EARTHQUAKE INSURANCE: A PRACTICAL GUIDE, by R. Scott Erlewine. 

From The California Insurance Law & Regulation Reporter, Vol. 2:1 (January 1990) pp. 22-31

I. INTRODUCTION.

It is estimated that only 10% of the approximately $10 billion in recent earthquake losses are insured. Such losses have spawned a variety of complex legal issues involving both insurance coverage and claims adjusting.

The outline below is a brief introduction to these topics.  Because the policy terms and coverages vary significantly between different insurance companies, the specific language contained in a client's policy should be carefully reviewed and analyzed. This area is further complicated by the recent inclusion of new, restrictive, policy language and statutory enactments, which have yet to be judicially tested.

II. THE HOMEOWNER'S POLICY

A. Overview. The homeowner's policy provides coverage for property loss and liability. Property coverage is divided into separate subcoverages: (1) the dwelling and other structures on the insured property (hereinafter "buildings"); (2) personal property; (3) loss of use; and (4) "additional" coverages.  Coverage for buildings is typically written on an "all risk" basis, whereby all losses are covered except those specifically excluded. Conversely, the "personal property" coverage is generally written on a "specified perils" basis, meaning that coverage exists only if the loss is caused by one of the listed perils, and even then, subject to various exclusions.

The coverage analysis for earthquake losses initially focuses on the policy exclusion for any loss caused by "earth movement". The policy defines "earth movement" as "any loss caused by, resulting from, contributed to or aggravated by earthquake, landslide, mudflow, earth sinking, rising or shifting."  Absent other considerations, this exclusion precludes most coverage for earthquake related losses.

For an additional -- and often substantial -- premium, the insured has the option to purchase "earthquake coverage". This coverage is added by way of endorsement to the policy or, in some cases, by a separate "earthquake coverage" policy.

The "earthquake coverage" endorsement provides that coverage is afforded for losses to the buildings and personal property caused by an earthquake. The language differs between insurance companies, and should be carefully reviewed in each instance. Particular attention should be paid on whether the endorsement nullifies the earth movement exclusion in its entirety or only to the extent that it refers to "earthquakes". Some earthquake coverages exclude damage to exterior masonry/veneer.

The earthquake coverage is subject to significant deductibles, since it is considered "catastrophic insurance". If more than one earthquake shock occurs within a 72 hour period, it is considered a single earthquake.  Where damage has occurred from multiple earthquakes occurring more than 72 hours apart, a deductible for each earthquake may apply.

B. Policies Having Earthquake Coverage. Where the insured has purchased "earthquake" coverage, the coverage afforded is generally the same as for a fire loss.  The exception is that earthquake coverage is subject to large deductibles.

1. Buildings And Personal Property.

a.  Earthquake Coverage.

(1) Amount Of Coverage. The homeowner's policy provides property insurance in two forms: actual cash value (basic coverage) or replacement cost. The courts have defined actual cash value to mean fair market value not replacement cost less depreciation. (Jefferson Insurance Co. v. Superior Court, 3 Cal.3d 398, 402 C1970). Under this coverage, the insurance company is obligated to pay the lesser of the amount necessary to repair or replace the damaged property or the fair market value of the loss up to the stated policy limit.

The majority of homeowners obtain "replacement cost" coverage.  The term "replacement cost" is often misleading. Although a few insurance companies guarantee that they will actually replace or repair the building no matter what the cost, most policies provide limited replacement coverage equal to a specified percentage (typically 25% or 50%) over and above the stated policy limits. Under this limited coverage, the insurance company is obligated to pay for the cost of repair or replacement up to the lesser of (1) the extended policy limit or (2) the actual cost of repair or replacement. Where the cost of the repair or replacement is greater than the extended limits, the homeowner is required to pay the balance.

Issue: The fact that replacement cost coverage is limited comes as a surprise to many insureds. Based on the insurance company's representations and the manner in which the insurance policy is written, an insured may reasonably believe he purchased full replacement cost coverage. You should check whether the insurance company has made any type of representations, oral or written, concerning the scope of such coverage, and whether the insured has been adequately notified of the limits. The policy should also be reviewed to determine whether it sufficiently notifies the insured of this limitation on coverage. Where the insurer or its agent has misled the insured regarding the scope of coverage, the insured may have a claim that the full replacement coverage should be provided. See, e.g. Eddy v. Sharp, 199 Cal.App.3d 858 (1988); Wesrick v. State Farm Ins. Co., 137 Cal.App.3d 685 (1982).

(2) Deductibles. Earthquake coverage is subject to large deductibles. They are referred to on the earthquake coverage endorsement itself. These deductibles are most often stated as a percentage of the applicable policy limit. The percentage generally varies between 5 and 25 percent, which applies separately to coverages for the buildings and personal property. The deductible does not apply to "loss of use" coverage.  For example, where the insured has $100,000 of actual cash value coverage on his house, with a 10% earthquake deductible, and sustains $15,000 in earthquake damage, the insurance company is only required to pay $5,000. An insured whose total damages are below the amount of the deductible will receive no insurance benefits for the loss.

Issue: The size of the deductible also comes as a surprise to many insureds. They are often under the impression that the deductible only applies against the amount of total damages, not the limit (or extended limit) of insurance. Again, the policy and any other relevant insurance documents should be checked to see if they unambiguously advise the insured of how the deductible is calculated. For example, where the declarations (front) page of the policy only lists the deductible in terms of a certain percentage, and does not state what the percentage is applied against (i.e., policy limits), it is arguably ambiguous and should be construed in favor of any reasonable interpretation favoring the insured. The declarations page is typically the only part of the policy which the insured has read prior to a loss. The insurance company also has the ability at the time of issuance of the policy to state the deductible in specific dollar rather than percentage terms. To the extent it fails to do so or the policy is ambiguous, this may provide the insured with an argument that the deductible should only apply against the amount of damages.

The rules governing policy interpretation generally favor the insured. Under California law, insurance policies must be construed to give the protection the insured reasonably has the right to expect. Gray v. Zurich Insurance Co., 65 Cal.2d 263, 269270, fn. 7 (1966).  Accordingly, any ambiguity or uncertainty must be resolved against the insurer. Continental Casualty Co. v. Phoenix Construction Co., 46 Cal.2d 423, 437 (1956).  General policy coverage provisions must be interpreted broadly so as to provide maximum coverage to the insured (State Farm Mutual Automobile Insurance Co. v. Partridge, 10 Cal.3d 94, 101 (1973)), whereas exclusions must be interpreted narrowly to limit their effect (id. at 102).  Limitations which defeat the insured's known expectations concerning insurance coverage must be called to his attention. Logan v. John Hancock Mutual Life Insurance Co., 41 Cal.App.3d 388, 995 (1974). As well, exclusions must be set forth in "plain, clear and conspicuous" terms to be enforceable. Gray v. Zurich Insurance Co, supra, 65 Cal.2d 263, 271.

b. Other Coverages. Separate and apart from the coverage afforded by the earthquake endorsement, there is also coverage for any loss caused by "fire, explosion or glass breakage" resulting from an earthquake. These coverages are stated in terms of an exception to the "earth movement" exclusion. They are subject to generally low deductibles.

The advantage to the insured in claiming under these coverages, rather than under the earthquake endorsement, is that the earthquake deductibles do not apply. The downside is that the policy only covers losses "ensuing" from the fire, explosion or glass breakage. The insurance company may argue that, where the building was destroyed by earthquake, causing a fire to erupt, there is no or very little "fire" coverage because there was no "ensuing loss" resulting from the fire.  The insured might argue that the exclusion is ambiguous.

Losses resulting from smoke, wind, water, theft and vandalism are separately covered. Low deductibles generally apply to such losses. Any specially scheduled personal property (such as furs, china, glassware, etc.) is likewise covered. These coverages are generally not subject to any deductible.

2. Loss of Use .  In addition to coverage for property damage per se, the policy provides "loss of use" coverage up to a stated limit.  Where the earthquake (or other covered loss) renders the home partially or wholly uninhabitable, most insurance companies will pay, at the insured's option, either (1) the insured's additional living expenses, meaning any necessary and reasonable increase in living expenses incurred so that the insured's household can maintain its normal standard of living; or (2) fair rental value, meaning the fair rental value of that part of the home where the insured resides less any expenses that do not continue while the premises is uninhabitable. The insurance company is only obligated to make such payments for the shortest time required to repair or replace the damage or, if the insured permanently relocates, the shortest time required for the insured to settle elsewhere. No deductibles apply to this coverage.

"Loss of use" coverage also applies where all or a portion of the property was rented to others and has been rendered uninhabitable. As well, there is limited "loss of use" coverage where a civil authority prohibits the insured from occupying the home as a result of direct damage to neighboring premises.

Issue: There was presumably a rush immediately after the earthquake for displaced insureds to find alternative, comparable housing.  To do so, they may have been required to sign an extended lease (e.g., one year) due to market conditions. Where the insured's residence has been repaired or replaced prior to the end of the lease, the insurance company might argue that it is not required to make any further "loss of use" payments even though the insured is still obligated on the lease. The policy specifically states that the insurance company does not cover any loss or expense "due to cancellation of a lease or agreement."

3. Additional Coverages.

a. Debris Removal.  The policy covers the reasonable expenses incurred by the insured in the removal of debris. 'The debris removal expense is included in the policy limit. However, an additional 5 percent of that limit will be available to cover such expense where the amount payable for the actual damage to the property plus the debris removal expense exceeds the policy limit. The earthquake deductible may apply to this coverage.

b. Reasonable Repairs. The policy covers the reasonable cost incurred by the insured for necessary repairs made solely to protect the covered property from further damage. The policy states that this coverage does not increase the policy limit which applies to the property being repaired.

Issue: There remains a number of buildings that may have to be demolished as a result of earthquake damage. This decision may take several weeks or months, depending on the findings of a careful investigation. In the interim, the city may contend that the building presents a safety hazard to the public, and require that it must either be immediately demolished or shored up.  The insurance company may argue that, in the event it is required to pay to shore the building up, this reduces the policy limit available for the ultimate repair, or demolition and replacement. The insured should argue that this "reasonable repair" constitutes an "additional coverage," and should not apply against the policy limits. The language of the "reasonable repair" clause is arguably ambiguous since, unlike the "debris removal" section, it does not specify that the expense is included in the applicable policy limit.

c. Trees, Shrubs And Plants. Although there is additional coverage for trees, shrubs and other plants, this appears only to apply where the damage is caused by fire or lightning.  It is unclear whether coverage exists where the damage is caused by earthquake.

d. Property Removed. The policy covers damage to personal property from any cause (not just a specified peril) when it is removed from a premises endangered by a covered peril and for not more than 30 days.

e. Collapse. There is limited additional coverage for collapse of buildings.

f. Freezer Food. There is limited coverage for spoiled food resulting from interruption of electricity or mechanical breakdown or failure of refrigeration.

C. Exclusions.

1. Concurrent Causation. Assuming coverage for earthquake damage otherwise exists under an "all risk" or "all peril" policy, the question arises whether any excluded cause(s) in any way contributed to the loss, and, if so, what effect, if any, this has on coverage. This brings into play the "concurrent causation" doctrine. Specifically, the issue is whether coverage exists where the damage has resulted from two or more concurrent causes, at least one covered and one excluded under the policy.

In Garvey v. State Farm Fire & Casualty Co., 48 Cal.3d 395 (1983), the Supreme Court recently applied a "predominant cause" analysis to determine whether coverage was afforded under the policy. In that case, the insured's deck broke away from his house. The damage was caused by a combination of two concurrent causes: land subsidence (an excluded cause) and negligent construction (a covered cause). The Supreme Court held that the "predominant cause" would decide whether the loss was covered and remanded the case for that determination.

The applicability of this "predominant cause" test to the 1989 earthquake losses is an open question. This is because the Garvey court construed language contained in a pre-1983 homeowners policy. In 1983, the insurance industry revised its standard homeowner's form to specifically exclude coverage where any one of several causes of the loss is itself excluded. The validity of this recent language has not yet been tested or interpreted by the California state appellate courts.  Several out- of-state courts have refused to enforce this language. See, e.g., Safeco Insurance Company of America v. Hirschmann, 112 Wash. 2d 621, 773 P. 2d 413 (1983); Contra: State Farm Fire G Casualty Co. v. Martin, 872 F.2d 319, 321 (9th Cir. 1989). The insured might argue that the language is unenforceable because, inter alia, (1) it defeats the reasonable expectation of the insured as to coverage; and/or (2) the insured was not given proper notice of the exclusion under the "plain, clear and conspicuous" test. This latter argument may carry even greater weight where the insured has continuously been a policyholder with the same company beginning prior to 1983, and was not properly notified of the new limitations on coverage or policy language. See, e.g. Insurance Code Section 678.

2. Earth Movement.  Although the insured's losses were earthquake related, there is a question whether the "earth movement" exclusion may operate to exclude losses which were contributed to by prior settling or shifting of the land. This might include, for example, preexisting fractures or cracks in a building worsened by the earthquake or a building which would not have been knocked off its foundation but for the fact that the land had earlier settled. It is unclear whether all, some, or none of the resulting damage is covered by insurance under these circumstances. The answer may depend, in part, upon the validity of the "concurrent causation" exclusion discussed above.  The language of the earthquake endorsement should be carefully reviewed to see whether it nullifies the "earth movement" exclusion in its entirety or only to the extent that it refers to earthquakes. The "earth movement" exclusion, by its terms, does not apply to losses resulting from fire, explosion or glass breakage.

3. Faulty, Inadequate Or Defective Planning, Design, or Construction. In 1983, the insurance industry also added a new exclusion to attempt to avoid the finding of Garvey and earlier decisions that negligent construction is a covered risk under a homeowner's policy. As a result, today's policies generally contain the following exclusion for losses caused by:

"Faulty, inadequate or defective: (1) planning, zoning, development, surveying, siting; (2) design, specifications, workmanship, repair, construction, compaction; (3) materials used in repair, construction, renovation or remodeling; (4) maintenance; (5) establishment or enforcement of building codes or standards for construction or materials."

This exclusion, if enforceable, would presumably deny coverage under the Garvey scenario. This language likewise has not been tested or interpreted by the appellate courts. The insured might assert the same arguments discussed above with respect to the "concurrent causation" exclusion.

Issue: This "negligent design" exclusion presents a trap for the unwary. Even where the insured has purchased earthquake coverage, this coverage may be negated if the insurer can show that negligent construction or design, for example, contributed in any way to the earthquake loss. The insured might argue, inter alia, that this interpretation would be void as against public policy, defeat the reasonable expectations of the insured, and render earthquake coverage illusory.  The legislative history for the earthquake statutes, discussed below, may support this type of argument.  Nevertheless, where the insured is considering pursuit of claims against negligent third parties who may have contributed to the loss (e.g., contractor, architect, the city, or the like), he should be aware that such action, by itself, may provide the insurance company with an argument that the entire loss is excluded from coverage.

4. Code Upgrades. A problem may arise where damage has resulted to buildings which were not in compliance with the 1989 building codes at the time of the earthquake. The insurance industry appears to take the position that coverage is excluded for any repair or replacement construction to the extent it involves bringing the building up to code where it had previously failed to comply.  The insurer generally relies upon an exclusion in the policy which excludes any loss resulting from "ordinance or law, meaning enforcement of any ordinance or law relating to construction, repair, or demolition of a building or other structure." Also, the standard form of fire insurance policy mandated by California Insurance Code Section 2071 states that coverage is provided "to the extent of the actual cash value of the property at the time of loss..., without allowance for any increased cost of repair or construction by reason of any ordinance or law regulating construction or repair... against all loss caused by fire...."

The insured might argue that because the standard form does not, by its terms, mention replacement cost coverage, the "ordinance or law" provision does not apply to a replacement coverage policy. The insured might also argue, inter alia, that the loss was caused by an earthquake, not by an ordinance or law (see, e.g. Fidelity and Guaranty Insurance Underwriters, Inc. v. Allied Realty Co., Ltd., 384 S.E. 2d 613 (1989), that adoption of the insurance company's interpretation of the exclusion would make the contract illusory and defeat the reasonable expectations of the insured that his property would be "replaced" in the event of a loss, and that the exclusion fails to meet the "plain, clear and conspicuous" requirement.

This latter contention may find support in the premium structure. The typical homeowner's insurance premium for replacement cost coverage is calculated as a cost per square foot based upon a construction cost guide used by the insurance companies. This guide presumably assumes that the building is up to code. Thus, the insured is likely paying premiums premised upon the building being up to code. It would provide a windfall to allow the insurer to charge premiums based upon a building being up to code, and then deny any obligation to pay to replace or repair the building to the extent necessary to comply with current codes for losses resulting from the earthquake.

D. Policies Without Earthquake Coverage. Where the insured did not specifically purchase "earthquake coverage," the "earth movement" exclusion would likely apply to exclude coverage for any earthquake-related losses. Nevertheless, there may still be coverage for some types of losses.

1. Compliance With Statutory Requirements. The first matter which should be checked is whether the insurance company met the statutory requirement that it offer the homeowner in writing the option to purchase earthquake coverage.  This insurance industry sponsored law became effective January 1, 1985.  See Insurance Code Sections 1008-10088.

This legislation requires that the insurer must, on a one-time basis, offer earthquake coverage to the residential insured. "Residential insurance" is defined as individually owned residential structures of not more than four dwelling units, individually owned condominium units or individually owned mobile homes and their contents located in this state and used exclusively for residential purposes or tenant's policy insuring personal contents of a residential unit located in California.   Section 10087(a).   The offer must follow a prescribed written form, and be made prior to, concurrent with or within 60 days following the issuance or renewal of the policy. Section 10083.

The insured has 30 days in which to accept the offer. Section 10085. If accepted, the coverage must be continued so long as the policy or any renewal policy remains in effect or until the insured requests its deletion. Section 10086. If not accepted within that time, the insured is conclusively presumed to have rejected the offer, and the insurance company has no further obligation to offer or provide earthquake coverage to the insured at any time in connection with any continuation, reinstatement, or renewal of the policy. Section 10086. This means that if the insured had had his home insured with the same company since at least 1981, the insurer was required to offer earthquake insurance to him upon the first renewal after January 1, 1985. In all other cases, the insurer was required to offer such coverage on or before the date of issuance of a new policy or within 60 days thereafter.

The statute is silent on the insured's remedy where the insurer has failed to comply with the mandatory "offer" provisions.  If the insurance company did not offer earthquake coverage to the insured as required by the statute, the insured should argue that he is entitled to coverage for his earthquake damage. One caveat: Section 10088 specifically provides that, absent an endorsement or an additional policy provision specifically covering earthquake, no policy shall be held to provide coverage for any loss sustained by way of earthquake.

2. Concurrent Causation. This is a complicated area.  The insured may be able to show that his losses resulted from concurrent causes: (1) e.g. negligent construction (a covered cause under pre-1983 language) and (2) the earthquake (an excluded cause). He would then contend that the Garvey "predominant cause" test should apply to determine coverage. This will be a difficult argument for two reasons.  First, as previously discussed, the new policy language purports to exclude (a) "concurrent causation" losses where any one of the causes is excluded; and (b) negligent construction, design, etc.  Second, the Insurance Code now appears to expressly bar concurrent causation where any one of the causes is earthquake- related. Section 10088 specifically provides that:

"...in the absence of an endorsement or an additional policy provision specifically covering the peril of earthquake, no policy which by its terms does not cover the peril of earthquake shall provide or shall be held to provide coverage for any loss or damage when earthquake is a proximate cause regardless of whether the loss or damage also directly or indirectly results from or has contributed to, concurrently or in any sequence by any other proximate or  remote cause, whether or not covered by the policy."

According to the legislative history, the deletion of  "concurrent causation" in the earthquake context was the quid pro quo for the insurers agreeing to the mandatory requirement that they offer earthquake coverage to residential homeowners.

This statutory language has not been interpreted by the courts. It has inherent inequity and may warrant due process consideration. As one example, although the insurance companies are only required to offer residential homeowners the option of purchasing earthquake coverage, the statutory bar for "concurrent causation" specifically applies to all types of policies, including, for example, commercial and business policies.

3. Alternative Coverages. Notwithstanding the absence of an "earthquake coverage" endorsement, there is coverage for any "ensuing" loss caused by fire, explosion, or glass breakage resulting from an earthquake. As previously discussed, this is stated in terms of an exception to the "earth movement" exclusion.  This coverage is not subject to the earthquake deductible.

Losses resulting from wind, smoke, theft and vandalism are covered, as is any specially scheduled personal property.

Under a few policies, there is limited "loss of use" coverage, even in the absence of earthquake insurance.  This provides limited additional living expenses or fair rental value payments in the event the insured's home is rendered uninhabitable.

4. Insurance Company Conduct. Whether or not the insured has "earthquake coverage," two other potential areas may warrant consideration arising from the insurer's conduct.

a. Negligent Misrepresentation. To the extent that the insurance company or its agent or an insurance broker has misrepresented the coverage to the insured or failed to provide requested coverage, they may be liable for negligence or negligent misrepresentation.

b. Estoppel. Where the insured has detrimentally relied upon certain actions by the insurance company after the loss, the insurance company may under certain circumstances be estopped to deny coverage. See, e.g., Hartford Fire Insurance Co. v. Spartan Realty International, Inc., 196 Cal.App.3d 1320 (1987).

III. NONHOMEOWNER'S COVERAGE

A. Landlord's Coverage. The principles discussed above would generally apply to Landlord's property coverage.

B. Business Insurance. The principles discussed above would likewise apply to commercial property coverages for business.  Such policies should be checked to determine whether they provide additional separate coverages, including for example, business interruption, loss of valuable papers, loss of accounts receivable, damage to electronic or word processing data, earthquake sprinkler leakage, and loss of refrigeration.

Issue: The valuation of "business interruption" losses may prove difficult.  The insured should gather as much documentation as possible to show (1) loss of income and (2) that the loss of income was caused directly by physical damage to the insured property.

C. Automobile Coverage. If the insured has "comprehensive" automobile coverage, then any damage to the automobile is covered whether or not it was caused by the earthquake. However, where the damage is the result of collision or upset, then those separate coverages apply.

D. Condominium Owners.  Condominium owners should look at their association policy and their unit owner's policy. The same principles apply as under a homeowner's policy. In addition, the insured may have earthquake loss assessment coverage for assessments by the association for repair of earthquake damage.

E. Renters' Insurance. Renters must purchase specific earthquake coverage to recover for damage to personal property, which is subject to the general earthquake coverage deductible. The same principles apply as under the homeowner's policy.

F. Liability Insurance. The "earth movement" or "earthquake" exclusions only affect property insurance. Such exclusions do not apply to coverage for the insured's liability to others for earthquake-related injuries or losses.

IV. CLAIMS ADJUSTMENT

The adjustment of an insurance claim for earthquake damage often requires special attention due to the complexity of the coverage issues.

A. All relevant insurance documents, including policies, endorsements, correspondence, etc., should be reviewed to determine potential areas of coverage and any potential problems on the horizon.

B. The insured or his counsel should do a thorough factual investigation, since the extent of benefits will likely depend upon a series of factual determinations as to the condition of the property. The insured should, for example:

1. Photograph all damage and cleanup efforts, and provide duplicate photographs to his counsel.
2. Make a written chronology of the events which caused the damage and direct it to his counsel. The chronology should state at the top "for my counsel's use only.
3. Prepare an inventory of all damaged property.

3. In the event the insured can also demonstrate that the insurance company acted with fraud,  malice or oppression, he may also be entitled to recover punitive damages. Civil Code Section 3294; Neal v. Farmers Insurance Exchange, supra, 21 Cal.3d 910, 928.

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