I. POLICY COVERAGE
Insurance is divided into two basic classes: Liability (for “third party” claims against you) and Property (for “first party” losses to your own property).
A. Property Coverage for Earthquake Damage
The insurance policy typically provides coverage as follows:
“We will pay for direct physical loss or damage to Covered Property at the premises described in the Declarations caused by or resulting from any Covered Cause of Loss.”
Earthquake damage is ordinarily excluded, and must be purchased separately. For purposes of this discussion, we are assuming that the policyholder has purchased the Earthquake coverage. Without it, recovery on a claim for this type of damage would likely prove very difficult.
B. Basic Questions Determining Coverage
1. Is There Loss or Damage?
Presuming there is no dispute as to what is the “Covered Property,” the first question encountered is, was there “direct physical loss or damage?”
Generally, this requires actual physical damage, but the quantity of damage is not considered. If there is a crack in the plaster or broken glass, there is physical damage (putting aside for the moment whether the particular damage is excluded, or is within the deductible).
2. Was the Damage a Result of a Covered Cause of Loss?
If there is damage, the next question is whether it is “caused by or resulting from any Covered Cause of Loss.” For this, we have to look to the policy terms to determine what are “covered causes of loss.”
3. Was the Damage a Result of an Excluded Cause?
Even if damage might otherwise fall within the covered causes, there may be specific exclusions for particular types of damage. Example: Losses from acts of war are typically excluded.
C. Relevant Exclusions and Definitions
Any loss is covered only to the extent it falls within covered definitions and avoids exclusions in the policy.
1. Ordinance or Law Exclusion
A potentially formidable obstacle to the policyholder is the common exclusion for repairs and modifications that are required by ordinance, law and regulations (which exclusion also specifically applies to the Earthquake Endorsement). This Exclusion provides that the Insurer
“will not pay for loss or damage caused directly or indirectly by any of the following . . . regardless of any other cause or event that contributes concurrently or in any sequence to the loss:” “The enforcement of any ordinance or law: (1) Regulating the construction, use or repair of any property; or (2) Requiring the tearing down of any property, including the cost of removing its debris.”
a. Ordinance or Law Term Excludes Only Losses Incurred from Enforcement of Law
The insurer “will not pay for loss or damage [from] enforcement of any ordinance or law.” If the loss or damage is not caused by enforcement of law, the policyholder can and should argue that the exclusion should not apply. The question is fact specific: Was the damage caused by enforcement of law, or by other causes that are covered, such as earthquakes.
b. Ordinance or Law Endorsement to Avoid Exclusion
Like other exclusions, the Ordinance or Law exclusion is avoided by purchasing a separate endorsement, the Building Ordinance Endorsement. FORM: CP 04 05 Ordinance or Law Coverage
Generally, the Ordinance or Law Coverage endorsement provides coverage for (a) demolition of damaged or undamaged parts of a structure, when required to comply with ordinance or law; (b) repair or construction required by ordinance or law, or zoning or land use restrictions; and (c) increased costs of repair or reconstruction caused by enforcement of building, zoning or land use ordinance or law (for similar occupancy as currently in use).
Note that there must still first be a “covered cause of loss,” which means there must be physical damage to the property from a cause that is within the coverage of the policy.
Also note that Ordinance or Law Coverage also requires that repairs or replacements actually be made, as soon as reasonably possible and not more than two years from the loss (unless extended by written agreement).
2. Other Common Exclusions
Other standard exclusions that could come into play include exclusions of damage that are caused by:
a. “Delay, loss of use or loss of market.”
b. “Wear and tear.”
c. “Rust, corrosion, fungus, decay, deterioration, hidden or latent defect or any quality in property that causes it to damage or destroy itself.”
d. “Settling, cracking, shrinking or expansion.”
e. “Acts or decisions, including the failure to act or decide, of any person, group, organization or governmental body.”
f. “Faulty, inadequate or defective: (1) Planning, zoning, development, surveying, siting; (2) Design, specifications, workmanship, repair, construction, renovation, remodeling, grading, compaction; (3) Materials used in repair, construction, renovation or remodeling; or (4) Maintenance.”
FORM: CP 10 30 (Causes of Loss – Special Form)
D. Relevant Duties of the Policyholder
1. Give insurance company prompt notice of the loss or damage.
2. Take reasonable steps to protect the property from further damage.
3. Permit insurance company to inspect the property and records, and cooperate in the investigation and settlement of the claim. Robinson v. National Auto Ins. Co., 132 Cal. App. 2d 709, 712-16 (1955) (denial of claim justified for failure to cooperate in investigation).
II. Is Steel Moment Resisting Frame Investigation, Repair and Retrofit a Covered Loss?
This presents a fact specific question, and cannot be answered for all policyholders and all circumstances. Some factual considerations are objective (such as whether there was damage) and others are more subjective (such as what was the reason for the inspection and repairs). All relevant factual circumstances, as well as the exact terms of the particular insurance policy in question, must be examined to determine the answer in any particular instance.
A. Coverage of Investigation Expenses
1. No Coverage for Investigation, Unless Covered Damage Exists
McMillan Scripps North Partnership v. Royal Insurance Company of America, 19 Cal. App. 4th 12 (4th Dist. 1993), is the only reported California decision on whether inspection costs are reimbursable under a first- party (not third party liability) insurance policy. Policyholder McMillan had received notice from San Diego County to determine the cause of gasoline odors and remedy the problem. McMillan retained a consultant, who discovered gasoline leakage that pre-dated McMillan’s insurance policy covering pollution. McMillan conceded there was no coverage for the leakage, but requested reimbursement for the investigation. The insurer refused, and McMillan sued the insurer for bad faith (breach of the insurer’s implied promise to deal fairly and in good faith). The Court of Appeal in San Diego found this was a novel question in California. The Court of Appeal held that the insurer had no duty to reimburse for investigation costs unless the investigation reveals a covered loss, or there is a specific promise of reimbursement for investigation in the policy.
Since most policies do not expressly provide for reimbursement of investigation expenses, the implication of the McMillan Scripps case is that a covered loss is required before investigation expenses will be recoverable. This has two potential applications:
a. When the Investigation Reveals Covered Damage
McMillan Scripps suggests that the costs of inspection are covered when the investigation reveals a covered loss, but the case does not expressly say so. Instead, it says the inverse: The insurer cannot be held to cover investigation costs when there is no covered damage found.
b. When Covered Damage Engenders the Investigation
McMillan Scripps also may be read to suggest that inspection costs are recoverable when there is covered damage, which leads the policyholder to investigate for additional damage. This is again not a direct holding of McMillan Scripps, but an implication from its holding that investigation costs are not covered unless covered damage is revealed.
2. Applying the Relevant Duties of the Policyholder
In considering whether investigation costs are part of a covered loss, recall that a covered loss is based on physical damage, but not based on physical damage of any particular amount. Presuming that there is some physical damage (broken plaster, broken glass, etc.) from a covered cause, the policyholder’s duties apply. Those duties include:
a. Give insurance company prompt notice of the loss or damage.
b. Take reasonable steps to protect the property from further damage from covered causes (such as further earthquakes and aftershocks).
If the policyholder must make an inspection as part of the policyholder’s reasonable steps to protect the property from further damage, that should be covered. The assistance of an engineer who advises the necessity and scope of investigation required would be of considerable importance. If the inspection reveals damage that is a covered loss under the policy, the McMillan Scripps case says that the inspection cost is covered.
3. Ordinance and Law Coverage Should Have No Effect on Investigation Cost Claims
Whether the policyholder has or has not purchased Ordinance and Law Coverage, the analysis and result should not change as to the costs of investigations (which is distinct from questions of coverage for repair or retrofit costs). Ordinance and Law Coverage does not include any specific coverage for inspection or investigation. Ordinance and Law Coverage still requires a “covered cause of loss,” which means there still must be physical damage to the property from a cause that is within the coverage of the policy before the Ordinance and Law Coverage applies.
B. Coverage for Repair or Retrofit
Presuming that the policyholder has earthquake coverage, and inspection reveals damaged joints, the cost of repairs to the damaged joints are likely to be covered. The more difficult questions arise when a retrofit is performed.
1. If Retrofit of Damaged Joints (or All Joints) is Required by Ordinance
a. If the Policyholder Purchased Ordinance or Law Coverage
If the policyholder has purchased Ordinance or Law Coverage, and there has been damage from a covered cause, the policyholder should receive the benefits of Ordinance or Law Coverage: Retrofit of damaged joints should be covered if it is required to comply with current ordinance.
b. If No Ordinance or Law Coverage was Purchased
The policyholder will have no inherent right to any “code upgrade” repairs that are required by law. All the insurer is required to do is repair the property to its “pre-loss condition” — the same condition in which it was immediately prior to the damage. Bischel v. Fire Ins. Exchange, 1 Cal. App. 4th 1168 (1991) (insurer not required to pay to rebuild boat dock to changed code, only to pre-loss condition). The question here is a fact specific one: Is the retrofit that is required by law also the one that is the most effective and efficient method of repairing the damage? The insurance company probably has considerable discretion in this determination, so it is important to develop the supporting facts with consulting engineers and contractors. The assistance of an attorney is advisable, to help marshal and present the facts in the best interests of the policyholder. Where the full measure of damage cannot be had from the insurance carrier, the policyholder may consider whether the insurance broker or agent who sold the policy gave appropriate advise or should share in some of the loss.
2. If it is Not Certain Whether the Ordinance Requires Repair or Retrofit
a. If the Policyholder Purchased Ordinance or Law Coverage
If the policyholder has purchased Ordinance or Law Coverage, and there has been damage from a covered cause, the policyholder most likely should attempt to show to the insurer that the ordinance does require retrofitting rather than repair. This would most clearly place the cost of retrofit within the coverage purchased by the policyholder. The assistance of an engineer and counsel is advisable to best present the position of the policyholder, and to negotiate any compromise that may be appropriate.
b. If the Policyholder Did Not Purchase Ordinance or Law Coverage
If the policyholder has not purchased Ordinance or Law Coverage, but there has been damage from a covered cause, the policyholder would likely be better off taking the position that the ordinance does not require retrofit. This is because, if the only reason for the retrofit is the requirements of ordinance, the cost of retrofitting would fall squarely within the typical “ordinance” exclusion of the insurance policy. Rather, the policyholder would likely be more successful if he or she could convince the insurer that retrofit is the best method of repair, instead of just being required by law. It is important to develop the supporting facts with consulting engineers and contractors, and the assistance of an attorney is also advisable to help persuade the insurer of the policyholder’s position, or to negotiate a compromise position.
C. Other Impediments to Coverage
Aside from meeting definitional requirements and avoiding exclusions in the policy, there are additional requirements that may impede your ability to get coverage. Some of these are found among the policyholders’ duties:
1. Prompt Notice Required
The policyholder must give prompt notice of losses. Here, the earthquake was more than 20 months ago. If there was no notice to the insurer of damage in the last 20 months, you can be assured the insurance company will raise at least questions about the delay. It would be best to have some idea of the answers appropriate to the particular circumstances involved, before the questions are asked.
2. Claim Already Adjusted
The flip side of the same coin is, when notice has been given, it may not have included all of the damage ultimately discovered. The insurer may well have questions about why earlier notice given did not include the damages now claimed. Taken to its extreme, the policyholder may have given notice of damage, negotiated with the insurer, and “adjusted” (settled) the claim. The policyholder who later attempts to raise additional damage claims is likely to encounter strong resistance from the insurer, who will assert that the claim has been settled and cannot be reopened. Again, knowing the issues and questions that are likely to arise will help to avoiding missteps that can affect coverage.
3. Limitations of Actions
Limitations on actions may preclude remedies in court actions, when an insurer wrongfully refuses coverage. Statutory limits may be as long as four years from breach. But contracts, including insurance contracts, can and do shorten that time to file an action. The Standard Fire Policy that is drafted by law in California includes a one year limitation of actions.
D. Amount of Claim Covered
The amount of the claim that will be covered is subject to many variables depending on the terms of the policy, including:
1. Actual Cash Value or Replacement Cost 2. Cost of Repair, under either coverage, at insurer’s option. 3. Earthquake insurance typically has a separate deductible, 5% or more of the entire value of the property.
As well, the policyholder’s co-insurance obligation may limit recovery if the property was underinsured.
III. PROTECTION OF POLICYHOLDERS’ RIGHTS
Insurance policies are contracts. When people have questions about their rights under contracts, like leases and purchase agreements, they often go to lawyers. Questions about an insurance policy should be no different. As a policyholder, you have certain rights and obligations. Those rights and obligations may not always be entirely clear. It is often beneficial to discuss your rights and duties with a lawyer before addressing issues with the other party to a contract.
The law provides an attorney-client privilege so that the client can freely discuss with the attorney all of the underlying facts, and receive the benefit of the attorney’s advice as to how to best preserve the client’s rights. Those communications are confidential and protected against disclosure to other parties. This allows the party to assemble and present the facts in a manner best suited to preserving his or her rights. This applies to insurance policyholders as well as any other contracting parties.
By contrast, if the policyholder directs his thoughts, comments and whatever facts he or she thinks may be involved, to persons other than an attorney (such as an insurance company, agent or broker), many things may be said that may affect the insurance company’s response to the claim presented. The comments of the policyholder may significantly affect the outcome of the insurer’s determination of the claim, without the policyholder realizing the impact of his or her words.
It should be no surprise that insurers use lawyers. They are among the largest employers of lawyers in the U.S. When they have questions concerning their rights and obligations under insurance policies, they huddle with their lawyers. Their communications are also protected by the attorney-client privilege. Insurance companies make good use of their ability to converse in privacy with their lawyers, to best protect their own interests under the insurance policy.
To protect against unpleasant surprises, and to protect your rights in the insurance policy you purchased, it’s best to obtain the advice of a lawyer as early as possible in the process of deciding whether and how to make a claim.
In a “man bites dog” case, Prudential Insurance was a landowner who leased the L.A. Mart Building. In the 1980’s, Prudential wanted to voluntarily retrofit the building to improve earthquake safety. The building met all current codes, even though it did not comply with seismic standards for new construction. Prudential tried to pass along the cost of the retrofit to its tenant, L.A. Mart, saying the retrofit was “required by law,” and “repairs” to “comply with law” were the tenant’s obligation under the lease. The “law” that Prudential was talking about was tort liability case law — where the property owner may be liable for negligently maintained conditions.
The Ninth Circuit disagreed with Prudential. The “law” that counts under the lease is the law controlling building construction, including ordinance and regulation. Prudential failed in trying to assert that the seismic retrofit was required by law, and therefore the tenant’s responsibility.