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Risk Management "It depends" Before answering insured’s hypothetical questions, take time to study policy language By Donald S. Malecki, CPCU When an impending hurricane requires home owners to vacate their homes and take refuge on higher ground, miles away, and for several weeks, the question arises whether their additional living expenses are covered even if their homes, apartment or condominium units ultimately sustain no damage. Ask agents, brokers or virtually anyone whose livelihood is insurance and they are likely to answer that additional living expense or fair rental value coverage would not apply, and that any coverage growing out of an order of civil authority applies for a maximum of two weeks. Most practitioners reaching this conclusion, particularly claims people, would likely say that regardless of the homeowners form in question, direct physical loss to property must occur before any loss of use coverages is activated. Special form coverage is different When tackling questions about how coverage forms may apply, it is necessary to read the appropriate forms before answering any questions about policy coverage. In exploring whether loss of use might be covered even without direct physical loss to covered property, let’s look at the Homeowners 3 policy, the most popular homeowners form. The Homeowners 3 provides rather broad property coverages, second only in breadth to those of the Homeowners 5 policy. Since policies differ among insurers, reference here is made to the policy forms of the Insurance Services Office (ISO). Under the perils insured against for purposes of Coverage A - Dwelling, and Coverage B - Other Structures, the insuring agreement states that “(we) the insurer insure against risk of direct physical loss to covered property.” The word “risk” was inserted around 1984, in forms providing special coverage, as a substitute for the earlier phrase “all risks,” in order to avoid the problem of older policies that sometimes were interpreted to cover all losses. An insurance practitioner who reads this insuring agreement would likely conclude that there needs to be direct physical damage to covered property from a cause of loss not otherwise excluded before coverage could apply. A closer look at that insuring agreement, however, reveals that direct physical damage is not necessary. In insurance terminology, the word “risk” can mean many things, including the subject of insurance or the chance of loss. A person who purchases property insurance, for example, is referred to as a risk. When applied to property loss exposures, another meaning of risk—chance of loss—refers to the possibility of direct physical loss, which exists whether or not any property damage or destruction ever occurs. Referring to Coverage D - Loss of Use of the Homeowners 3 policy, coverage is said to apply for additional living expense, if a loss covered under Section I—which includes all property coverages A, B, C and D—makes that part of the residence premises, as defined, where the named insured resides not fit to live in. When this condition applies, the insurer will cover any loss involving the necessary increase in living expenses incurred by the named insured so that his or her household can maintain its normal standard of living. The important point here is that for additional living expense, coverage is triggered when the residence premises is not fit to live in. There is no question that places of habitation were not fit to live in when impending hurricanes, like Katrina, Rita and Dennis were about to strike the United States in 2005. If coverage applies for additional living expense, it also would apply to loss of fair rental value, which applies when any part of the residence premises is being rented to others at the time of such risk of physical loss. Court cases Some people are convinced about an argument only when one or more court decisions can substantiate it. In fact, when some insurance companies make coverage reductions to their forms, they sometimes do so in response to adverse court decisions. However, in doing so, it is not unusual for an insurer to rely on a case that addresses coverage that is entirely different from the coverage in question. An example is the 2001 amendment made to exclusion J (1), Damage to Property, of the standard CGL policy relating to costs or expenses for mitigating damage to property owned, rented or occupied by the named insured or others. The case relied on to substantiate this change was Aetna Insurance Co. v. Aaron, 685 A.2d 858 (Md. App. 1996). This involved a suit brought by a condominium association against one of its unit owners for costs the association incurred to repair the glass enclosure installed around the unit owner’s balcony area in order to prevent damage to another unit owner. Another example is the 2001 revis-ion to CGL provisions specifically dealing with exclusion G, aircraft, auto or watercraft. In adding to this exclusion, claims involving negligence in supervision, hiring, employment, training or monitoring of others, reliance was made on the case of Worchester Mutual Ins. Co. v. Marnell, 496 N.E. 2d 158 (Mass. 1986), which involved a homeowners policy. A case that helps to buttress the idea that “risk of direct physical loss” does not require physical loss as a condition precedent is Customized Distribution Services v. Zurich Insurance Co., 862 A.2d 560 (Sup. Ct. N.J. App. Div. 2004). This case involved a warehouseman’s liability policy and the claim that by misrotation of a beverage product, i.e., shipping it out of turn, and keeping products past expiration, the product lost value. This court also referred to the case of Ocean Winds Council of Co-Owners, Inc. v. Auto-Owner Insurance Co., 565 S.E. 2d 306 (Sup. Ct. S. C. 2002), which it thought was persuasive. This case appeared to involve a commercial property policy and the additional coverage of collapse. The insured here brought suit against its insurer to recover for collapse of the insured’s buildings before they fell. It was alleged that the buildings had suffered “substantial structural impairment” from hidden decay as a result of water infiltration and termite damage, although the buildings had not yet fallen to the ground. With the collapse coverage of this policy agreeing to pay for loss or damage caused by or resulting from risks of direct physical loss involving collapse of a building or any part of a building, the court concluded that coverage applied. It is important to note here that most insurers have all but fixed this gap in coverage by redefining the term “collapse” and by substituting reference to the phrase “risks of direct physical loss” with the phrase “direct physical loss to covered property caused by collapse.…” If these cases are not enough to convince someone that coverage applies even in the absence of direct physical loss, one needs to compare the wording of the Homeowners 3 policy for Coverages A and B with the wording of Coverage C. Recall that Coverages A and B insure against risk of direct physical loss to the property described, i.e., dwelling and other structures. Coverage C - Personal Property, on the other hand, is covered for direct physical loss to the described property. Realistic conclusion To be frank about it, agents, brokers, and others whose work involves insurance know or should know that the property policies covering certain property against the risk of direct physical loss are intended to limit coverage to losses resulting from direct physical damage or destruction. In fact, many of the property forms have since been fixed, including the standard condominium unit owners’ form. However, this problem still exists with Homeowners 5 policy, which provides special causes of loss coverage on the dwelling (Coverage A), other structures (Coverage B), and personal property (Coverage C), and the Standard Dwelling Property 3 Special Form DP 00 03. How independently filed property forms read is open to question. What is important here is that forms containing this glitch need to be fixed because, with the current wording, it would be very difficult to convince a layperson (claimant) and his or her legal counsel that coverage for loss of use of one’s residence premises in the absence of direct physical loss really is not intended to be covered. In the meantime, while it can be argued that additional living expense and fair rental value clearly are covered under the Homeowners 3 and 5 forms, up to 30% of the Coverage A - Dwelling limit, in the event of an impending hurricane (or some other peril), it would probably be smart for agents and brokers to keep their distance when confronted with such a coverage question, even if it is hypothetical. n The author |
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