Ordeal by Ordinance – Now Its Floridas Turn – Claims Magazine

Property insurers adjusting Hurricane Andrew claims are uncertain whether they owe for additional building costs imposed by ordinance. Theoretically, there should be no coverage for building upgrades under most policies. Most policies exclude loss caused by the enforcement of any ordinance or law regulating construction, repair or demolition of buildings. Although an exclusion of this type is found in property forms, a few do incorporate some ordinance or law coverage, and some insurers offer an optional endorsement. Later in the article we will cover adjusting practices relevant to an endorsement, but first we'll cover recent developments with respect to an unendorsed policy.

Chapter 11C of the Dade County Code, enacted pursuant to National Flood Insurance Program regulations, requires that any building which is located in a flood zone and is damaged to 50% or more of its market value must be elevated to or above the applicable flood plain level. This is dubbed "the 50% Rule."

On January 26, Dade County filed suit against Allstate and State Farm to force them to bear the costs imposed by the 50% Rule. By suing those two companies, the County hopes to obtain a favorable ruling which will bind all insurers writing in Florida.

The Dade County attorneys assert that the ordinance or law exclusion does not preclude coverage for these costs because the 50% Rule renders the buildings a constructive total loss and because the policy language runs counter to insureds' reasonable expectations, is ambiguous, and is against public policy.

There are three reported Florida cases concerning ordinance or law exclusions: Netherlands Ins. Co. v. Fowler, 181 So.2d 692 (Fla. App. 1966); Regency Baptist Temple v. Insurance Co. of N. Am., 352 So.2d 1242 (Fla. App. 1977); and Reliance Ins. Co. v. Harris, 503 So.2d 1321 (Fla. App. 1987). They indicate that the Dade County attorneys are likely to win their case with respect to constructive total losses but to lose it with respect to partial losses.

What is a constructive total loss? If it would cost more to elevate a building and then repair it than it would cost to demolish the dwelling and start over, the 50% Rule renders the building a constructive total loss. In two appellate cases (Fowler and Harris, supra), Florida courts have held that when an ordinance renders a building a constructive total loss, the insurer must pay policy limits in accord with the valued policy law, Fla. Stat. sec. 627.702.

The valued policy law states that, in the event of total loss, an insurer's liability shall be the amount for which the property was insured. Florida's valued policy law applies to partial losses only if caused by fire or lightning.

A partial loss will exist if the cost of elevating and then repairing a building is less than the cost to demolish it and start over. In the Regency Baptist case, a Florida appellate court considered a claim involving roof trusses which had been constructed upside down. After a loss to the roof, an ordinance required that the entire roof be replaced right side up. The court held that the insurer was liable only for what it would have cost to repair the damaged portion and not for the increased cost of demolishing and reconstructing the undamaged portion of the roof. Thus, that case is cited for the proposition that the ordinance or law exclusion is valid with respect to partial losses in Florida.

The Florida Supreme Court has not yet considered an ordinance or law case. It is likely that the Court, if it were to consider the current litigation, would follow previous law with respect to the application of the valued policy law to a constructive total loss. Courts considering claims governed by valued policy laws have been unanimous in giving the ordinance or law exclusion no effect. See, e.g., Hertog v. Milwaukee Mut. Ins. Co., 415 N.W.2d 370 (Minn. App. 1987); Palatine Ins. Co. v. Nunn, 55 So. 44 (Miss 1911); Stahlberg v. Travelers Indem. Co., 568 S.W.2d 79 (Mo. App. 1978); Dinneen v. American Ins. Co., 152 N.W. 307 (Neb. 1915); Stevick v. Northwest G.F. Mut. Ins. Co., 281 N.W.2d 60 (N.D. 1979); Scanlan v. Home Ins. Co., 79 S.W.2d 186 (Tex. App. 1935). In both total and partial loss situations where valued policy laws have not governed, courts have been split. Some have upheld the exclusion, as did the Florida roof truss case discussed above. See, e.g., Bishel v. Fire Ins. Exchange, 2 Cal. Rptr.2d 575 (Cal. App. 1991); Cohen Furniture Co. v. St. Paul Ins. Co., 573 N.E.2d 851 (Ill. App. 1991); Midwood Sanatorium v. Fireman's Fund Ins. Co., 185 N.E. 674 (N.Y. 1933).

Others have refused to apply the exclusion on the ground that any additional costs were really the result of the insured peril which caused the physical loss, and not the result of the operation of the ordinance. See, e.g., Garnett v. Transamerica Ins. Serv., 800 P.2d 656 (Idaho, 1990); Maryland Casualty v. Frank, 452 P.2d 919 (Nev. 1969); Starczewsi v. Uniguard Ins. Group, 810 P.2d 58 (Wash. App. 1991)(dicta).

For example, in Garnett, the insured building suffered severe fire damage. Rebuilding was allowed as long as it included code improvements. The court held the insurer liable for the cost to rebuild, including code improvements, despite the presence of an ordinance or law exclusion. The court said that the improvements were part of the cost of repairing the fire loss. It reasoned that the exclusion would apply in a situation where safety improvements were required by code but where no loss by an insured peril took place to set the code requirements in operation.

The Dade County attorneys do not rest their case on a causation argument. They argue instead that an insured would expect "replacement cost" to include all costs necessary to replace in accord with legal requirements, since there is no other way to repair or replace, save legally. They allege ambiguity of the exclusion on the basis that it does not indicate if the ordinances or laws referred to are those passed after construction of the building, after policy issuance, or after the loss. Also, they allege that the juxtaposition of the exclusion with the replacement cost provisions creates ambiguity. Finally, they allege that the exclusion is against public policy for two reasons. First, ordinances become an integral part of all contracts. Second, the exclusion encourages both illegal construction and abandonment of neighborhoods, since people cannot afford legal repairs without insurance coverage. It will be interesting to see how Florida courts respond to these allegations.

It is also interesting to relate the Florida situation to the turn of events in California after the Oakland fires. At the time of the fires, a California appellate court, in McCorkle v. State Farm Ins. Co., 270 Cal. Rptr. 492 (Cal. App. 1990), had refused an insured coverage for a code upgrade involving replacement of a wood garage floor with a cement garage floor.

The court explicitly did not reach the ordinance or law exclusion because it based its result on valuation language calling for equivalent construction. Additionally, California has no valued policy statute along the lines of the one in Florida. (Cal. Stat. sec. 2050 et seq. allows an insured to select either an open or a valued policy.) But, despite a favorable legal climate for enforcement of an ordinance or law exclusion, the California Insurance Commissioner urged insurers to pay for code upgrade costs.

Even before the Commissioner adopted that position, there was legislative concern that insureds did not understand the type of coverage they had purchased. One Senator proposed a bill which involved a mandatory offering of guaranteed replacement cost coverage, including coverage for code upgrades. The insurance industry, feeling that it would be too difficult for some companies to rate those exposures, successfully lobbied to change the prososal to a bill involving a mandatory disclosure statement which must accompany all residential property policies. The bill, SB 1854, passed. The disclosure statement informs the insured what type of policy was purchased. The categories include guaranteed replacement cost with full code upgrade coverage, guaranteed replacement cost with limited or no code upgrade coverage, extended replacement cost, replacement cost to limits, actual cash value, and building code upgrade. The disclosure statement contains a more detailed description of the types of coverage available. It will be some time before the efficacy of this legislation is known.

Returning to Florida, suppose the Florida courts affirm the validity of the roof truss case, thereby giving effect to the ordinance or law exclusion in situations involving partial losses. Concerns will remain about public awareness and comprehension of the exclusion. These concerns have been articulated by the Dade County attorneys and were at the base of the California legislation. Notwithstanding any differences in the political climate in Florida and California, it is interesting to consider whether a similar bill might be adopted in Florida, or whether insurers might voluntarily adopt a revised declarations page allowing some insureds to opt for or decline guaranteed replacement cost and/or building upgrade coverage. This line of thinking assumes that Florida insurers will continue to offer some building upgrade coverage. If they do offer such coverage, claimspeople will, of course, need to interpret it.

During the past year we have received several questions from member companies indicating surprise at the breadth of various ordinance or law endorsements. These endorsements vary from company to company and from personal to commercial lines within the same company. It became clear that there is as much uncertainty about the scope of ordinance or law coverage as there is about ordinance or law exclusions. But where there is considerable law regarding ordinance or law exclusions, there is almost no law regarding the scope of ordinance or law coverage. It is interesting to consider, from a claimsperson's viewpoint, some of the issues which have surfaced in our discussions of various ordinance or law endorsements.

As a preliminary, we need to clarify that an endorsement providing full ordinance or law coverage generally does not cancel the effect of an ordinance or law exclusion. The exclusion still applies to any loss caused by the enforcement of ordinance or law in the absence of a covered loss. Courts will enforce the exclusion in this circumstance. See, e.g., Sweeney v. City of Shreveport, 584 So.2d 1248, (La. App. 1991).

The exclusion is also intended to preclude coverage for costs imposed by enforcement of ordinance or law after the occurrence of a covered loss. An ordinance or law endorsement is intended to cover all or some of these costs. A claimsperson adjusting a loss under an ordinance or law endorsement must consider both the nature of the ordinance involved and the nature of the costs.

First of all, the claimsperson must consider the type of ordinance encompassed by the endorsement. Naturally, any such coverage would include ordinances governing building code upgrades. But how about ordinances governing zoning or land use requirements? Most municipal building codes are adapted from a couple of building codes used nationwide. Thus, insurers can calculate with some uniformity, based on age and type of construction, the potential costs imposed by these laws. Zoning and land use requirements, however, are unique to each municipality. These types of ordinances may require that a partially damaged building move across town. Further, what about ordinances governing detection or prevention of pollution? This type of ordinance will vary with the type of pollution hazards present in a given community. The possible costs can also be difficult to predict.

Once the claimsperson has determined the type of ordinance covered by the endorsement, he must ascertain when the ordinance became effective. We spoke previously of the new California disclosure law. The statutory description of full building upgrade coverage states that the ordinance must be in effect at the time of repair or rebuilding. Some insurers, however, may not choose to underwrite costs a municipality imposes subsequent to the loss. Therefore, some forms will specify that the ordinance must have been in effect at the time of loss. Alternatively, some insurers may specify that the ordinance must have been in effect at the last policy renewal before the loss or at the time of policy inception.

Next, a claimsperson must ascertain the relationship between the loss and the enforcement of the ordinance. Is it enough that an ordinance is being enforced as a condition to the issuance of a building permit or certificate of occupancy? Consider an inspector who visits a restaurant after a fire and discovers that a new grease trap is needed. The grease trap was not involved in the fire, and the inspector could have ordered it replaced at any time. The inspector requires the insured to replace the grease trap as a precondition to his issuing a building permit. Is the cost of the grease trap covered, even though the inspector could have required its replacement in the absence of a covered loss? Or, is the endorsement drafted more narrowly in this regard?

Whereas the concerns addressed above deal with the ordinance itself, the following concerns deal with the nature of the costs which are covered. Any building upgrade coverage will cover the increased cost to repair or replace damaged property to comply with the ordinance in question. For example, if a wood garage floor is destroyed and an ordinance requires that garage floors be constructed of cement, then coverage would be available for the additional cost represented by the difference between the cost of wood and cement.

But what about property which is not damaged by a covered peril but which nevertheless must be replaced in upgraded condition due to the operation of an ordinance? Within this category there are three types of costs. First, the cost to demolish or remove the property; second, the loss of value of the property; and third, the cost to replace the property to comply with ordinance or law,

to the extent that such cost exceeds the loss of value of the original property. An example of this type of situation is where an ordinance requires that any property damaged to 60% of its assessed valuation be completely rebuilt in accord with municipal code. Another example is where some windows of a building are damaged but all windows must be replaced with energy efficient models in accord with municipal code.

Another cost which may or may not be covered under a given endorsement is the cost of building or installing any item or system not present on the premises prior to the loss. For example, an ordinance may require that a structure be outfitted with a sprinkler system before an occupancy permit will issue.

Finally, a claimsperson must be alert for conditions accompanying the ordinance or law coverage. Is there an additional amount of insurance available for the coverage or is the coverage encompassed within the general policy limits? Must the insured actually repair or rebuild to receive coverage for the cost of the upgrade? Must replacement occur on the same site? Backing up from the specifics of ordinance or law endorsements, one might conceptualize the basics regarding ordinance or law exclusions and coverages by considering the following dichotomy. When an ordinance or law requires that a property be upgraded, in the absence of loss or damage to that property, the ordinance or law might be considered, in insurance parlance, a "peril." But when an ordinance or law requires that a property be upgraded after covered loss or damage to that property, the ordinance or law might more aptly be characterized as imposing additional "costs" of repair.

Ordinance or law exclusions are intended to preclude coverage for both these situations. An ordinance or law endorsement, however, is intended to provide coverage only where the ordinance or law results in additional costs after a covered loss. This dichotomy is useful in understanding the response of some courts and the expectations of policyholders. As discussed previously, some courts have ignored ordinance or law exclusions on the basis that all costs imposed by ordinance or law after a covered loss were caused by the peril which caused the loss and not by the operation of ordinance or law. As also discussed above, Dade County is arguing that replacement cost coverage, in particular, must include all costs to replace in compliance with law. To clarify this matter, companies may want to consider a declarations page allowing insureds to opt for or decline defined aspects of ordinance or law coverage. Of course, as discussed above, California now requires that a disclosure statement accompany each residential policy and describe, among other information, the level of code upgrade coverage purchased with that policy.

An understanding of the peril/costs dichotomy also underscores the importance of being specific in the drafting of any ordinance or law endorsement and the importance of making an informed coverage interpretation. If the endorsement is not specific, a policyholder may expect and a court may hold that the endorsement includes all additional costs imposed by ordinance or law after a covered loss.