The “Courts” view of Under Insurance Cases
The Good, the Bad and the Ugly!
We are going to start with the good which is hard to find in cases of “under-insurance”. The good news is that California, at least, has learned its lesson after years of massive fires; earthquakes; and, we can’t forget, riots. Whether natural disasters or man-made we have seen our share of CAT losses and learned firsthand what underinsurance; incorrect insurance or failure to place coverage, at all means when a major loss occurs.
So, what is the good news? The good news is that last year, the California Department of Insurancepassed and enforced new regulations that require all insurance agent/brokers that write residential insurance to take a class specifically in residential valuation and comply with new regulations for estimators and record maintenance. This regulation was made as a direct result of a demand made against the California Department of Insurance by the claim ravaged insureds of the San Diego fires to go after the culprits—the insurance
representatives—who sold (or didn’t sell) the correct coverage. This is good news because now the agents have the tools to use for estimators and a better understanding of the legal requirements.
This is clearly NOT a California problem only. As I write this article, my TV is updating the status of Hurricane Isaac. It was only a month ago that Colorado was hit by wildfires where insurers expect to pay out nearly $450 million to victims of the Waldo Canyon and High Park fires according to the Rocky Mountain Insurance Information Association. Whether it is a single property loss or one classified as a CAT loss, the insurance industry faces the question of whether the insurance written was adequate from both a coverage and limit perspective. The majority of these claims come from homeowners who have lost their homes.
The “bad news” is that no matter how well we try to write the residential coverage to value, it is a guessing game at best. Let’s begin with the basics: how do we decide what limit to write for a homeowner? Here are a couple of the methods or a combination of approaches:
1. An escrow company or bank demands that a certain limit be written to cover the loan on the policy
2. An insured may request a limit of insurance to cover the amount they paid for the home
3. An insured might request the same limit that the prior homeowner had on their policy
4. The agent or representative may base the amount on the issuing insurance company’s worksheet. What we have all experienced is that there can be a significant difference from one company to another as to the amount of insurance that is being required. What do we do then?
5. The agent or representative may base the amount may provide a secondary cost estimator based on other resources such as Marshall & Swift which provides yet another amount for the home insurance
6. The agent or representative may personally go out and inspect the property and do an on sight estimator. The reality is that most individuals in the insurance industry have minimal knowledge of what goes in to a home inspection
7. On rare occasions there is a formal appraisal performed for insurance purposes—again another number then the one we calculated with the insurance company’s estimator
8. And we cannot forget the plea from our insured to write the very lowest amount possible so they can save money. Trust me they will not remember that discussion when the house burns to the ground.
Regardless of how we determine the values, all methods have one common element which is that amount of insurance is probably too low to handle a total loss that involves all the unknown costs we never took into consideration. This coverage deficiency is especially true in a loss that involves more than just a single home, such as in the wildfires or hurricanes, where the cost of reconstruction skyrockets with the escalated cost of labor and shortage of materials. To make these matters worse, the other coverages provided in the Homeowners Policy are percentages of the limit that was set on the Dwelling—if that amount was underinsured then the other limits may prove inadequate, as well.
The good and the bad……
The insurance industry solution to the chronic problem of underinsurance in residential property was twofold: Guaranteed Replacement Cost or Extended Replacement Cost.
• Guaranteed was basically a limitless policy for the Dwelling—“guaranteeing”, as the title suggests “full replacement cost”. But that form fell short of “full replacement cost” or any guarantee. We learned that the hard way in the aftermath of San Jose, California fires when we first “learned” that “guaranteed” did not mean the policy guaranteed to pick up the cost of all the new ordinance or laws in affect at the time of loss. This left the insureds without funds to bring their homes up to the building code requirements mandated for replacement.
• The use of “Guaranteed Replacement Cost” on residential is not readily available by most carriers. Even if the companies are saying they are writing “Guaranteed Replacement Cost”, they are most probably issuing an Extended Replacement Cost Endorsement referred to as ERC. ERC extends the coverage over and above the policy limit by a percentage indicated in the policy. Typically 25% is the minimum increase. The Extended Replacement Cost does NOT include Building Ordinance which must be written for a separate amount of insurance typically by endorsement.
You are sued. Short and simple, the claim did not go well and your client has decided to sue you and anyone else they can name in the lawsuit. Discovery now begins often times going back years and years when you first wrote the coverage. You will answer such questions as:
1. Who set the limit of insurance initially (very possibly does not even work for you anymore)
2. Who else was involved in setting limit during the term of the policy (we are talking everyone who touched that file AND the producer(s) who spoke with the insured.
3. Was the insurance reviewed annually and a new estimator completed and reviewed?
4. Is there a clear documentation trail? We are talking not just the old fashion hard copies but all the laws regulating electronic discovery.
5. Did the insured ever receive any of the estimates in writing? This is now required by law in California but best practices was that we always provided our insureds this information
6. Did the insured acknowledge receipt of the estimator and verify in writing that the amount was acceptable?
The reality is that, in most cases, insureds rely on their insurance agent/broker to set the policy limit and to make sure they are “fully” covered. However, the general rule is that an insured is responsible for the establishment of the policy limit. Case law in California has, historically, been kind to the insurance agent or broker in finding that they do not have the “duty” to suggest or volunteer that an insured should purchase higher limits or additional coverages. (Fitzpatrick v. Hayes, (1997) 57. Cal.App.4 916. So far this sounds like good news but it is about to get “Ugly”
There are important cases that were decided before Fitzpatrick v. Hayes that weighs heavily on the obligation of the insurance agent/broker in setting limit. One of the most important was Jones v. Grewe (1987) 89Cal.App.3rd 950. This case involved third party liability and the court held that an insurance agent could NOT be held liable for failing to obtain sufficient limits on a third-party liability policy. The Jones case held that an agent could not reasonably forecast the upper limit of liability that an insured might need. The case went on to reason that if liability were extended to agents for not obtaining sufficient liability limits that it would amount to an insurance agent being put in the position of an excess insurer. It is important to remember that this case dealt with liability and not setting limits on property.
In 1992, the Jones decision was followed by Free v. Republic Ins. Co (1992) Cal.App.4th 1726. This case involved a homeowner who specifically asked his broker whether his policy limits were sufficient to cover his home for a total fire loss. The broker affirmed that he was “fully insured to value”. The insured sustained a loss for which he did not have adequate limit and sued his broker. The broker was held liable. In the Free v. Republic case, the court made a distinction about “misrepresentation” in setting limits on a first party (property coverage) as opposed to a third party (liability coverage) as held in Jones v. Grewe. The court reasoned that a broker/agent can objectively determine the amount of replacement cost value for a dwelling in the event of a total loss which is not the case of the subjectivity concerns in a third party policy.
In 1996 the court ruled in Desai v. Farmers Ins. Exchange, (1996) a47 Cal.App.4th 1110. In this case the insured requested that his agent provide him with “100% coverage” for his home in the event of a total loss. The insured issued a policy for $150,000 which included earthquake and there was no Guaranteed Replacement Cost provision. The insured suffered damage in the Northridge Earthquake with a cost to repair the home at $546,757. The court held on appeal that the agent negligently represented that the policy provided 100% replacement cost and that the language in the policy representations found in areas such as the “value protection” clause and inflation protection that gave more credence to the assertion the insured was fully covered. .
Back now to Fitzpatrick v. Hayes. (a997) 57 Cal.App.4th 916, which was referenced in the beginning of this article. The Fitzpatrick case had the precedent cases of Jones, Free and Desai to rely on its opinion. The Fitzpatrick case set the three recognized exceptions, under California law, to the general rule of whether agents and brokers could be held liable for under insurance. The general proposition is that an insurance agent does not have a duty to volunteer to an insured the need to procure additional or different insurance coverage UNLESS one of the three following situations occurs:
1. The agent misrepresents the nature, extent or scope of the coverage being offered or provided;
2. There is a request or inquiry by the insured for a particular type or extent of coverage; or
3. The agent assumes an additional duty by either express agreement or by “holding himself out” as having expertise in a given field of insurance being sought by the insured.
In looking through these criterion, and understanding that only one has to apply for an agent to be held liable, it is easy to see how an agent could fall in the trap. The questions would be:
1. Did the agent represent to the insured that the limits were adequate
2. Did the insured specifically ask the agent if they had adequate coverage; full coverage; 100% coverage or any other qualifier of this type.
We spoke earlier of the practice and requirement that agents use insurance company’s estimators to arrive at a minimum amount of insurance to be offered the insured. As we go through this process with our insured, it clearly gives them a false sense of security that we know what we are doing. It is an understatement that we have to be cautious as to how we communicate the estimator’s figures—emphasizing this is an “estimator” and this is an “estimate” only NOT an appraisal of property. What the Fitzpatrick case cautions us is that if the insured requests full coverage or questions the agent to affirm that the coverage is adequate, and we say “yes” that the agent will fall within one of the Fitzpatrick exceptions. There are, of course, situations where an insured never spoke with their agent about the policy limits. This may not get us off the hook, however. This lack of communication may be because the insured has relied on the insurance agent’s expertise in the area of estimating the value and did not feel they had to get any further involved. Even though the agent may not have had any oral or written communication concerning values; courts will check to see if there is any advertising, such as on a website, or other promotional materials that would portray the agent as “holding himself out” as being an expert. The reality is that the very first thing we do, as expert witnesses, is check out the agent’s website to read the representations that are being made.
The cases cited in this article are from California; however, every state has their own case law as relates to an agent or brokers responsibility for underinsurance. The legal issues we discussed here will be the same issues that each of the cases of underinsurance will contain. I believe that other states will follow the requirement set by the Department of Insurance to mandate education and regulate how records are to be maintained.
The Good, the Bad and the Ugly was a lot funnier when viewed as the movie about a bounty hunting scam to find a fortune in gold buried in a remote cemetery. (stared Clint Eastwood, Eli Wallach and Lee Van Cleef in 1966). Unfortunately, there is no humor in a court of law regardless of what state you are from.
Laurie Infantino AFIS, CISC, CIC, CRIS, ACSR, CISR
President, Insurance Community Center