Insurance can be defined as a contractual arrangement for transferring and distributing risk. For that reason, insurance coverage is premised on the exchange of risk and the chance that an unintended or unexpected event will occur. Consistent with this principle, insurance carriers do not intend to provide coverage for a loss that has already occurred, is in progress, or is substantially certain to occur. Yet, situations will arise where policyholders attempt to obtain insurance coverage for a loss that has already occurred or that is in progress. A classic example is the homeowner who calls his agent to obtain flood insurance while water from a burst pipe rises on the floor around his ankles. In response, courts have developed a common-law rule most often referred to as the “known loss” doctrine, which provides that there is no coverage for a loss that has already occurred at the time the insured applied for the policy. While this might appear to be a straightforward principle—surely, one cannot purchase insurance coverage for a loss that has already occurred—courts have not reached consistent results regarding the determination of what constitutes a “loss” or the standard by which the insured’s knowledge must be proven.
These questions become more complicated in the context of liability insurance for third-party claims. The application of the known loss doctrine to first-party property insurance is relatively straightforward. Once the event giving rise to the claim occurs—such as a flood or a fire—there will rarely be any uncertainty about whether there has been a loss, even if the full extent of the loss is not yet known. However, there may still be uncertainty about whether a particular event will give rise to liability claims. And it is not always clear what the “loss” is or what the insured “knew.” This article discusses the application of the known loss doctrine in the context of liability insurance for third-party claims and the issues courts have struggled with in determining whether to apply the rule.