After every major disaster involving extensive flooding, politicians and class-action lawyers take aim at the flood exclusion in homeowners' policies, looking for ways to overcome decades of legal precedent supporting the exclusion. Sometimes they succeed, after which insurance companies adjust their policies to make them as clear and unambiguous as possible that damage due to flood is not covered. They then file the revised policy forms with state insurance regulators and negotiate the terms until they can obtain approval from the state and issue them to policyholders.
Some of these encounters with creative policyholder advocates are instructive and involve principles that should be familiar to any seasoned insurance practitioner. In the wake of Hurricane Katrina, others may be hearing these arguments for the first time. Two worth particular attention are the principles of "concurrent causation" and "efficient proximate cause."
The principle of concurrent causation has been widely recognized for many decades and works in favor of policyholders. To understand it, you have to keep in your head the difference between cause and effect. An insurance policy specifies what causes it covers (usually called "hazards" or "perils"). It also specifies what effects it covers (usually called "loss" or "damage") and which perils and losses are excluded from coverage. Those details are found in various sections of the policy language, such as "Perils Insured Against" and "Exclusions."
Concurrent causation principles say that if two causes combine to produce loss or damage, and one of the two causes is excluded (e.g. flood) and the other is covered (e.g. windstorm), the loss will be covered. Insurance companies have drafted their policies in light of this basic principle for over a century, tweaking policies from time to time as fine points were re-interpreted, often in response to disasters that revealed unanticipated exposures. Many of those disasters, and much of the law interpreting the policies, comes out of California, home to earthquakes, mudslides, floods and brushfires.
Lessons from California
With its substantial body of law interpreting policy provisions in varied circumstances, California illustrates the complexity of the issues faced by insurers in Alabama, Louisiana and Mississippi in the wake of Katrina. California's law derives from interpretation of decisions of its Supreme Court, especially Sabella v. Wisler, 59 Cal. 2d 21, 377 P.2d 889 (1963), and State Farm v. Partridge, 10 Cal.3d 94, 514 P.2d 123 (1973).
Sabella established that when more than one cause is sequentially involved in a loss, the court must determine the single cause that set into motion the other causes or chain of events leading to the damage. In Sabella, a building contractor negligently installed a sewer line to a house it constructed on uncompacted fill. The sewer ruptured and flowed water into the fill, which settled under the house, cracking the foundation.
The insurer denied coverage due to an earth-movement exclusion. The court found that because the "efficient moving cause" (builder's negligence) was covered, the loss or damage was covered, even though an intervening cause (earth movement) was expressly excluded, because the efficient moving cause set in motion the intervening cause.
Partridge established that a different approach must be used when two entirely independent causes combine to result in loss or damage, but neither set into motion the other. In such a case, "coverage under a ... policy is equally available to an insured whenever an insured risk constitutes simply a concurrent proximate cause of the injuries."
On Sept. 10, 1976, Hurricane Kathleen dropped heavy rains in California, overwhelming old levees and flooding the community of Palm Desert in the Coachella Valley. The community had historically been subject to flooding that had been controlled for decades by levees built by government authorities. Insurers denied claims by homeowners for damage due to flooding and a lawsuit followed.
Safeco's policies included industry-standard language designed to cover "all risks" not excluded by the contract language. The contracts included, in bold letters, statements that they did not insure against loss "caused by, resulting from, contributed to or aggravated by … flood, surface water, waves, tidal water or tidal wave overflow of streams or other bodies of water, or spray from any of the foregoing, all whether driven by wind or not."
In their lawsuit, policyholders asserted that although the policies excluded flooding, they did not exclude the independent concurrent cause of negligence in design or maintenance of levees. They successfully argued that because the loss resulted from the concurrence of an excluded hazard and a covered hazard, it was covered under California law. Although the court ruled that Safeco had to pay the loss, it did find that Safeco had not acted in bad faith in denying the claims, because the issue had been legally uncertain before its decision. Safeco Ins. Co. v. Guyton, 692 F.2d 551 (9th Cir. 1982).
Following Safeco, California state courts criticized the federal court decision and further developed the law of concurrent causation. In 1986, applying the Sabella and Partridge cases, the California Court of Appeals decided it was a question of fact whether two concurring causes were independent or dependent causes of a homeowner's injury. This left the jury to decide whether the loss was covered. Garvey v. State Farm, 227 Cal.Rptr. 209 (Cal.App. 1986).
Other states reached similar conclusions in similar situations. Legislation was introduced to clarify the law. An example is California Ins. Code §530, which provides: "An insurer is liable for a loss of which a peril insured against was the proximate cause, although a peril not contemplated by the contract may have been a remote cause of the loss; but he is not liable for a loss of which the peril insured against was only a remote cause."
At the same time, insurance companies scrambled to draft, file and get state approval of policy language to avoid the unexpected consequences of decisions such as Sabella and Partridge. Their new language excluded loss due to certain perils (such as flood and earth movement) "whether other causes acted concurrently or in any sequence with the excluded event to produce the loss."
In 1989, a federal court upheld this "concurrent causation exclusion" in the face of an insured's argument that it violated §530. The 9th U.S. Circuit Court of Appeals said, "An insurance company has the right to limit the coverage of a policy issued by it and when it has done so, the plain language of the limitation must be respected. … California Insurance Code §530 provides guidance when a policy is silent on concurrent causation; it does not prohibit inclusion of a provision similar to the concurrent causation provision in the State Farm policy." State Farm v. Martin, 872 F.2d 319 at 321 (9th Cir. 1989).
Similar results have been reached elsewhere in cases involving floods resulting from the failure of dams due to alleged government negligence. On July 15, 1982, the Lawn Lake Dam in Rocky Mountain National Park failed, destroying commercial property downstream. The property owners' "all risk" insurance policies included a provision that, "The Company shall not be liable for loss … caused by, resulting from, contributed to, or aggravated by any of the following: … flood, surface water, waves, tidal water or tidal waves, overflow of streams or other bodies of water, or spray from any of the foregoing, all whether driven by wind or not."
The Supreme Court of Colorado rejected policyholders' claims that the "efficient moving cause" of the loss was third party negligence leading to the failure of the dam, finding that the rule regarding such causes "must yield to the language of the insurance policy in question." Kane v. Royal Ins. Co. of America, 768 P.2d 678, 78 A.L.R.4th 797 (Colo, 1989).
Mississippi, which was particularly hard hit by Hurricane Katrina, has an instructive precedent regarding flood exclusions, decided after Hurricane Georges in 1998. Eaker v. State Farm, 216 F.Supp.2d 606, 2001 WL 1900617 (S.D. Miss. 2001).
Eaker involved claims against State Farm by a homeowner whose property was insured under both a National Flood Insurance Program Standard Flood Insurance Policy (SFIP) and under a commercial homeowners policy form HO-3. Both policies were written by State Farm, which wrote the SFIP as a "write your own" (WYO) fiscal agent of the U.S. government's NFIP.
Because the insureds failed to file a proof of loss within 60 days as required by the SFIP, the court ruled that all claims under the flood policy were barred. The fact that the insureds were unaware of the filing requirement did not matter, the court said, because the requirement was clearly set forth in the language of the policy.
The court also addressed the insureds' claim that State Farm wrongly denied coverage under their homeowners policy. "The policy language clearly and unequivocally excludes coverage for the settlement of the foundation, the claim which the Plaintiffs are asserting," the court noted, pointing to the policy's "earth movement," "water damage" and "settling/cracking" exclusions. The court also declined to apply the doctrine of "efficient proximate cause" asserted by the Eakers, because "the Mississippi courts have not specifically adopted the efficient proximate cause doctrine."
There will be many tragic stories coming out of Hurricane Katrina. Many lessons will be learned, and some of those lessons will result in changes in industry practices. Let us hope that some of the learning is about the realities of flood insurance and flood exclusions in homeowners' policies.