The terrible fire in Seaside Heights last week got me to thinking about some of the vagaries of fire insurance. (As an aside, the people along the Jersey Shore absolutely can’t catch a break.)

The contents of fire insurance policies are heavily regulated by statute. An interesting case recently came up in the Second Circuit on the question of coverage limitations and statutory requirements.  Facts:  Pacific Indemnity sold a fire insurance policy to an entity known as Quaker Hills, which owned a custom-built home in upstate New York.  (The principal of Quaker Hills is Trevor Davis, a Manhattan-based real estate developer, and this was one of his residences.)  The policy had a property damage limit of $14,388,000, but contained an “apportionment-of-loss” clause, that limited Pacific’s exposure to 38% of any covered loss.

The house burned down, and Pacific refused to pay more than 38% of $14,388,000, or approximately $5.5 million. Quaker Hills, unhappy because the total amount of its claim was $26.5 million when extended replacement costs were included, then argued that the apportionment-of-loss clause was unenforceable and illegal under New York law, on the ground that it conflicted with the standard fire insurance provisions prescribed by statute.  Specifically, statutory minimums for fire insurance are established by N.Y. Ins. Law §3404, which requires that the policy must provide the lesser of either (1) the actual cash value of the property at the time of loss; (2) the replacement cost; or (3) the value of the property as predetermined in the policy.  (New Jersey has a similar statute at N.J.S.A. §17:36-5.20 et seq.) Quaker Hills argued that, because of the 38% clause, the policy provided substantially less coverage than was required by the statute.

Pacific countered that the 38% clause was similar to a coinsurance provision, and that coinsurance provisions repeatedly have been upheld in fire insurance policies.  The Court explained the concept of coinsurance as follows: “A coinsurance clause divides the risk between the insurer and the insured in the event of a partial loss if the insured has failed to carry insurance up to a certain percentage of the value of the property, typically 80%…The purpose of coinsurance, therefore, is to protect [policyholders] by encouraging them to value fairly their own property, and not undervalue it in order to receive a lower premium.”  (Emphasis added.)  (Note:  Here, the loss was total, not partial.) 

The Court stated that coinsurance clauses “merely required the [policyholder], as a condition of receiving a lower premium rate, to stand part of the loss himself, where he does not take out full insurance or insurance to the percentage of the value specified.” In other words, public policy favors coinsurance clauses “because they are designed to prevent property owners from recovering full value for losses on property that they have chosen to undervalue for insurance purposes in order to be charged lower premiums.” The Court, however, noted that “coinsurance clauses in New York are not applicable when, as here, the property was totally, rather than partially, destroyed.”

In the end, the Second Circuit did what many good judges do: Punted. The Court certified the matter to the New York Court of Appeals, New York’s highest court, asking the following specific question, among others: “In an insurance policy that provides a stated dollar amount of loss coverage in the event of a fire, does a policy clause that, in exchange for a reduction in the premium charged, limits the insurer’s liability to a percentage of any loss violate New York Insurance Law?”

Patience is a virtue, so I guess we’ll have to wait for a final answer.  While we’re waiting, though, I’ll reiterate something that I’ve previously said on this blog: always review the insured values on your property policy, and the coinsurance clause, to make sure you have adequate protection before a loss happens.

You can read the full decision here in Quaker Hills, LLC v. Pacific Indemnity Co. by clicking here