What Do We Cover? Read the Policy!

By Pamela A. Okano

Typically, a homeowners insurance policy provides first-party property coverage for the dwelling itself and the homeowner’s personal property, as well as third-party liability coverage. This article discusses the major features of the typical insuring agreement of a first-party, all-risk homeowners property policy.

Surprisingly, there is little consensus on what makes a physical loss ‘direct.’

First, the insuring agreement requires “physical loss.” The typical first-party homeowners policy does not define “physical loss.” Consequently, courts have had to develop a definition for the term. “Physical” has been held to mean “material,” “having material existence,” or “perceptible especially through the senses and subject to the laws of nature.” The property damaged must have a material existence, be formed out of tangible matter, or be perceptible to the sense of touch.

The physical loss must generally be to the property insured. If the property insured has not sustained physical loss, the claim will not fall within the insuring agreement and there will be no coverage. Physical loss does not require that the insured property be destroyed, only damaged, and structural damage is not required. That the insured property may be threatened with future physical damage is insufficient. For example, where a policy insured the dwelling, but not the land, the court ruled there was no coverage for damage to the dwelling and its supporting land absent physical damage to the insured dwelling.

The physical loss must be “direct physical loss.” The cases discussing direct loss tend to define it in terms of the causal connection between the loss and a specified hazard. Most cases deciding the issue have involved specified-perils policies where—arguably—the direct loss requirement makes more sense because the primary question presented by the insuring agreement in such policies is the relationship between the loss and the covered peril. In contrast, under an all-risks policy, the relationship between a loss and a specific peril is presented in the exclusions.

Surprisingly, there is little consensus on what makes a physical loss “direct.” Some courts have ruled that direct loss is one that is proximately rather than remotely caused by an insured hazard. For example, many courts have found coverage for food spoiled by an electrical outage owing to windstorm where the policies covered direct loss by windstorm. On the other hand, one court ruled that a flooded car did not incur direct loss by windstorm. In this example, a hurricane caused a carport housing the vehicle to collapse; as a result, the car could not be moved to safety from rapidly rising water.

Other courts have ruled that direct loss is one that is “efficiently” caused by a specific peril. Still other courts have ruled that direct loss refers to the immediate—as opposed to consequential—physical damage resulting from the insured hazard. Some courts have ruled that direct loss means that the insured hazard was sufficient to, and did, cause the damage, even though there might have been other contributing causes.

Whether diminution in property value as a result of pollution or contamination should be considered a direct physical loss is not clear. An argument exists that it should be considered an indirect economic loss, as a loss that flows from, but does not consist of, a physical loss to property. Similarly, several authorities hold that diminution in value is not “property damage” under a third-party policy.

Some home­owners policies specifically require that direct physical loss be “accidental.” One court has explained that including an accident requirement in the insuring agreement “makes it clear that the insured is not protected against loss resulting from his own intentional and malicious acts.” A common example of a nonaccidental loss is arson committed by the insured.

Even if the insuring agreement does not specifically require the loss to be accidental, all-risks policies are frequently interpreted to cover “all fortuitous losses not resulting from misconduct or fraud, unless the policy contains a specific provision expressly excluding the loss from coverage.” Fundamental to insurance, the fortuity doctrine precludes one from insuring against a certainty. Certainty is antithetical to insurance. In other words, “the fortuity doctrine holds that insurance is not available for losses that the policyholder knows of, planned, intended, or is aware are substantially certain to occur.”

In essence, the doctrine operates as an unwritten exclusion; nevertheless, the insured has the burden of showing that the loss was fortuitous. Consequently, under an all-risks policy, the insured must show a fortuitous physical loss or damage to covered property; the burden then shifts to the insurer to show that the loss is excluded from coverage.

Originally, losses occurring from inherent defects in the insured property or from ordinary wear and tear were not considered fortuitous; in more recent years, however, courts have focused more on the insured’s awareness of the loss. Some courts have judged fortuity by an objective standard. Under the objective view, a loss is not fortuitous if it was certain to occur; in other words, the loss was inevitable when the policy was issued. This approach has been criticized as depending on hindsight. More recently, some courts have focused on the more modern subjective test, where an event is fortuitous if it was contingent (i.e.,unknown to the parties when the policy incepted).

To collect on a first-party property insurance policy, one must have an insurable interest in the property insured. This is true whether the policy expressly says so or not.

Insurable interest has been defined to mean “an interest of such a nature that an occurrence of the event insured against would cause a financial loss to the insured.”

While one who owns property has an insurable interest in it, ownership is not required. Rather, any legal or equitable interest is sufficient to create an insurable interest. However, mere possession and the expectation of ownership, without more, do not establish an insurable interest; many courts have ruled that a mere option to purchase is insufficient. More than one person or entity may have an insurable interest in the same property.

Trigger of first-party coverage will generally involve the policy period. In most first-party property coverages, the policy period requirement will not be part of the insuring agreement but may be set forth in the policy conditions. Nevertheless, the question of trigger is fundamental.

Ordinarily, trigger of coverage is not problematic: The policy in effect when the fire or hurricane occurred will apply. Unless the fire or hurricane began while the policy was in effect and continued after the policy expired, trigger of coverage will not present any unusual legal issues. What if the loss is a latent, progressively worsening one? Should only the policy in effect when the loss commenced apply? Or should all policies in effect while the loss was growing progressively worse apply? Or should only the policy in effect when the loss was discovered apply?

The majority-trigger rule in third-party liability cases is the continuous trigger rule—every policy in effect when at least some property damage occurs is triggered. In first-party cases, however, the majority of courts that have decided the trigger question have adopted the manifestation rule for progressively worsening loss situations, even though they might apply some other rule in third-party cases. Most of these courts have so ruled without regard to what the policy may have said about the trigger.

is a shareholder in the Seattle, Washington, law firm of Reed McClure.

Copyright 2007

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This article is an abridged and edited version of one that originally appeared on page 60 of Probate & Property, March/April 2007 (21:2). For more information or to obtain a copy of the periodical in which the full article appears, please call the ABA Service Center at 800/285-2221.

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