Risk Management

Expect the unexpected

Insurers use novel arguments to deny claims

By Donald S. Malecki, CPCU

In light of the increasing number of incidents involving the theft of copper wiring, piping, and other property, one of the hottest topics in insurance circles today concerns vacant property exposures and how to cover them.

What is especially ruthless about the thieves is their total disregard for the damage or destruction of property they cause while extracting copper or other valuable property. In many cases, the damage or destruction costs more than the property that was stolen.

It is understandable why carriers that insure vacant property place both monetary and coverage limits on the policies they are willing to issue. Vacant property, simply stated, is an easy target for thieves.

This does not mean that occupied buildings are safe from these destructive thieves, since even these properties have been targets after closing hours. It is just that thefts, along with damage or destruction, are less likely to involve buildings that are occupied, particularly if they are protected with alarms and other safeguards.

In light of this fact, one might not expect an insurer that provided coverage on a vacant property to deny a claim for damage that occurred when the property was occupied.

After all, what would be the rationale?

Consider the case of Desiree Debartolo v. Underwriters at Lloyd's of London, Sup. Ct. VT 2007. The owner of a restaurant closed the business and let her insurance policy lapse. The mortgage holder, however, demanded that the owner obtain property insurance in a sufficient amount to pay the $92,000 outstanding debt.

Accordingly, the owner applied for a six-month policy with a limit sufficient to meet the balance of the mortgage. On the application, the owner represented that the restaurant was "closed for the season."

Because property insurance was not reasonably available from domestic insurers, the restaurant owner's broker arranged coverage through Lloyd's of London, which was a licensed surplus lines provider in Vermont. The policy's declarations page described the covered property as a "vacant restaurant."

Accompanying the policy was a letter from the producer stating that if the insured decided to reopen the restaurant, she would be required to notify the producer so he could make the necessary changes to the policy. The restaurant owner did not read the policy or the producer's letter.

The policy covered property damage resulting from fire, with several pages of exclusions and limitations, but none stating that the reopening of the business would void the coverage. The policy also included a vacancy permit, which provided that the Vacancy Loss Condition (the exclusion for vacancy) did not apply to direct physical loss or damage (1) at the location and (2) during the permit period shown in the policy.

Unbeknownst to the producer and the insurer, the owner reopened the restaurant, only to find that a plumbing leak had soaked the carpeting. To rid the carpeting of water, the owner tried to dry it with a kerosene heater. The heater caused a fire that resulted in damage to the restaurant that exceeded the policy limit.

Lloyd's denied the claim, contending that the policy provided coverage only while the restaurant remained vacant and that the owner had intentionally concealed a known, material fact both at the time she applied for insurance and at the time of loss, namely, that she had intended to reopen the restaurant and that she actually did so.

When the restaurant owner filed suit, Lloyd's presented a multitude of arguments to support its denial of coverage, but the court rejected all of them.  On appeal, the Vermont Supreme Court left undisturbed the decision of the lower court, which held: (1) that the policy was ambiguous as to whether coverage would have continued had the restaurant reopened, (2) that the restaurant owner had not concealed from Lloyd's that she had reopened the restaurant, and (3) that neither party had acted in bad faith.

The position of the Vermont Supreme Court is noteworthy because, although there is copious case law on the interpretation of vacancy provisions of property policies, neither party nor the court had found any cases that included facts that were closely analogous to the case in hand.

The typical vacancy-provision case, the court said, concerned virtually the opposite circumstance; that is, a situation in which an insured property arguably becomes vacant, thereby possibly voiding coverage by operation of a vacancy provision that explicitly conditioned coverage on the property's remaining occupied.

It is telling that, despite the unusual circumstances of this case, the insurer did not want to provide coverage, even though an occupied building is considered a better risk than a vacant one.

In fact, one argument made by Lloyd's in this matter was that it would not, as a surplus lines insurer, have been allowed to issue a policy to a restaurant that would have reopened at any time during the policy period.

The court disagreed with Lloyd's argument on this point. In doing so, the court stated that surplus line coverage would have been available not only to a permanently vacant restaurant, but also to one that was vacant when the policy was purchased but would reopen during the policy period.

The court observed that the coverage could not have been obtained on more reasonable terms from admitted insurers. Lloyd's status as a surplus lines insurer, the court added, would not work in its favor to construe the policy against the restaurant owner.

As unusual as Lloyd's approach was, the result might have been different in another jurisdiction, given that the restaurant owner had not read the policy or her producer's letter of instruction.

No matter how reputable a provider of insurance may appear to be, even those that have long-standing experience and are able to write many coverages often not otherwise available, producers must deal with them at arm's length. Producers must anticipate that insurers will raise arguments similar to those presented in the case cited above; and producers must be aware that, in the event of a lawsuit, they may be blamed along with the insurer.

A tunnel or a hole?

Another interesting case focused on the meaning of the term "building" with respect to insurance coverage.  In Montana Rail Link, Inc., v. The Travelers Indemnity Company, No. CV 10-16-M-DWM (U.S. District Court for the Dist. of MT 2011), the court had to resolve an argument that arose after the partial collapse of a railroad tunnel that was being repaired.

Originally constructed in 1881, the tunnel was being renovated when a section collapsed and buried the track. As a result, the tunnel was completely closed and rail travel was blocked for approximately 25 days.

The railroad's policy covered direct physical loss or damage to property related to rolling stock and its contents, mechanical construction equipment or motive power equipment, railroad tracks, roadbeds, catenaries, signals, bridges and buildings.

When the insurer denied coverage on the grounds that a tunnel was not a building, the court (showing a sense of humor) stated: "The tunnel fell in and the relationship between the insurer and its insured had fallen out."

The question to be decided was whether a tunnel was a hole or, considered in its entirety, was a building. The railroad based its case on the notion that a roof alone makes a hole a building. The insurer's "hole card," on the other hand, was its argument that a hole is a hole and bricks alone do not make a building within the meaning of the policy. The insurer won this argument.

The question of what constitutes a building is important, in part because of the unusual construction taking place today and in part because some policies that refer to buildings should also refer to other structures. The reason is that a building is a structure but not all structures are buildings.

This means that if a property policy covers buildings, it also should cover structures. For example, in Bergeron v. State Farm F&C Co., 766 A.2d 256 (N.H. Sup. Ct. 2000) dealing with a homeowners policy, a dam collapsed while being constructed by its owner. The insurer denied the claim because coverage for collapse was limited to a building or part of a building. There was no mention in the policy of covering the collapse of a structure.

When the monorail in Seattle sustained smoke damage, in the case of Seattle Monorail Services v. Affiliated FM Insurance Co., 2005 WL 2333482 (W.D. Wash.), the property insurer denied coverage because it said the monorail was neither a building nor a structure. The court disagreed and held that the monorail was a structure.

These cases underline the need for producers to be knowledgeable about the insurers whose products they sell and about the definitions and provisions of policies. As shown in the case involving the vacancy/occupancy issue, it is good E&O risk management practice to inform the insured in writing of steps he or she is required to take should circumstances change the exposure.