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Protection from the Storm: Are You at Risk?

By: Kurt W. Melchior
06/24/08

The recent wildfires in Northern California and elsewhere provide a timely reminder that you should evaluate your property insurance—particularly your homeowner's policy, including policy provisions and limits—each year. It seems the media tell the same story after every disaster: that most homeowner policies do not fully cover the costs of rebuilding. A recent Court of Appeal decision involving a homeowner policy underscores this point. It must be noted, however, that these issues are not unique to homeowner insurance but can and do apply more broadly to all property insurance.

There are several reasons why your policy may not fully cover rebuilding costs. Many policies are not "guaranteed replacement" policies. Some have overall limits that have not kept place with ever-increasing costs of construction. Still others lack "building code upgrade" endorsements. Homeowners are often surprised to learn that property policies (even those with "guaranteed replacement" provisions) only cover the cost of rebuilding structures as they existed, which creates a problem in those controlling jurisdictions that do not permit rebuilding older structures as they existed. Consulting with builders in your local area about the likely cost of mandatory building code upgrades, some of which are designed to provide better fire safety in state-designated fire hazard areas, can help you avoid this particular pitfall.

Homeowners need to periodically re-examine their policy limits to make sure their properties are adequately insured. The law generally does not require agents and insurers to undertake that task unless they are specifically asked to do so. It is up to you to make sure your insurance agent or broker understands the value and extent of the coverage you're seeking. You should not only insist on the extent of coverage you want, but should also read the binder and the policy to be certain you actually get what you're seeking. A recent Court of Appeal decision that places the responsibility for obtaining adequate insurance squarely on homeowners underscores this point.

In Everett v. State Farm General Insurance Company, the Court of Appeal rejected a policyholder's argument that her "replacement cost" policy required State Farm to cover the entire cost of rebuilding her destroyed home. The initial policy, purchased in 1991 and renewed annually, was a "guaranteed replacement cost coverage" policy that promised to pay the full amount of repairing a damaged or destroyed dwelling with "like or equivalent construction" and without regard to policy limits. But State Farm discontinued that coverage in 1997. Its renewal notice that year and thereafter explained that "guaranteed replacement" coverage was no longer available and that homeowners were themselves responsible for obtaining sufficient insurance to cover the increasing value of their homes. Everett accepted and annually renewed the more restrictive policy, which was in effect when a wildfire destroyed her home. She sued State Farm and her broker for breach of contract, bad faith, and fraud.

The trial court granted summary judgment for the insurer and the Court of Appeal affirmed, holding that the policy was not ambiguous but instead clearly stated that any "replacement" would be subject to the limits stated on the declarations page. The Court further held that the insurer had given adequate notice that it was the policyholder's responsibility to obtain sufficient coverage and that the insurer had no duty to adjust the policy limits to keep pace with inflation.

You may be thinking that because insurance companies and their agents want to sell as much insurance as they possibly can, the inadequate coverage problems we have described are uncommon. But this is simply not the case. For whatever reason, many agents and insurers sell policies that are insufficient to rebuild a destroyed structure. The small premium savings may help the insurer and the agent compete for business, but the inadequate insurance leaves the policyholder holding the bag when a major loss occurs.

This is the first in a series of occasional reports about general principles relating to buying, owning, and dealing with insurance policies.

Kurt W. Melchior is a litigation partner with Nossaman in San Francisco, where he chairs the Firm's insurance coverage practice group. He has over 50 years' experience litigating complex commercial matters, including class actions, antitrust, insurance coverage, health care, and professional responsibility cases. He can be reached at (415) 438-7279 or kmelchior@nossaman.com.

Thomas D. Long is a litigation partner with Nossaman in Los Angeles who focuses his practice on complex commercial disputes. He counsels private businesses and public entities on insurance issues and also represents them in coverage litigation under all types of insurance policies, including commercial general liability, property, employment practices liability, directors' and officers' and professional liability policies. He can be reached at (213) 612-7871 or tlong@nossaman.com.

Deborah E. Beck is a senior litigation associate with Nossaman in San Francisco who focuses her practice on appellate, environmental, and insurance coverage issues. She counsels private businesses and public entities on insurance issues and also represents them in complex coverage litigation under all types of insurance policies, including commercial general liability, property, employment practices liability, directors' and officers' and professional liability policies. She can be reached at (415) 438-7254 or dbeck@nossaman.com.

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