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A first-party property policy does not insure property: it insures an individual, partnership, corporation, or other entity against the risk of loss of the property. Before an insured can claim compensation under a first-party property insurance policy, the insured must prove that there was damage to property whose risk of loss was covered by the policy. The obligation that the insurance imposes on the insured is often relatively easy to fulfill.
For example, the charred building in the event of a fire need only be shown to the insurer. Other situations may not be as easy to prove. Is a building hanging over a newly created cliff damaged? Has a church steeped in the smell of gasoline suffered property damage? Was missing property stolen? Has a building showing signs of collapse, subject to an insured peril called “collapse?”
Often an insurer needs the wisdom of Solomon to reach an accurate and fair outcome. The first party property manager is obligated to assist the insured in determining the presence or absence of property damage due to the risk of damage insured against and not excluded and work to fulfill any promises made by the policy.
When a first party property insurance policy insures against the risk of physical loss of certain real property or personal property, regardless of whether the policy is a named peril, all risk, special risk or direct risk of physical loss, the insured must first prove that there is damage to the property . An insured can also claim for loss of use of the property that is the subject of the insurance.
The insured may retain the property and suffer a constructive loss of use through denial of access or risk of imminent destruction. IN Hughes v. Potomac Insurance Co., 199 Cal. App. 2d 239 (1962), the court found coverage after the ground next to the house slid away, causing the undamaged house to hang over a cliff. The California Court of Appeal found that damages to a structure existed if it was not a safe place for people to live even though all the walls were standing and the roof kept out the rain.
Although a loss of use may in some cases involve a physical loss, “loss of use” and “physical loss or damage” are not synonymous. Indeed, construing physical loss as requiring only loss of use extends “physical” beyond its ordinary meaning and may in some cases “render the word `physical’ meaningless.” IN Source Food Tech., Inc. v. US Fidelity and Guar. Co., 465 F.3d 834, 835 (8th Cir.2006), the court found no coverage under a policy that covered “direct physical loss of property” when the property was meat that was not allowed to cross the U.S. border and was therefore treated as unusable but in fact not destroyed or contaminated.
The Covid 19 pandemic caused serious litigation over the question of what constitutes physical loss or damage and how a limitation in an insurance policy defeats attempts to obtain coverage for loss of use of property and business interruption caused by orders from government agencies.
Oral Surgeons, PC, sued its insurance companies for loss of income. Oral Surgeons offers oral and maxillofacial surgery services at its four offices in the Des Moines, Iowa, area. Oral surgeons stopped performing non-emergency procedures in late March 2020, after the governor of Iowa declared a state of emergency and imposed restrictions on dental practice due to the COVID-19 pandemic. Oral surgeons resumed procedures in May 2020 when restrictions were lifted, in accordance with Iowa Dental Board guidelines. Insurer refused to pay maxillofacial surgeons sued.
IN Oral Surgeons, PC v. The Cincinnati Insurance Company, The Restaurant Law Center Amicus on behalf of Appellant(s), American Property Casualty Insurance Association; National Association of Mutual Insurance Companies Amici, no. 20-3211, United States Court of Appeals for the Eighth Circuit (July 2, 2021) asked the Eighth Circuit of Oral Surgeons and Certain Amici to find that the loss of use of its office was physical loss and that Oral Surgeons were entitled to business interruption benefits.
Oral Surgeons filed a claim with The Cincinnati Insurance Company (Cincinnati) for losses it suffered as a result of the non-emergency shutdown. The policy insured oral surgeons against lost business income and certain additional expenses incurred due to business interruption “caused by direct ‘loss’ to property.” Police defined “loss” as “unintentional physical loss or unintended physical injury.”
Cincinnati responded that the policy could not afford coverage because there was no direct physical loss or physical damage to the oral surgeons’ property. Oral surgeons agreed. The district court granted Cincinnati’s motion to dismiss, concluding that maxillofacial surgeons were not entitled to declaratory judgment.
Oral Surgeons’ appeal argued that the covid-19 pandemic and the related government-imposed restrictions on performing non-emergency dental procedures constituted a “direct ‘loss’ to property because oral surgeons were unable to fully use their offices. Oral Surgeons argued that the policy’s disjunctive definition of ” loss” as “physical loss” or “physical injury” created an ambiguity that must be interpreted against Cincinnati. To give the terms separate meanings, Oral Surgeons proposes to define physical loss to include “lost business or inability to use business” and define physical damage as a physical change to property.
An appellate court must interpret the policy to give effect to the parties’ intent. The intent is determined by the language of the policy itself, unless there is ambiguity. Ambiguity exists only when the policy language is subject to two reasonable interpretations. Generally speaking, the plain meaning of the insurance contract prevails.
The Cincinnati policy clearly required direct “physical loss” or “physical damage” to trigger business interruption and additional expense coverage. Accordingly, there must be some physicality in the loss or damage to property. Oral surgeons therefore needed to prove that a physical alteration, physical contamination or physical destruction of its property caused a loss.
The common use of “physical” in connection with a loss therefore means the loss of something material or tangible at some level. The policy cannot reasonably be construed to cover mere loss of use when the insured’s property has suffered no physical damage or injury. The Eighth Circuit refused to find “loss of use” and “physical loss or damage” synonymous. Rather, they are opposites.
The unequivocal requirement that the loss or damage be physical in nature is consistent with the policy’s coverage of lost business income and incidental expenses incurred from the date of the physical damage to the insured’s property until the insured restores the damaged property to use. The “Restoration Period” begins at the time of “loss” and ends the earlier of:
- Date when the property in the “premises” is to be repaired, rebuilt or replaced with reasonable speed and similar quality; or
- The date on which operations resume at a new permanent location.
Property that has suffered physical loss or physical damage requires restoration. That the policy provides coverage until property is “repaired, rebuilt or replaced” or until business is resumed elsewhere assumes physical change to the property, not just loss of use. When the only reason the property was not used was an order from a government agency is not a physical loss or physical damage. In fact, the property where maxillofacial surgeons practiced was unchanged for the entire time they were unable to perform maxillofacial surgery.
The complaint generally alleged that oral surgeons were suspending non-emergency procedures due to the COVID-19 pandemic and the related restrictions imposed by the government. Thus, the complaint alleged no facts showing that it had discontinued operations because of direct “accidental physical loss or accidental physical injury, regardless of the precise definitions of the terms “loss” or “injury.”
Because the insurance clearly did not provide coverage for the oral surgeon’s partial loss of use of his offices, absent direct physical loss or physical injury. If there is no ambiguity, an appellate court will not write a new policy to impose liability on the insurer.
There is no doubt that orders to close businesses due to fears of the spread of Covid-19 caused harm – a loss of business income – to oral surgeons and all other businesses forced to close by order of the state or any entity. This order did not damage the property which was the subject of the policy and there was no need to restore it because when the order was withdrawn the oral surgeons could start their business immediately. No insurance policy insures against all possible losses. The loss claimed by the oral surgeons was a loss for which no insurance benefits were available.
When a home contains walls built from Chinese plasterboard that over time released sulfurous gas into the home, property damage was found to have occurred even though the walls remained intact. (Travco Inc. Co. v. Ward, 715 F.Supp.2d 699 (ED Va. 2010))
Other cases have similarly accepted the view that “damage” includes loss of function or value including loss of power to the insured’s premises. (Dundee Mutt. ins. Co v. Marifjeren1998 ND 222, 587 NW2d 191, Gene. Mills, Inc. v. Gold Medal Ins. Co.622 NW2d 147, (Minn.Ct.App.2001); Pepsico, Inc. v. Winterthur Int’l Am. ins. Co., 24 AD3d 743, 806 NYS2d 709 (2005); Wakefern Food Corp v. Liberty Mutual, 406 N.J. Super. 406 NJ Super. 524, 968 A.2d 724 (App. Div. 2009)).
In common usage and generally accepted definitions, physical damage to property means “a distinct, detectable and physical change” to its structure. 10 Sofa on insurance Section 148:46 (3d ed. 1998). Physical damage to a building as a whole from sources imperceptible to the naked eye must meet a higher threshold. Colorado Supreme Court in Western Fire Ins. Co. v. First Presbyterian Church165 color 34, [968 A.2d 738] 437 P.2d 52 (1968), concluded that coverage was triggered when authorities ordered a building closed after gasoline fumes seeped into a building’s structure and made its use unsafe. Although neither the building nor its elements have been demonstrably altered, its function was eliminated. [Wakefern Food v. Liberty Mut. Ins., 968 A.2d 724, 406 N.J. Super. 524 (N.J. Super., 2009)]
This post is adapted from my book Zalma on Insurance Claims Part 104, Third Edition Available as Kindle book; Available as hardcover; Available as paperback;
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Barry Zalma, Esq., CFE, now limits his practice to serving as an insurance consultant specializing in insurance coverage, insurance claims management, insurance bad faith and insurance fraud for insurers and policyholders alike. He practiced law in California for more than 44 years as an insurance coverage and claims attorney and more than 54 years in the insurance industry. He can be reached at http://www.zalma.com and zalma@zalma.com
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