insurance &

the Regulation of Firearmstom baker & thomas o. farrish

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Along with the recognition that we live in the age of the insurance statehas come the recognition that private insurance institutions play govern-mental roles.1 If the core “governmental” activities have become the tra-ditional “insurance” activities of risk spreading and loss prevention, theninsurance is governance and, accordingly, all insurance institutions aregovernmental. For that reason, any comprehensive account of regula-tion should at least consider the role of insurance institutions—all themore so when one of the forms of regulation under examination is tortlaw, because liability insurance has the capacity to translate tort law’sincentives into prices and directives.

This chapter has three goals. First, the chapter presents a preliminarydescription and analysis of liability insurance as a form of regulation.Although we have not ‹nished all of the work required to present a com-pletely satisfactory picture of insurance as regulation, the progress thatwe have made has informed considerably our research on guns andinsurance, and we offer the conceptual framework presented here in thatspirit. Second, and most important for this volume, the chapter describeswhat the U.S. liability insurance industry does (and does not do) to reg-ulate gun activity. In the process, we consider how liability insuranceaddresses several kinds of gun-related litigation: intentional and acci-dental shooting cases, traditional products liability lawsuits, and therecent mass tort litigation. Finally, the chapter re›ects on the implica-tions of this case study for understanding liability insurance as a form of

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regulation and for understanding tort law as a deterrence andloss-spreading institution.

Regulation by Liability Insurance

The paradigmatic form of regulation by insurance is facilitative. Insur-ance spreads the costs of loss, which facilitates activities that might causeloss. Absent insurance, people might be unwilling to proceed in the faceof the risk of loss (or, in the case of pro‹t-oriented activity, mightdemand a higher potential return before proceeding) and might wellhave to cease activity if and when the risk matured into an actual loss. Anearly seventeenth-century Act of Parliament described this role of insur-ance in the shipping trade as follows.

[B]y meanes of whiche Policies of Assurance it comethe to passe,upon the losse or perishinge of any Shippe there followethe not theundoinge of any Man, but the losse lightethe rather easilie uponmany, then heavily upon fewe, and rather upon them that adven-ture not then those that doe adventure, whereby all Merchantes,sp[ec]ialie the younger sorte, are allured to venture more willinglieand more freelie.2

While this description emphasizes the bene‹ts of ‹rst-party insurance(insurance that we buy to protect our own property, life, or health), lossspreading is the main attraction of liability insurance as well. By spread-ing the costs of liability among insurance purchasers, liability insurancehelps individuals avoid ‹nancial ruin when they cause harm to others.

The fact that the “costs of liability” are based on the “costs of injuryto others” means that liability insurance also spreads the costs of injury.In other words, liability insurance is not only a shield for defendants, it isalso the institution that makes it possible to think of tort law as aloss-spreading system. Of course, the fact that tort law can be under-stood as a loss-spreading system does not necessarily make it an effectiveone. Among other structural problems, the fact that people buy liabilityinsurance for the purpose of protecting themselves from the claims ofothers (and not for the purpose of protecting those others) creates verysigni‹cant complications for injury cost spreading, some of which will beillustrated in this case study.

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Almost every other aspect of regulation by insurance follows from thefacilitative, loss-spreading role of insurance. The power to refuse to takethe risk gives an insurance company leverage over the party with the risk.And the decision to take the risk gives the insurance company incentive tomanage that risk, both before and after it matures into loss. This leverageand incentive translate into the following broad categories of regulationby insurance: gatekeeping, loss prevention, engagement with public reg-ulators, liability limitation, selective exclusion, management of loss costs,and research and education. The sections that follow brie›y describe eachusing examples from a variety of insurance contexts.

Gatekeeping

Obtaining insurance is often a prerequisite to other activity. You can’tregister a car without auto insurance, take out a mortgage without home-owners’ insurance, obtain a commercial loan without business owners’insurance, bid on a government contract without a surety bond, adver-tise on network television without media liability insurance, ‹nance amovie without cast insurance, sign a commercial lease without commer-cial property and liability insurance, obtain practice privileges at mosthospitals without medical malpractice insurance, and so on. All theselegal or institutional requirements make insurance companies importantgatekeepers in large sectors of the U.S. economy (and undoubtedly inother parts of the developed world as well).

Liability insurance requirements arise in two main contexts. First,governments sometimes mandate insurance as a way of making sure thatpeople or businesses that engage in certain activities will be ‹nanciallyresponsible (at least to some degree) for their liabilities. Automobileinsurance is the most common example; other examples include medicalmalpractice insurance requirements in some states and environmentalinsurance requirements for hazardous waste handlers.3 Second, commer-cial contracts often require that parties have insurance either to makesure that the parties will be able to cover losses to the counter-parties(e.g., landlords requiring tenants to purchase insurance) or to make surethat the parties will be able to cover the losses of people who would oth-erwise sue the counter-parties (e.g., hospitals requiring physicians tohave malpractice insurance).

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Going through the gate requires meeting the insurance companies’standards, as well as paying the necessary premiums. This gatekeepingrole gives insurance companies the potential to serve as very signi‹cantregulators (while at the same time making access to “private” insurancean intensely “public” issue).4

Loss Prevention

Once an insurance institution assumes responsibility for the ‹nancialconsequences of a given harm, it has an incentive to prevent that harm.Insurers prevent harm in four main ways, each of which is potentiallyapplicable to liability insurance: by establishing underwriting proce-dures that make loss prevention activities a condition of obtaining insur-ance, by establishing pricing structures that give policyholders an incen-tive to undertake speci‹c loss prevention activities, by adoptingrisk-based pricing more generally, and by engaging in loss preven-tion–oriented monitoring during the course of the insurance relation-ship.5 Risk-based pricing is a means of internalizing the loss costs associ-ated with a range of activities. Provided that the policyholder has controlover the level or type of activities covered by the insurance, this costinternalization can promote decisions that balance the costs of harm andprevention.6

Engagement with Public Regulators

Insurance organizations regularly work with public agencies to further lossprevention and related risk management goals. Although much of thisaspect of regulation by insurance could ‹t under the more general headingof “loss prevention,” the involvement of the state makes it differentenough from private contract requirements to deserve special attention.Insurance organizations attempt to in›uence the agencies that are respon-sible for housing codes, road and highway design, automobile safety regu-lations, environmental cleanup procedures, and many other activities thataffect the frequency or magnitude of insured losses. From the perspectiveof insurance institutions, the involvement of the public agencies helps withenforcement of loss prevention norms. In addition, the public agency can



become a potent source for the collection and transmission of loss-relatedinformation, which helps in pricing future policies.7

Elimination or Reduction of Liability

From a social perspective, the liability insurance “loss” is the harm thatforms the basis for the underlying liability that is insured. From the eco-nomic perspective of the people who are liable, however, the loss is notthe harm itself but rather the liability arising from that harm. From apotential defendant’s perspective, “loss prevention” is really “liabilityprevention,” and the elimination of liability is just as effective as theelimination of the harm and, at least potentially, much cheaper.

As this suggests, insurance organizations can prevent insured losses byreducing or limiting the liability that forms the basis for liability insur-ance claims. Although completely eliminating liability would hardly fur-ther the interests of liability insurers (eliminating liability eliminates theneed for liability insurance), eliminating some potentially very costly lia-bilities could serve insurers’ interests, at least in the short term, particu-larly when the insurance that might otherwise cover those liabilities hasalready been priced and sold. This may explain why insurers have beeninvolved in a number of efforts over the years to “reform” tort law in amanner that reduces liabilities across the board (e.g., damages caps) orthat addresses speci‹c kinds of liabilities (e.g., asbestos and environmen-tal liabilities). Whatever else one may think about it, elimination orreduction of liability regulates—or, better yet, deregulates—activitiesthrough the withdrawal of the incentives and institutional arrangementsthat follow from tort liability.

Selective Exclusion

Insurers also can reduce the number of insured claims by refusing to pro-vide coverage for speci‹c kinds of losses. In general, these “selectiveexclusions” arise out of three kinds of circumstances: moral hazard,known losses, and potential losses that insurers determine are too uncer-tain. The most common example of moral hazard exclusion is the exclu-sion of intentional harm. Known loss exclusions include exclusions for



asbestos claims and other product-speci‹c exclusions inserted into man-ufacturers’ liability insurance policies once mass tort litigation involvingthat product has commenced (commonly referred to as “laser exclu-sions” because of their narrow focus). Exclusions for losses that aredeemed too uncertain include exclusions for environmental claims instandard liability insurance policies. In practice, selective exclusion canamount to the elimination of the liabilities that are excluded, particularlywhen the potentially liable parties are individuals (because of the obsta-cles to collecting real money from real people)8 but also if and when theliabilities overwhelm the assets of organizational defendants.9

Management of Loss Costs

Along with working to prevent loss (or liability), insurance companiesalso attempt to reduce the cost of harm that does occur. Loss cost man-agement is a signi‹cant focus of almost any kind of insurance arrange-ment in which the insurer promises to indemnify the policyholder for agiven type of loss (as opposed to an insurance arrangement in which theinsurer promises to pay a ‹xed amount in the event of loss). While thereis nothing a life insurer can do to manage its loss costs after a covereddeath has occurred, there is a great deal that a health insurer can do tomanage medical costs, that a disability insurer can do to promote reha-bilitation, and that a liability insurer can do to manage the defense ofclaims. Within the medical and legal profession, loss cost management isone of the most visible forms of regulation by insurance, as doctors (whoare regulated by managed care practices) and tort defense lawyers (whoare regulated by litigation management guidelines) can report. Nearlyall of tort law is systematically affected by the loss cost managementaspect of liability insurance, because it is tort loss cost management thatturns almost all tort lawsuits into a contest with a “repeat player” on thedefense side.10

Research and Education

Insurance was among the earliest information businesses. Indeed, from acertain perspective an insurance company is simply a tool for the collec-



tion, analysis, and use of information. The core analytical task of aninsurance enterprise is identifying future losses, choosing which of thoselosses it is willing to insure, estimating their frequency and magnitude,preparing insurance contracts that re›ect those choices, and then decid-ing how much to charge which classes of people in return for this protec-tion. In addition, insurance companies need to learn how to motivatepeople to buy their insurance, and they ought to learn as much as possi-ble about how to prevent loss. All of this produces knowledge, much ofwhich can have consequences beyond the insurance enterprise. Forexample, over the years, insurance institutions have been a signi‹cantforce in the development and dissemination of harm-reducing technolo-gies and practices. While of course insurers use this research in theirunderwriting and pricing, consumers also use this information to makedecisions about what kinds of products to buy. Examples of suchresearch and education in the liability context include risk managementseminars and advice provided to doctors, lawyers, and other profession-als; the occupational safety and related research carried out under theauspices of (or in cooperation with) workers’ compensation insurers;and at least some aspects of the extensive efforts by insurance-supportedgroups in the automobile safety arena (although much of this researchcan be understood as an effort to reduce ‹rst-party property insurancelosses).

Gun Regulation by Insurance?

In exploring how the U.S. insurance industry approaches gun risks, wefocused our efforts on liability insurance. Health and disability insuranceprimarily is sold through employment-based group policies that do notpresent an opportunity to engage in individual underwriting, and lifeinsurance companies do not appear to consider gun-related risks inunderwriting and pricing their products.11 Moreover, the focus of thisvolume is on gun-related tort liability, which is the province of liabilityinsurers. Although we did not set out to learn about property insurancefor guns, we could not avoid learning something about that topicbecause liability insurance commonly is sold together with propertyinsurance. We focused on insurance for gun manufacturers, wholesalers,and retailers, as well as organizations and consumers involved in the



recreational use of guns. We did not investigate insurance for public orprivate law enforcement organizations.

Personal Lines Liability Insurers

Personal lines liability insurers have adopted as their only approach togun-related injuries the strategy of selective exclusion. Individual cover-age for nonoccupational liability risks is provided as part of standard res-idential package insurance policies (such as a homeowners’ or renters’policy). These insurance policies universally include an exclusion forintentional harm, which eliminates coverage for the vast majority ofgun-related injuries.12 Allstate and some other insurers have adopted aneven more restrictive version of the intentional harm exclusion thatexcludes coverage for harm resulting from criminal acts, regardless ofwhether the harm was intentional.13 Allstate has applied this exclusion toaccidental injuries involving ‹rearms, and, on the whole, courts haveupheld this approach.14

Typically, insurers with the largest market share in this market do notinquire whether applicants have guns, except in situations in which itappears likely that the applicant may have very valuable guns thatrequire the purchase of additional insurance protection to guard againsttheft.15 As a result, there is no effort to engage in gun-related preventionthrough underwriting or pricing, and gun risks do not play a role in per-sonal lines insurance gatekeeping.

This hands-off approach to gun ownership makes sense because theintentional harm exclusion means that only a very small percentage ofgun injuries are even potentially covered by liability insurance. In addi-tion, we learned of a controversy involving State Farm that suggests thatbeing perceived as hostile to gun owners may pose some reputationalrisk to an insurance company.16 This controversy notwithstanding, weare inclined to discount any conspiracy explanations for personal linesinsurers’ decision to ignore gun-related liability risks. Were insurancecompanies to be persuaded that changes in gun designs (e.g., internallocks or personalized, “smart” guns) would pay off in signi‹cantlyreduced liability insurance claims, they might well offer homeowners’insurance discounts based on gun design. After all, it’s not “anti-gun” tooffer a discount for a safer gun.17 But, given the relatively low cost of the



liability insurance portion of homeowners’ insurance (as compared tothe property insurance portion) and the relatively small number of acci-dental gun injuries,18 we are inclined to doubt that insurers will ever offersuch discounts.19

Commercial Liability Insurers

With regard to commercial gun risks, insurers employ a somewhatbroader array of regulatory techniques. Selective exclusion is the maintool, but there is evidence of gatekeeping and prevention. In this sectionwe will ‹rst describe the insurance environment for gun-related busi-nesses and then characterize insurers’ approaches in terms of our con-ceptual framework.

commercial insurers and gun risks

Unlike personal lines insurers, commercial insurers do differentiatebetween those customers that present gun risks and those that do not.Although the treatment of a gun risk is left to the discretion of the indi-vidual insurer, and in some cases the individual underwriter, there areindustrywide recommendations that channel that discretion.

When deciding whom to insure, and at what price, many insurers relyon statistical and actuarial data compiled by the Insurance ServicesOf‹ce (ISO). ISO collects loss data from insurers and other entities andorganizes it according to the type, or “classi‹cation,” of business thatproduced the loss. As a result, ISO’s classi‹cations effectively make up aset of de facto industry standards. If ISO classi‹es, say, lamp manufac-turers differently from lamp shade manufacturers, the insurers who relyon ISO’s statistics will classify and price them differently as well.

ISO’s classi‹cation scheme shows that there are relatively fewinstances in which gun-risk businesses are classed differently from other,similar businesses. Retail sporting goods stores all carry the same generalliability classi‹cation (18206) whether they sell ‹rearms or not.20 Pawn-shops are also classed the same whether they deal in guns or not. Jewelrystores, liquor stores, and bars are classed the same whether or not theykeep guns on premises for security purposes.

Gun-risk businesses that have their own classi‹cations are primarily



those that present signi‹cant products liability exposures. Firearms man-ufacturers, for example, are classed separately. Ammunition manufac-turers are classed separately as well and indeed are further dividedbetween those that manufacture smokeless powder and those that do not.Other gun risks that do not present signi‹cant products liability expo-sures but nevertheless have their own classi‹cations include gunsmiths,shooting clubs, and shooting galleries.

Although industry standard setters do not set mandatory rules for thetreatment of gun risks, they do recommend that insurers take such risksinto account. The A.M. Best Underwriting Guide, for example, character-izes ‹rearms risks as a “serious exposure” in which the “potential forinjury is severe.”21 Best offers a number of recommendations to under-writers who are considering insuring such risks, depending on the typeof business seeking coverage.

Sporting Goods Stores. Although ISO does not class gun-selling sport-ing goods stores differently than gun-free ones, Best’s UnderwritingGuide advises the underwriter that the “hazard index” presented by agun retailer is higher. Interestingly, the primary area in which Best seesheightened exposure is not in general liability but rather in propertyinsurance coverage—commercial crime and ‹re in particular. On a scaleof one to ten, Best characterizes the general liability hazard index of asporting goods store at six whether it sells guns or not. But the under-writer is advised that the ordinary commercial crime hazard index of ‹vebecomes “higher with the sale of ‹rearms and ammunition.” Due to theheightened crime and ‹re exposures, Best recommends that the insurerconsider several factors before agreeing to insure a gun retailer.

Given this focus on ‹re and crime, it is not surprising that most ofBest’s recommendations have to do with the prospective insured’s gunand ammunition storage practices. Best recommends that the under-writer investigate whether guns are kept in locked display cases con-structed of tempered glass. In addition, Best recommends that the under-writer determine whether ‹rearms are stored unloaded and separatelyfrom ammunition. It recommends that the insurer investigate the type ofammunition stored on premises—black powder presents explosion haz-ards that small ri›e cartridges do not—and it recommends that theinsurer con‹rm that the insured follows all state and federal regulationsin the storage of ammunition.



Best does not offer many speci‹c recommendations concerning thegeneral liability and products liability perils. It reminds the underwriterthat the potential for injury is severe and that a retailer is likely to benamed as a defendant in any products liability suit brought against amanufacturer.

Information on how carriers are implementing these recommenda-tions is sparse. One carrier (The Hartford) will not insure a sportinggoods store that sells handguns.22 Another carrier (Safeco) will insure asporting goods store if its gun sales are “incidental.” Safeco regards gunsales as incidental if they are less than 15–20 percent of the store’s totalsales, and the underwriter accounts for the incidental gun risk by manu-ally adjusting the premium upward.23 The four largest U.S. writers ofcommercial insurance (AIG, CNA, Travelers, and Liberty Mutual)24

declined requests for interviews.Anecdotal evidence suggests that it is becoming increasingly dif‹cult

for a gun retailer to get general liability insurance, notwithstandingBest’s relatively unthreatening portrayal of the exposure and the actionsof individual carriers such as Safeco. John Badowski, managing directorof the National Association of Firearms Retailers and director of retailpartnership programs for the National Shooting Sports Foundation(NSSF), has noted an increase in the frequency with which ‹rearmsretailers are reporting refusal or nonrenewal of insurance.25 Badowski’sassessment is con‹rmed by Robert Chiarello, an Elizabeth, New Jersey,insurance broker who administers an insurance program endorsed by theNational Association of Sporting Goods Wholesalers.26

Badowski indicates that the NSSF has attempted to increase gunretailers’ attractiveness to insurers by conducting its own loss controlactivities. The NSSF has created a dealer education program entitled“Don’t Lie for the Other Guy” that is intended to increase the dealer’sability to recognize and prevent straw purchases. NSSF, in consultationwith a team of engineers, has created a gun display case highly resistantto “smash and grab” thefts. Badowski reports that these loss controlefforts have yet to show success in reducing insurer reluctance to acceptretail gun risks.27 This may be because of the general “hardening” of theproperty casualty insurance market at the time of our interviews over thelast three years,28 as well as concern that retailers may be drawn into themass tort gun litigation (though that latter concern is addressed in partthrough selective exclusion, as explained later).



Gunsmiths. ISO maintains a separate classi‹cation (95620) for gun-smiths. Gunsmiths are those businesses that are primarily engaged in the“repair and maintenance of ‹rearms” and may also engage in “engrav-ing, bluing, ‹tting a gun speci‹cally to a customer, suggesting gunimprovements to a manufacturer, and selling ‹rearms and other shootingequipment on a retail basis.” “In addition to conducting their own busi-ness, some insureds also will do warranty work for major manufacturers,much like an authorized service center.”29

Although a gunsmith’s entire business is gun related and a sportinggoods retailer’s business is only partially so, Best’s general liability haz-ard index is lower for gunsmiths than for sporting goods stores. On ascale of one to ten, Best rates the general liability hazard index of a sport-ing goods retailer at six and that of a gunsmith at four.30 This might sug-gest that Best sees other sporting goods (rollerblades, treadmills, etc.) asmore productive of general liability losses than guns.31 Best rates theproducts liability hazard index of both gunsmiths and sporting goodsstores at six and the crime hazard index of both at ‹ve. Best sees a sport-ing goods retailer as a higher ‹re hazard than a gunsmith—the former isa six, the latter a ‹ve—but the ‹re exposure presented by a gunsmith issaid to be “much higher with ammunition on the premises.” Workers’compensation is the only line in which the hazard index is higher for agunsmith (eight) than for a sporting goods retailer (four). This is due inpart to the presence of ‹rearms but also to the presence of cutting anddrilling machinery.32

As with sporting goods stores, Best’s Underwriting Guide recom-mends that the underwriter survey the applicant’s gun and ammunitionstorage practices before agreeing to insure her. Best also recommendsthat the underwriter review any contracts the gunsmith may have signedwith manufacturers for whom she does warranty work, with a view todetermining whether the gunsmith has agreed to indemnify the manu-facturer for any personal injuries arising from serviced guns. In addition,Best recommends that the underwriter review the professionalquali‹cations of the applicant, since her skill in gunsmithing ought to bedirectly proportional to the rate at which her repairs will fail and produceproducts liability losses. The underwriter is also advised to determinewhether the gunsmith designs any parts or assemblies for gun manufac-turers, since such work would increase the likelihood that the gunsmithwould be named in a products suit against the manufacturer.



Best also makes a number of recommendations speci‹c to lines ofinsurance other than general liability. Since gunsmiths frequently needto test-‹re guns to ensure that their repairs are satisfactory, Best recom-mends that workers’ compensation underwriters determine whether thegunsmith’s employees have received proper training in the ‹ring ofguns. Best also recommends that crime underwriters look closely at thecrime rate in the insured’s neighborhood and at the types of guns onwhich she works. Gunsmiths who work on valuable antiques will havemore severe bailee losses.

Hunting Clubs, Ri›e Clubs, and Shooting Ranges. We were unable toobtain access to Best’s recommendations for these kinds of risks. Wewere able to locate other documents that provide a window into howinsurers approach these risks, however. Carpenter Insurance Service ofAnnapolis, Maryland, administers a hunting club insurance program forthe Northland Insurance Company, an arm of Travelers. We obtained acopy of Northland’s application for hunting club liability insurance, andthe underwriting questionnaire contained in that application tells usmuch about the risks that Northland perceives in such clubs. Applicantsare asked whether they allow the use of horses on their premises;whether they own any vehicles or allow the use of members’ vehicles ontheir premises; whether they hold a liquor license or allow members toparticipate in hunting or shooting activity while under the in›uence ofalcohol; whether they use tree stands; and whether all members carryproper ‹rearms permits.33 Another insurance program for hunting clubsis available through the National Ri›e Association (NRA). The NRAendorses a program administered by Lockton Risk of Kansas City.Lockton is willing to quote, if not issue, insurance for a hunting club onthe strength of an exceptionally short questionnaire. Lockton’s applica-tion asks the prospective insured to report the number of members it has;whether it uses tree stands; whether it is NRA af‹liated, and what itslocations are.34

Lockton Risk also offers an NRA-endorsed insurance plan for ri›eclubs and shooting ranges. Here, the questionnaire is more extensive.Before Lockton will issue a quote, it requires the applicant to reveal thetype of range to be insured (indoor, outdoor, ri›e, archery, skeet/trap,etc.), the number of range lanes, and the design of the range. In addition,



Lockton requires a description of the range’s safety practices, includingwhether it has posted range safety rules, on-site range safety of‹cers, andrequired ear and eye protection. Lockton also asks the prospectiveinsured about its environmental practices, including the range’s ventila-tion and its disposal methods for spent lead shot.35

Gun Manufacturers and Distributors. Little public information exists onthe insurance environment for gun manufacturers and distributors. Gunmanufacturers and distributors appear to be unable to obtain insurancefrom the standard commercial insurance market and, thus, can onlyobtain their insurance from a special, less heavily regulated type of insur-ance known as “surplus lines” insurance. Although it is dif‹cult to gen-eralize about such a ›exible insurance instrument, surplus lines insurancetends to be more expensive and offered by organizations that are admin-istratively leaner and, accordingly, less likely to engage in the morehands-on approaches to risk management (prevention, engagement withpublic regulators, research, and education). Some of the leading surplusline insurance companies are subsidiaries of well-known insurancegroups (AIG, Zurich, Travelers, etc.) and, thus, would seem to haveaccess to very signi‹cant administrative resources. Nevertheless, thesesubsidiaries tend to be run relatively autonomously.

Interviews with industry participants indicate that, even in the contextof the ordinarily expensive surplus lines environment, gun manufactur-ers and distributors are experiencing a “hard market” for insurance.Robert Chiarello, the New Jersey insurance broker, indicates that anumber of carriers have withdrawn from the gun manufacturer productsliability market. To Chiarello’s knowledge, there are “only about ‹veplayers” remaining in the market. AIG writes products liability for man-ufacturers and distributors through its Lexington Insurance subsidiary.Admiral, Granite State, and New Hampshire Insurance have manufac-turer and distributor programs as well.36

In addition to these providers, insurance is available through a captiveinsurance company founded by some of the larger gun manufacturers.The captive—Sporting Activities Insurance Limited, or SAIL—is aBermuda corporation formed in 1986 with the assistance of Chiarello.37

It insures or has insured Smith & Wesson and Navegar, among others.38

Tom McDermott, a New York attorney who investigates fraudulently



undercapitalized insurance companies, classi‹es SAIL as a “legitimateinsurer” and not as an example of the “sleazy insurance” problemaddressed later.39

Chiarello reports that gun insurers do not directly discriminatebetween “reputable” gun manufacturers such as Colt and “junk gun”manufacturers such as Bryco but that some of their underwriting guide-lines indirectly produce the same practical result. The rating basis for agun manufacturer—indeed, for manufacturers generally—is gross sales.But “carriers will look not only at the gross dollar amount of sales butalso at how those sales are earned. A company that makes a million dol-lars selling a thousand units will present a different exposure than some-one who makes the same million dollars selling one hundred units.” Sowhile the underwriter might not enter the process expecting to treat aBryco differently from a Colt, the two manufacturers end up beingtreated differently because of the larger number of exposure units Brycopresents per each unit of sales. In addition, Chiarello reports that under-writers understand consumers of expensive guns to be better educated inthe use of ‹rearms and therefore less likely to injure themselves.Chiarello cites Anschutz, the German manufacturer of competition airri›es used in the Olympics, as a manufacturer with an enviable lossrecord. “Anyone who spends three thousand dollars on an air gun prob-ably knows what he’s doing.”40

Chiarello provided us with documents that expand on his verbaldescription of the underwriting concerns of gun insurers. Chiarello hastaken the underwriting concerns of the several market participants andsynthesized them into a common insurance application. By asking hiscustomers to answer every underwriting question asked by any of hismarkets, Chiarello saves his customers from having to ‹ll out a separateapplication for each insurer that may express interest in the risk. An acci-dental by-product of this customer service measure is that the Chiarelloapplication gives us a composite view of the underwriting concerns ofthe market as a whole.

Chiarello’s application is actually two separate documents—one forgeneral liability coverage generally and another for products liabilityspeci‹cally. Commercial liability insurance policies typically excludeproducts liability coverage from the “general liability” coverage andprovide it under a separate “products liability” heading. Chiarello’s gen-eral liability application asks the prospective insured about business his-



tory, gross sales and payroll, the nature of her operations, the type ofbuilding occupied, loss history, and trade group af‹liations.41 In addi-tion, it asks distributors about the sources of their products—evidentlythe carriers Chiarello represents are more concerned with distributors offoreign guns than with distributors of domestic ones, presumablybecause they suspect that plaintiffs will not want to locate foreign manu-facturers and will instead sue their distributors.

The products liability application asks many of the same questions. Inaddition, it asks deeper questions about the insured’s business back-ground, including whether the insured purchased any businesses and, ifso, whether it assumed that business’s liabilities. The application alsoasks the prospective insured to describe quality control and loss controlactivities and to break down sales according to the type of gun pro-duced—ri›es, shotguns, or handguns. Finally, the application asksabout claims history at a greater level of detail.42

the “sleazy insurance” problem

A December 2002 article in the online journal Slate claimed that insurersabet the marketing of “junk guns” by helping irresponsible gun manu-facturers put up a facade of ‹nancial responsibility.43 According to thearticle, makers of junk guns teamed up with “sleazy” insurance compa-nies to defraud ‹rearms distributors and retailers into believing thatthey—the manufacturers—could face their products liability obliga-tions. If not for the contributions of sleazy insurance companies to thisscheme, distributors and retailers would not have marketed junk gunsand the public would have been safer as a result.

The primary source for the article was Tom McDermott, the NewYork attorney referred to earlier, and the example presented in the arti-cle was an insurance company called Leeds and London. According toMcDermott, Leeds and London was conceived by an insurance brokerand a principal of the now defunct low-end gun manufacturer LorcinEngineering. In addition to Lorcin, Leeds and London insured anotherlow-end manufacturer by the name of Davis Industries; McDermott saysthat Davis “had to have known” that the insurance provided by Leedsand London was illegitimate because the premium was too low.44 Evi-dently Leeds and London branched out, offering to cover hard-to-insureoperators of carnival rides. A Maryland carnival operator discovered



problems with Leeds when a state inspector refused to accept itscerti‹cate of insurance, and the company collapsed soon after.45

McDermott believes that Leeds-issued certi‹cates of insurance per-suaded distributors and retailers to market products that they otherwisewould not have marketed. He attributes the existence of the scheme to anear-collapse of state monitoring of insurer solvency in the surplus linesarena46 and reports that gun distributors and retailers will have to moni-tor the quality of the insurance carried by the manufacturers they repre-sent, because “no one else is.”47

Robert Chiarello, the New Jersey insurance broker, disagrees withMcDermott’s characterization of the reach of what he calls the “rogueinsurer problem” but agrees that distributors and retailers must take itupon themselves to ensure the ‹nancial responsibility of the manufactur-ers they represent. Indeed, Chiarello reports that retailers and distribu-tors have already assumed that duty and have, if anything, becomeoverzealous in their oversight of manufacturers’ insurance. Chiarelloclaims that this oversight was prompted less by the collapse of bad actorslike Leeds than by the collapse of more upstanding market participantslike Reliance and Legion.48 Since the collapse of Reliance, “all of the dis-tributors will not accept” a manufacturer’s certi‹cate of insurance “fromsomeone they do not know.” Chiarello relates an anecdote in which adistributor questioned a certi‹cate of insurance from the venerable gunmanufacturer Browning, merely because Browning had “gone digital”and had sent its certi‹cate in a format with which the distributor wasunfamiliar.49

commercial insurers and gun regulation by insurance

Selective Exclusion. Selective exclusion is the commercial liabilityinsurance industry’s main approach to the kinds of gun-related injuriesthat are the focus of gun control advocacy generally and the mass tort lit-igation in particular. There are two main parts to insurers’ exclusion ofgun violence risks. First, many insurers exclude products liability cover-age from the liability insurance that they sell to businesses such as sport-ing goods stores, hunting clubs, ri›e ranges, and gunsmiths (i.e., busi-nesses other than manufacturers and distributors)50 and, sometimes,even to manufacturers and distributors.51 Second, all or most of the rela-tively few insurers that are willing to provide products liability coverage



to manufacturers and distributors appear to have adopted in recent yearsan exclusion designed to eliminate coverage for mass tort gun litiga-tion.52

We were able to obtain a copy of one such mass tort exclusion. Theexclusion applies to any “industry liability claim,” which is de‹ned toinclude any class action, whether or not certi‹ed as such, and any claimbrought by a municipality, interest group or other entity that has notitself been injured in a bodily way.53 The clear intent of this exclusion isto eliminate any doubt about whether there is coverage for the currentround of gun-related mass tort litigation. For example, the omission ofproperty damage as a coverage trigger is not accidental. The small con-tribution of municipal property damage (e.g., bullet holes in police cruis-ers) to the overall costs of gun violence has occasionally become animportant battleground. Gun manufacturers challenge the municipali-ties’ standing to sue for what the manufacturers claim is an indirectinjury, derivative of injuries to third parties. The municipalities cite,inter alia, their own property damage as proof that they have suffereddirect injury and thus have standing.54

Even without the mass tort or products liability exclusions, some lia-bility insurers have argued that the municipal litigation is not covered.To date, there are only two published opinions, one favoring the insur-ance companies and one favoring a manufacturer, and both of theseopinions rest on unusual circumstances that may limit their precedentalvalue.55 The coverage litigation continues, and there are substantialarguments on both sides, suggesting that manufacturers and distributorscannot count on coverage even under the old forms.56

Gatekeeping. Insurers have the opportunity to act as gatekeepers wheninsurance is a necessity. Distributors apparently regularly require thatmanufacturers provide evidence of product liability insurance coveragebefore they will agree to distribute the manufacturers’ guns, and someretailers may as well.57 Thus, manufacturers who are unable to purchaseproduct liability coverage will not have access to those distributors orretailers. The “sleazy insurance” problem complicates this picture, how-ever, because manufacturers that are unable to get access to reliableinsurance coverage may nevertheless be able to obtain a certi‹cate ofinsurance that would satisfy an unsophisticated risk manager. While weare not in a position to evaluate the extent of this problem, a recent,



somewhat impressionistic study of insurance fraud by the sociologistRobert Tillman provides support for the claim that it exists.58

Other gatekeeping opportunities are presented when sporting goodsstores, gunsmiths, and other gun-related businesses that rent commercialspace are obligated under their lease agreements to purchase liabilityinsurance. (Insurance clauses are a standard feature in commercialleases.) Whether the liability insurance that these gun-related businessesobtain in fact provides comprehensive coverage against gun-relatedrisks is doubtful in the current insurance environment (because of theselective exclusion approach, addressed earlier). Nevertheless, the insur-ance would provide coverage against the ordinary liability risks that arelikely to motivate commercial landlords to require that their tenants beinsured.

Prevention. As noted previously, Best’s Underwriting Guide containsmany prevention-related suggestions for underwriters of businesseswith gun risks, but those suggestions largely concern ‹re and crimerisks. In the relatively few instances in which the suggestions addressbodily injury, the primary focus of concern is accidental injury on loca-tion, either by customers inspecting or using weapons or by employeesworking on them.59

Some exceptions appear in the entry for gunsmiths, which re›ects aconcern about liability relating to procedural irregularities in the sale ofguns, improper instruction in the use of guns, and improper repair ofguns. Under the heading for “general liability,” underwriters are cau-tioned to inquire the following:

Are special precautions taken to insure that only customers withlegal permits are allowed to buy guns? Are all employees who sellguns aware of local and state laws regarding age, criminal record,mental health and waiting periods? Does the insured instruct buy-ers on the use of guns? What are the quali‹cations of the instruc-tors and under what conditions are instructions given?

Under the heading for “products liability,” underwriters are cau-tioned as follows:

A serious exposure will exist relating to accidents arising from theimproper repair of customers’ guns. This may encompass faultywork or assembly, improper installation of parts, or use of substan-



dard parts. Improperly repaired guns can mis‹re and cause severebodily injury to the user as well as others around the user.

We were unable to determine whether underwriters in fact ask the ques-tions that Best suggests and, if the “wrong” answers are given, whetherthey deny applications. Assuming that they do, however, these preven-tion efforts are unlikely to address the intentional gun violence that is themain focus of this book. (The exception might be efforts directed atensuring that policyholders comply with gun laws.) Instead, insuranceindustry prevention efforts are directed at minimizing “normal,” acci-dental injuries associated with the legal use of guns—accidents in stores,explosions of powder and ammunition, and injuries from product mal-function.

Management of Loss Costs. Management of loss costs is an importantaspect of regulation by insurance generally, particularly because of theimpact on the medical and legal professions, but there does not appear tobe anything special about management of loss costs in the gun-injurycontext. For example, emergency room personnel have made greatstrides in the treatment of gun injuries, but those efforts do not appear tohave been led by health insurance interests. Similarly, insurance lawtextbooks commonly feature cases involving gun-related injuries, butthe cases are chosen because they nicely illustrate the dif‹cultiesinvolved in drawing lines between auto and homeowners’ insurance andbetween intentional and unintentional injuries,60 not because of a specialfocus in the insurance industry on defending gun-related injury cases.

Liability Limitation. In response to the recent gun-related mass tort lit-igation, there have been legislative efforts in the states and Congress tolimit liability. While insurance industry organizations appear to be sup-portive of at least some of these efforts, the insurance industry does notappear to be a driving force.61 This situation contrasts with that of recentlegislative efforts directed at limiting liability for asbestos-relatedinjuries, environmental cleanups, and medical malpractice, in whichinsurance industry organizations are intensively and publicly involved.Although it is always dif‹cult to provide persuasive causal explanationsfor inaction, the insurance industry’s ability to avoid the mass tort litiga-tion risk through selective exclusion is certainly a plausible explanation.



Conclusions and Implications

Although insurance may well be a form of governance, and insuranceinstitutions governmental, the approach to government described herewould hardly qualify as activist. Indeed, if we were to limit the use of theterm regulation to the command and control approach epitomized by theOccupational Safety and Health Administration and by much of thework of the Environmental Protection Agency, then there is very littleregulation by insurance of gun-related activities. As noted already, theguidelines from Best are directed primarily at preventing ‹re and theftand only secondarily at preventing the ordinary accidents that arise inthe context of the legal sale and use of guns. The only guidelines thataddress the gun violence that is the target of the mass tort gun litigationare those that encourage underwriters to make sure that gun sellers fol-low the procedural requirements established by the applicable state andfederal law.

Instead of command and control directives targeted at preventing andminimizing the costs of gun violence, what we ‹nd, instead, is selectiveexclusion. By excluding claims based on intentional harm, liability insur-ers have largely kept the costs of gun violence out from under the insur-ance umbrella. Where those costs have threatened to creep in—as in themunicipal litigation—insurers have responded by leaving the market orby further selective exclusion.

By excluding gun violence, the insurance industry cannot fairly beaccused of knowingly facilitating gun violence. Indeed, the historic,moral hazard justi‹cation for the most important exclusion—that forintentional harm—was ‹rst articulated precisely to protect insurers fromsimilar accusations.62 Yet, leaving gun violence outside the liabilityinsurance umbrella may in fact promote gun violence by depriving thegun arena of a potentially powerful institutional force for the preventionof harm. Unless liability insurance covers the costs of gun violence, thereis no incentive for the liability insurance industry to use the regulatorytools that it has available.

A liability insurance industry responsible for paying millions of dol-lars in gun-related claims in any given year would have an incentive tolearn more about gun violence and, if it determined that there werecost-effective prevention measures, to impose those prevention mea-sures on insureds either through the underwriting process or through



engagement with public regulators. In addition, depending on what theresearch revealed, owning a gun could lead to a premium surcharge,which could remove some guns from circulation. Moreover, as the con-ditional nature of this discussion suggests, insurance-funded researcherscould function as “honest brokers” in the debates over the safety andcosts of guns, much as they have in the ‹eld of auto and ‹re safety.

The liability insurance reform that would be most likely to bring gunviolence under the liability insurance umbrella would be the eliminationof the intentional harm exclusion in personal liability policies. Whilemany people who use guns undoubtedly do not have homeowners’ orrenters’ insurance, some do. Eliminating the intentional harm exclusionwould promote the deterrence goals of tort law for the reasons just sug-gested, without, in our view, affecting the behavior of someone who isdeciding whether to draw a gun.63 Eliminating the intentional harmexclusion would also promote the compensation and retribution goals oftort law.64 If there is an insurance company available to pay a claim, it ismuch more likely that a victim of gun violence will bring a tort actionagainst the perpetrators (furthering the retribution goal) and collect thedamages to which she or he is entitled under the law (furthering the com-pensation goal). Jennifer Wriggins has recently made similar observa-tions in the domestic violence context.65

As noted earlier, insurers have extended the selective exclusionapproach to gun violence by adopting an “industry liability” exclusionwhen the municipal litigation threatened to bring gun violence under theliability insurance umbrella. This has become standard procedure in themass tort context. Almost as soon as any manufacturer becomes the sub-ject of mass tort litigation, insurers adopt product-speci‹c exclusions thatpreclude any new coverage for the mass tort claims. In effect, liabilityinsurers offer manufacturers one set of policy limits per product; afterthat, liability for the product is treated as a “known loss” that cannot beinsured. This reality should temper whatever enthusiasm remains formass tort litigation as a loss-spreading device.

On the other hand, the routine practice of adopting product-speci‹cexclusions increases the power of tort litigation to force the withdrawalof a product from the market. The gun litigation failed in that regard, notbecause liability insurers came to the rescue of the manufacturers withpromises of continuing protection (they did not) but rather because themanufacturers successfully repulsed the litigation (with some help from



insurers under liability policies already sold). In considering whethermass tort litigation can force products off the market, it is important tokeep in mind a fundamental difference between gun litigation and otherproducts liability litigation. The gun litigation (like the tobacco litiga-tion before it) had the goal of shutting down entire businesses. That goalprompts a very different response than litigation directed at a singleproduct manufactured by a business that manufactures a variety of prod-ucts. In the latter context, mass tort litigation and the accompanyingwithdrawal of insurance might well prompt the manufacturer to cut itslosses, abandon the product, and move on, only to return the product tomarket if and when it prevails in the mass tort litigation.

Finally, the “sleazy insurance” problem highlights an important con-sequence of relying on insurance as regulation. When an individual orentity is motivated to buy insurance to get through the gate (and not pri-marily to obtain the risk-spreading and related bene‹ts), we can’t rely onthe market alone to ensure that the resulting insurance will be high qual-ity, because the person buying the insurance cares less about the qualityof the insurance. As this suggests, the more we rely on private insuranceto achieve social policy goals, the more we have to regulate insuranceitself. Absent a government mandate, the liability insurance industry haslittle reason to take on gun violence. If we force insurers to provideinsurance that they don’t want to provide and force consumers to pur-chase insurance that they don’t want to buy, we will need an administra-tive enforcement mechanism to ensure that insurers really provide andconsumers really purchase that insurance.



liability insurance & the regulation of firearms · insurance, bid on a government contract...

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