COMMON LAW, COMMON SENSE, COMMON MEANINGS
Should insurers cover the costs of avoiding a covered loss?
At issue in the Ken’s Foods case is a question of immediate
interest to every agent and broker: Must an insurer compensate an insured
for costs it incurs to prevent an imminent loss that could result in much greater costs?
By Joseph S. Harrington, CPCU
Ken’s Foods is not winning friends within the federal judiciary, but it may yet win its federal case.
In June of 2022, a federal appeals court noted with disdain that the maker of Ken’s salad dressings chose to raise state-based claims in a federal court. Then, after losing in the U.S. district court, the company asked the appellate court for help in seeking a favorable clarification of law finding from the state’s highest court.
In response, the appellate did as requested, but characterized the company’s strategy as “trying to take two bites at the cherry,” and predicted that all costs of the litigation would be eventually charged against Ken’s Foods.
And that was the favorable ruling for Ken’s Foods. Previously, a U.S. district court judge simply denied the company’s claim for insurance recovery for costs it incurred to prevent an insured loss. The appellate court only agreed to ask the state’s highest court whether the insurer has a common law obligation to cover those costs.
Some observers think Ken’s Foods attempt to win compensation is a long shot, but specialists in insurance law are watching the case for potentially far-reaching implications.
Whose cost? Whose loss?
At issue in the Ken’s Foods case is a question of immediate interest to every agent and broker: Must an insurer compensate an insured for costs it incurs to prevent an imminent loss that could result in much greater costs?
In the Ken’s case, there was an accidental release of wastewater at one of its plants in December 2018. Its insurer covered nearly $900,000 in clean-up costs under a pollution policy but denied coverage for other expenses Ken’s incurred to avoid a complete suspension of operations.
Ken’s concedes that the policy does not expressly cover costs to prevent losses, but claims it is entitled to such coverage nonetheless, because the costs it incurred were to prevent an insured loss from becoming greater. Had Ken’s not spent the money, the insurer would have had to pay put more than it did.
In its claim at the trial court, Ken’s Foods invoked a 2009 federal court ruling (Demers Bros. Trucking v. Certain Underwriters at Lloyd’s) that described a common law understanding regarding the mutual obligations of insureds and insurers to mitigate losses:
The common law imposes a duty on insured parties to mitigate insured loss. Absent an insurance policy provision to the contrary, the common law also recognizes the right of the insured to seek compensation from the insurer for the costs of mitigation. To be entitled to compensation, the insured must show that the mitigation expenses relate to an existing or imminent covered loss.
However displeased at Ken’s approach, the appellate court cites several passages from the authoritative treatise, Couch on Insurance, to support the notion of a common law duty on insurers to compensate insureds for the costs of loss mitigation.
“The rationale for this principle is common sense,” reads one citation. “Any other rule would provide the insured with the economic incentive to allow the loss to occur, to the detriment of the insurer, quite possibly the insured, and in a fair number of cases, to the general public, as well.”
If you’ve heard these arguments before, it may be from the evolution of coverage for building collapse, which insurers came to provide in property policies over the course of the 20th century.
Coverage for collapse seems odd at first glance, since the collapse of a building is an effect and not a cause, but the collapse of structures was apparently rare enough to be deemed insurable. Collapse coverage became untenable, in the eyes of insurers, as courts supported claims for costs incurred to prevent buildings from collapsing in the first place.
In an influential 1995 ruling (Allstate Ins. v. Forest Lynn Homeowners Ass’n), a U.S. district court in Washington state also invoked “common sense” in ruling that Allstate had to compensate a homeowners association for costs needed to prevent decaying walkways from collapsing.
“If the court were to adopt Allstate’s reasoning that the building or parts of the building must actually ‘fall down’ . . . insureds would have the incentive to allow the structure to progress to the point of falling down,” the court ruled. “Allstate’s argument would lead to the conclusion that there was no coverage until the structure fell, irrespective of whether repairs could have prevented the fall. This result defies common sense.”
Citing a 1987 case from Connecticut, the court further noted that requiring an insured to await an actual physical collapse “would also conflict with the insured’s contractual and common law duty to mitigate damages.”
Any way out?
For property insurers, growing attempts to apply collapse coverage to structural deterioration threatened to transform property insurance designed for fortuitous losses into funding for property maintenance.
Insurers responded by rewording and restructuring collapse coverage to (1) exclude loss from collapse from the basic property coverage and (2) add a separate coverage for collapse caused by specified perils and/or hidden causes. For purposes of coverage, collapse is defined to mean “abrupt falling down or caving in of a building” and does not apply to any part of a building that is merely in danger of collapsing.
In other words, collapse coverage has been adapted to a legal climate where the common, ordinary language of policies strictly controls the extent and application of coverage. For the past few decades, judges have become more and more reluctant to supplement policy language with common law considerations.
Yet, the question of “common sense,” or lack thereof, remains. It falls to agents and brokers to explain to their clients that they are required under a policy to take efforts to mitigate potential damage but may lose the benefit of their coverage if they do so too soon.
Joseph S. Harrington, CPCU, is an independent business writer specializing in property and casualty insurance coverages and operations. For 21 years, Joe was the communications director for the American Association of Insurance Services (AAIS), a P-C advisory organization. Prior to that, Joe worked in journalism and as a reporter and editor in financial services.