The common law of every state, including the common law of Iowa, includes "choice of law" rules.  These rules determine whether a controversy is to be determined by the law of the state in which the lawsuit is initiated or the law of some other state.  In this case, because the insured had its principal place of business in Iowa and the insurance contract was made in Iowa, Iowa choice of law rules instructed that the contract dispute should be resolved by reference to the Iowa common law of contract.  Had the insured had its principal place of business elsewhere (say, Ohio) and had the insurance contract been made in Ohio, the Iowa choice of law rules might dictate that the Iowa court should apply Ohio common law of contract to resolve the dispute. 

     Judge Posner, sitting as Circuit Court Judge for the Seventh Circuit, is applying Iowa choice of law rules (that in turn lead in this case to the application of the Iowa common law of contract) because this is a diversity action brought in federal district court located in Iowa.