Underground Sewer Line Damage and the Cause of Loss is Unknown! Who Pays Excavation Costs? – Claims Magazine

ISSUE

The insured suffered loss to the home's underground sewer line and filed a claim under a homeowners open perils policy. Although the sewer line was relatively old, contractors recently completed work on the home and their heavy vehicles could have caused the loss. The insured and insurer believed that the damage was below the ground in the yard, and that it may be necessary to excavate the lawn and earth in order to determine the cause of the damage.

Several questions arose:

(1) Must the insurer excavate the land to determine the cause of loss?

(2) If the insurer excavates the land and discovers that the cause of loss is excluded, can the insurer avoid paying the excavation cost?

(3) If the insured excavates the land to repair the loss without first notifying the insurer, and the cause of loss is then found to be an excluded cause, must the insurer pay any portion of the excavation costs?

ANALYSIS

First, if the insurer wishes to deny the claim, the insurer has a duty to investigate the loss, and excavation may be necessary to satisfy this duty. However, other methods of investigation may be sufficient to determine the cause of loss, so that the insurer need not incur excavation costs. Second, if the insurer excavates the land and finds that the cause of loss is not a covered cause, the insurer may potentially avoid paying at least a portion of the excavation costs. Finally, if the insured excavates the lawn without first consulting the insurer, the insurer could still be responsible for paying a portion of the excavation costs.

Duty to Investigate

An insured may establish a claim under an all risk policy by merely presenting a claim for a fortuitous loss to covered property to the insurer. The burden then shifts to the insurer, either pay the claim or begin an investigation if the insurer believes that the cause of loss is excluded. Ultimately, the insurer must establish that the cause of loss is not covered if the insurer wishes to deny coverage.

Where the loss is to pipe located below the surface of the ground, insurers can often determine the cause of loss without excavating the land. For example, insurers sometimes determine the cause of loss by hiring contractors, plumbers, or engineers. These professionals utilize small cameras or scopes to detect or determine the cause of blockage or leakage in an underground pipe without resorting to the shovel and backhoe. In addition, the plumbing professionals consider other available evidence such as the age of the home and plumbing system, loss history at the insured property, loss history at neighboring properties, and other factors tending to indicate the cause of loss. Consequently, use of these resources might enable an insurer to determine the cause of loss without conducting a complete excavation.

If the above mentioned methods of investigation fail, and excavation is deemed necessary in order to determine the cause of loss, then an insurer might be required to pay for all or a portion of the excavation. Of course, if an excavation is made, and the cause of loss to the underground pipe is found to be a covered cause, then the insurer owes the cost of excavating the land and replacing it, as part of the repair cost to the pipe or sewer line.

Insurer Investigates and Discovers Loss Is Excluded

Insurers typically accept responsibility for investigation expenses that the insurer initiates, even if the investigation establishes that the insured did not suffer a covered loss. Insurers incur and pay these expenses based upon the implied duty to investigate losses under first-party insurance coverage.

Note, however, that a California appellate court found that no implied duty to pay investigation costs would be imposed upon an insurer where a loss was ultimately found to be excluded. McMillin Scripps North Partnership v. Royal Ins. Co. of Am., 23 Cal. Rptr. 2d 243 (Cal. App. 4 Dist. 1993). In McMillin, the court held that an insurer was not obligated to pay $150,000 in investigation costs that a commercial property owner incurred in determining that a pollution loss was excluded. The majority of the justices concluded that the costs were not covered, regardless of whether they were incurred prior to or after filing the claim with the insurer.

Outside of California, reliance upon the McMillin holding may not be advisable, especially in the context of homeowners losses. Other states' courts would more likely find that an implied duty to pay investigation costs arises under first-party homeowners insurance coverage, and that therefore at least a portion of any excavation costs could be attributed to investigation. By following McMillin, an insurer runs the risk of failing to meet its implied duty to investigate. Further, the insurer may be found to have breached its duty of good faith with its insured, thus opening the possibility for a bad faith claim.

Furthermore, the reasoning of the justices in McMillin was not unanimous. A concurring justice concluded that an implied duty to pay investigation costs did arise under first-party insurance coverage, except where the insured either (1) incurred the costs before the insurer had been notified or (2) incurred costs before the insurer had a reasonable opportunity to conduct its own investigation.

Consequently, where an insurer initiates an excavation in order to investigate loss to underground pipe, the insurer should anticipate paying at least a portion of the costs. The insurer's obligation, however, would only extend to the amount of excavation necessary to determine the cause of loss. An insurer may not be required to pay the entire cost of excavating land to repair the damage.

Upon determining that the cause of loss is excluded, the insurer should give the insured the opportunity to take advantage of the partial excavation, if the insured wishes to effect repairs to the property at that time. If the insurer and insured each independently paid for and completed their own excavations, the result could be a waste of resources. A more reasonable approach is for the insured and insurer to reach an agreement prior to beginning any excavation work. The parties might agree that if the excavation reveals that the cause of loss is not covered, then the insured and the insurer will share the cost of the excavation and replacement of the land.

Insured Investigates Loss and Discovers Loss is Excluded

Many times an insured begins an investigation or repair before the insurer has had an opportunity to evaluate a claim or determine what investigative measures and expenses are necessary in order to establish the insurer's obligations under the policy. If the steps taken by the insured were reasonable, and the insurer was not prejudiced by the conduct, then the insurer may wish to pay the insured for a portion of the investigation costs, even if the insured discovered that the loss was excluded.

On the other hand, if the insured began the excavation and repairs without first consulting with the insurer, the insurer may have a basis for denying payment of any excavation costs. This is particularly true if the conduct was unreasonable, and the insurer was prejudiced by the acts of the insured. This would be consistent with the opinion of the concurring justice in McMillin, who said that the implied duty to investigate may not extend where the insured either (1) incurred the costs before the insurer had been notified or (2) incurred costs before the insurer had a reasonable opportunity to conduct its own investigation.