By Greg Johnson. A 2014 decision of the South Carolina Supreme Court decision invalidating a household (a/k/a “family” or “intra-family”) “step-down” (a/k/a “drop-down”) to a personal auto policy caused me to dust off my research from over a decade ago to determine whether such provisions would be invalid under Minnesota law as well. In Williams v. Gov’t Employees Ins. Co. (GEICO), 409 S.C. 586, 594, 762 S.E.2d 705, 709 (2014), the court held that a household step-down provision which purported to reduce the policy limits from $100,000 to $15,000 when the named insured or resident family member was injured, was void and unenforceable.
The Minnesota Supreme Court has not determined whether step-down provisions are enforceable under the Minnesota No-Fault Automobile Insurance Act. In a step-down provision, “the coverage ‘steps down’ from the actual policy limits to the minimum required by statute.” Liberty Mut. Ins. Co. v. Shores, 147 P.3d 456, 458 n. 4 (Utah Ct.App.2006) (quoting 1 Rowland H. Long, The Law of Liability Insurance, § 2.05 (2003)). Although such provisions are typically found in the exclusions section of the policy and may be called “exclusions” in court opinions, they are not actually exclusions because they do not bar all coverage under the policy.
The Minnesota No-Fault Act refers to bodily injury and property damage liability coverage as “residual liability coverage.” When addressing liability step-down provisions, it is important to distinguish between two different types: (1) those in a vehicle owner’s liability policy which reduces the liability coverage available to a permissive user-driver (a/k/a “omnibus”) insured (but not the named insured); and (2) those which purport to reduce the coverage available to the named insured or resident family member when injured in an accident.
The Minnesota Standard
The validity of step-down provisions must be measured against the following standard: Minnesota courts first consider whether the provision is unambiguous. Pepper v. State Farm Mut. Auto. Ins. Co., 813 N.W.2d 921, 925 (Minn.2012) (citing Latterell v. Progressive N. Ins. Co., 801 N.W.2d 917, 920 (Minn.2011)). If the provision is unambiguous, courts “then consider whether the exclusion omits coverage required by the No–Fault Act or contravenes the No–Fault Act. Id. (citing Latrell at 921). See also, Lobeck v. State Farm Mut. Auto. Ins. Co., 582 N.W.2d 246, 249 (Minn.1998) (same). “[S]o long as coverage required by law is not omitted and policy provisions do not contravene applicable statutes, the extent of the insurer’s liability is governed by the contract entered into.” Am. Family Mut. Ins. Co. v. Ryan, 330 N.W.2d 113, 115 (Minn.1983).
Omnibus Step-Down Provisions
A step-down provision which reduces the amount of liability coverage available to an omnibus insured should be found enforceable by the Minnesota Supreme Court. Omnibus step-down provisions are usually only found in the commercial auto context. The Minnesota Court of Appeals approved omnibus “step-down” provisions in Agency Rent-A-Car, Inc. v. American Family Mut. Auto. Ins. Co., 519 N.W.2d 483 (Minn. Ct. App. 1994) and State Farm Mut. Auto. Ins. Co. v. Universal Underwriters Ins. Co., 625 N.W.2d 160 (Minn. Ct. App. 2001), review denied (Minn. June 27, 2001), cases I handled for the involved rental car company and auto dealership insurer.
In Agency Rent-A-Car and Universal Underwriters, the insuring agreements provided one stated limit of liability for the named insured vehicle owner (a car rental company in Agency Rent-A-Car and dealership in Universal Underwriters) and another, lower limit (statutory minimum) for permissive user-customers. A typical provision provides that the permissive user-customer qualifies as an “insured” under the policy only to extent of the minimum limits required by law. In both cases, the step-down provisions were upheld. The vehicle owner’s self-insurance plan (in Agency Rent-A-Car) and liability insurer (in Universal Underwriters) was only required to extend minimum limits omnibus liability coverage to the customer on a primary basis, followed by the non-owned vehicle liability coverage available to the customer under his or her own personal auto policy, which applied on an excess basis. If uncompensated damages remained and the vehicle owner had any tort liability to the injured party (vicarious or active), the vehicle owner’s self-insurance plan or insurance policy would come back into play to pay up to the difference between its full liability limit and the minimum limits omnibus coverage afforded the permissive user-customer.
While nothing in the No-Fault Act expressly authorizes an omnibus step-down provision in a vehicle owner’s policy, such provisions do not contravene any provision of the No-Fault Act or public policy because they do not reduce the bodily injury liability protection the named insured purchased and, thus, do not reduce the coverage that is available to injured accident victims or any class of accident victims. The vehicle owner’s insurer remains liable to pay up to its full limits of liability regardless of the step-down provision. Omnibus step-down omnibus provisions only operate to allocate liability coverage between the policy issued to the vehicle owner and the permissive-user customer’s policy, if any. In Universal Underwriters, State Farm argued the No-Fault Act “prohibits [an] owner’s residual liability policy from providing different liability limits for the permissive user and the owner.” Id. at 164. Relying on Agency Rent-A-Car, the court rejected State Farm’s argument, holding: “[n]othing in [the No-Fault Act] shows a clear intent by the legislature to restrict an insurer’s right to freely contract for different liability limits for permissive drivers and owners so long as the minimum statutory coverage is provided.” Id. The permissive user-customer has no grounds to object to a step-down provision; a non-family member permissive user cannot claim any reasonable expectation that the vehicle owner’s policy would afford him or her more than minimum limits coverage.
It should be noted that the omnibus step-down provisions at issue in Agency Rent-A-Car and Universal Underwriters are distinguishable from the policy provisions at issue in Illinois Farmers Ins. Co. v. Depositors Ins. Co., 480 N.W.2d 657, 661 (Minn.Ct.App.1992). In that case, three men were killed in a single-vehicle accident in 1989. Donald Olson owned the vehicle and insured it through Depositors. His son, Joseph, had permission to use his father’s car. He allowed a friend, Kevin Redlund, drive the car. Two passengers’ heirs brought wrongful-death claims against Donald Olson and Redlund. Depositors insured Olson’s vehicle, with liability limits of $500,000 per person/$500,000 per accident. Farmers insured Redlund. The Depositors’ policy extended omnibus coverage to anyone using the insured vehicle with permission. Unlike the step-down omnibus provisions in Agency Rent-A-Car and Universal Underwriters — which specifically restricted the omnibus liability coverage to the minimum limits required by law — the Depositor’s policy contained an endorsement stating that the insurance available for any person other than the named insured or a resident relative (i.e., a permissive user) “that exceeds the financial responsibility law limits where the auto is principally garaged shall be excess over any other collectible insurance.” The “other insurance” clause of the Farmers’ policy likewise stated that “any insurance we provide for a vehicle you do not own shall be excess over any other collectible insurance.” Because the other insurance clauses of the two policies in Depositors conflicted, the Court of Appeals applied Minnesota’s three-part “closeness-to-the risk” test and held that Depositor’s policy was primarily liable up to its $500,000 limits, followed by the Farmers’ policy.
Household Step-Down Provisions
Household (a/k/a “family” or “intra-family”) step-down provisions differ significantly from omnibus step-down provisions. First, household exclusions have been banned in Minnesota since 1969. Hime v. State Farm Fire & Casualty Co., 284 N.W.2d 829 (Minn.1979) (citing Minn. Stat. § 65B.23, repealed by Laws 1974, c. 408 s 33 and noting that “Minnesota law has prohibited household or family exclusions in automobile liability insurance policies since 1969”), cert. denied, 444 U.S. 1032 (1980)).
Prior to 1969, household (a/k/a “intra-family”) exclusions for bodily injury sustained by the named insured and members of his or her family residing in the same household were held enforceable on the grounds that they served to prevent fraud and collusion by family members. See, Tomlyanovich v. Tomlyanovich, 239 Minn. 250, 58 N.W.2d 855, 862 (1953) (upholding household exclusion and noting that the “obvious purpose of the clause here involved is to exempt the insurer from liability to those persons to whom the insured, on account of close family ties, would be apt to be partial in case of injury”).
However, with the erosion of the common-law doctrines of inter-spousal and parental immunity and rejection of their purported rationale (i.e., the possibility of family members engaging in fraud and collusion), the legislature rejected the auto insurance industry’s efforts to incorporate those immunities into their policies by use of contractual household exclusions. Minnesota Statute § 65B.23, subd. 1(a) provided that “No policy of automobile liability insurance … shall contain an exclusion of liability for damages for bodily injury solely because the injured person is a resident or member of an insured’s household or related to the insured by blood or marriage.” Subdivision 1(b) prohibited exclusions for “bodily injury sustained by any person who is a named insured, except where such injury is sustained by a named insured who is driving the insured automobile at the time such injury is sustained.”
In 1979, in Hime, the Minnesota Supreme Court addressed a household exclusion in connection with an accident that occurred in 1972, before the No-Fault Act was in effect. The policy obligated State Farm to “pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages …,” but excluded “bodily injury to the insured or to any member of the family of the insured residing in the same household as the insured.” Id. at 831. The issue was whether Florida law (which enforced household exclusions) or Minnesota law (which did not) would apply as the policy was issued in Florida, but the accident occurred in Minnesota. The court held that application of Minnesota law was proper under Minnesota’s “choice-influencing considerations” and invalidated the household exclusion.
Second, while household step-down provisions do not eliminate all coverage as would be the case with a true household exclusion (the lone fact relied upon by auto insurers in support of the validity of household step-down provisions) household step-down provisions differ from the omnibus step-down provisions found enforceable in Agency Rent-A-Car and Universal Underwriters as the former purport to reduce the liability protection the named insured purchased, often significantly so, and thereby also serve to reduce the insurance coverage available to an entire class of accident victims based solely on the injured party’s status as a named insured or resident relative of the named insured’s household. Further, unlike omnibus step-down provisions – where the permissive user-customer has no expectation of being afforded more than minimum limits coverage –, a household step-down “may be a surprise to most policy holders. The insurance-buying public may assume that injured family members have the benefit of the full policy limits.” Frey v. United Servs. Auto. Ass’n, 743 N.W.2d 337, 343 (Minn. Ct. App. 2008).
The Minnesota Court of Appeals and Eighth Circuit Court of Appeals approved household step-down liability provisions in Frey v. United Servs. Auto. Ass’n, 743 N.W.2d 337 (Minn. Ct. App. 2008) and Babinski v. Am. Family Ins. Grp., 569 F.3d 349 (8th Cir. 2009). In Frey, the Minnesota Court of Appeals upheld a household step-down “exclusion” which reduced the stated policy limits from $300,000 to $30,000, the minimum amount required by Minnesota law. See Minn. Stat. § 65B.49, subd. 3(1). In Babinski, 569 F.3d 349 (8th Cir. 2009) (applying Minnesota law), the court, relying in large part on Frey and Universal Underwriters, upheld a household step-down “exclusion” which reduced the stated policy limits from $1,000,000 to $30,000.
In Frey, seventeen-year-old Nathan Frey was permissively operating a vehicle owned by his father, Stephen Frey, when he caused a one-vehicle accident. Stephen Frey and Thomas Alexander were killed in the accident and Nathan’s mother, Patricia Frey, and sister, Aven Frey, who was a college student in Iowa, sustained injuries. The vehicle was insured under a policy issued to Stephen Frey by USAA. The policy had stated limits of liability of $300,000 per person/$500,000 per accident. However, the exclusions section contained a step-down limit for bodily-injury liability coverage to $30,000 per person or $60,000 per accident when a “covered person” was legally liable to pay “a member of that covered person’s family residing in that covered person’s household.” It was undisputed that Nathan Frey was a covered person under policy. When Aven Frey submitted a claim for her injuries, USAA denied coverage for amounts above the policy’s step-down limits of $30,000/$60,000, claiming that Aven also resided in the home with her brother Nathan.
In holding the step-down provision valid and enforceable, the court first held the USAA policy did not “omit” any coverage required by Minnesota law because the policy still provided the minimum limits of liability coverage required by the No-Fault Act after application of the step-down provision. Id. at 341. The court next found that the step-down provision did not “contravene” applicable statutes. Id. Aven Frey argued, and the district court concluded, the step-down provision contravened Minnesota law and was unenforceable because USAA’s reduction of coverage for family members (i.e., a status-based exclusion) was not one of the enumerated grounds for cancellation or reduction of liability insurance under Minnesota law. However, the statute relied upon by the district court, Minn. Stat. § 65B.15 (2006), only governs changes in coverage during a policy term and, thus, had no applicability. The Court of Appeals also noted that while the Minnesota Department of Commerce’s 2005 procedure manual prohibited drop-down limits on bodily-injury coverage for resident family members (see Minn. Dep’t of Commerce, Private Passenger (Personal) Automobile Insurance, 7 (2005)), the “disapproval was withdrawn and there is no claim that this policy provision violates or violated a regulation of the Minnesota Department of Commerce or other state agency.” Id. at 342.
In Babinski v. Am. Family Ins. Grp., 569 F.3d 349 (8th Cir. 2009) (applying Minnesota law to an auto policy issued in South Dakota where the accident occurred in Minnesota), Kathi Babinski was killed in an automobile accident in Minnesota while her husband John, who was also killed, was driving a Dodge Ram pickup. The vehicle was insured under a policy issued by American Family. The policy required American Family to “pay compensatory damages an insured person is legally liable for because of bodily injury” and had liability limits of $1,000,000. However, the policy contained an exclusion providing that coverage did not apply to bodily injury to “[a]ny person related to the operator and residing in the household of the operator.” An exception to the exclusion then stated: “This exclusion applies only to the extent the limits of liability of this policy exceed the limits of liability required by law.”
After Kathi’s heirs commenced a wrongful death claim against John’s estate in Minnesota, American Family commenced a declaratory judgment action claiming that, pursuant to the “household drop-down exclusion,” it was only obligated to pay $30,000, the amount required by law, not the $1 million limits. See Minn. Stat. § 65B.49, subd. 3(1). Kathi’s heirs contended that the household step-down provision was unenforceable.
The Minnesota federal district court found the policy “vague, ambiguous, and [fell] far below any ordinary consumer’s reasonable expectation” as “it [was] impossible to tell from within the policy’s four corners the amount it [would] pay.” Id. at 351. The Eighth Circuit found the policy unambiguous. The court noted that in Agency Rent–A–Car, Inc. v. Am. Family Mut. Auto. Ins. Co., 519 N.W.2d 483 (Minn.Ct.App.1994), the Minnesota Court of Appeals found no ambiguity in a policy that limited liability coverage to “the MINIMUM dollar amount required” by a state’s “motor vehicle financial responsibility laws” and did not provide a specific dollar amount. “[T]he mere fact that we must look beyond the Policy’s four corners to state law in order to determine the exact dollar amount of coverage does not render the drop-down exclusion ambiguous under Minnesota law.” Id. at 352. The court also rejected application of the reasonable expectations doctrine, holding the doctrine “applies only on the few ‘egregious’ occasions when an exclusion is disguised in a policy’s definitions section.” Id. at 353 (quoting Allstate Ins. Co. v. Steele, 74 F.3d 878, 881 (8th Cir.1996)). According to the court, the household step-down provision was not hidden and “appear[ed] exactly where an insured would expect — in the Policy’s exclusions section.” Id. The court rejected Babinski’s assertion that because the provision was actually only a “limitation” or “reduction” of the liability limits, a reasonable insured would not expect to find it in the “exclusions” section of the policy. Id.
The court then addressed the issue of whether the step-down provision was valid and enforceable. In determining the provision was enforceable, the court noted that while the Minnesota Supreme Court had not specifically addressed the enforceability of household step-down exclusions, “the purpose of the no-fault act is to fully compensate the insured to the extent of the mandated insurance” (quoting Scheibel v. Ill. Farmers Ins. Co., 615 N.W.2d 34, 39 (Minn.2000)), and “the Minnesota Court of Appeals has consistently held that drop-down exclusions are enforceable so long as they satisfy the minimum coverage limits in Minnesota’s no-fault act.” Id. at 354 (citing Frey v. United Servs. Auto. Ass’n, 743 N.W.2d 337 (Minn.Ct.App.2008); Bundul v. Travelers Indem. Co., 753 N.W.2d 761 (Minn.Ct.App.2008) and State Farm Mut. Auto. Ins. Co. v. Universal Underwriters Ins. Co., 625 N.W.2d 160 (Minn.Ct.App.2001). Because the step-down provisions in these cases reduced the liability coverage “only to the extent the limits of liability of this policy exceed the limits of liability required by law,” the court held that it was enforceable in Minnesota.
The Minnesota Supreme Court has not determined whether step-down provisions from residual liability coverage are enforceable under the No-Fault Act. However, the Minnesota Supreme Court should hold that step-down provisions which reduce coverage to a non-family member omnibus insured (such as those involved in Agency Rent-A-Car and Universal Underwriters) are valid and enforceable. Such provisions have no adverse impact on the policyholder or accident victims.
While the Minnesota Court of Appeals and Eighth Circuit Court of Appeals upheld household step-down provisions in Frey (which could be viewed as dicta as the court ultimately held the step-down provision did not apply because the injured claimant did not qualify as a resident relative under the policy) and Babinski, the Minnesota Supreme Court would likely hold that household step-down provisions contravene the provisions of the No-Fault Act and are void and unenforceable. This assumes, however, that the correct legal arguments are made. The courts in Frey and Babinski were either not presented with, or overlooked, the strongest legal argument against the validity of household step-down provisions — a basic and fundamental concept I located in my decades old research that was built into the No-Fault Act when passed in 1974.
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