In a recent decision that could affect London market reinsurers, the Louisiana Eastern District Court was asked to determine the effect of exclusions appearing in a number of homeowners/all risk insurance policies. The policies were underwritten by a number of different insurers and included materially identical terms based on standard insurance policy wording recommended by the Insurance Services Office, Inc (the “ISO”). The ISO is an American body which provides products and services to help the insurance industry to measure, manage and reduce risk.
The policies excluded damage caused by “flood, surface water, waves, tidal water, overflow of a body of water, or spray from any of these, whether or not driven by wind” (the “ISO Exclusion”). The policyholders argued that the ISO Exclusion did not apply because the “efficient proximate cause” (applying Louisiana law) of the damage was the breach of canal walls in New Orleans during Hurricane Katrina, which was caused by their being negligently maintained. The damage was therefore a manmade (as opposed to natural) cause.
Some of the policies contained further exclusions in addition to the ISO Exclusion.
For example, before reciting the ISO Exclusion, a State Farm & Cas Co (“State Farm”) policy included a “lead in” provision which stated that cover was excluded for any loss which would not have occurred in the absence of one or more of the events cited in the ISO Exclusion, regardless of the cause of the excluded event.
A Hartford Ins Co of the Midwest (“Hartford”) policy contained, in addition to the ISO Exclusion, a specific flood definition which provided that the policy should not cover (amongst other things) loss or damage caused by (a) the design, workmanship, repair, construction or compaction of drainage ditches, levees or dams or (b) the collapse, cracking or shifting of buildings or other structures if it occurred during flood conditions or within 72 hours after the flood conditions ceased and which would not have occurred but for the flood. Flood was defined to include both the ISO wording and “release of water held by a dam, levy [sic] or dike or by a water or flood control device”.
The court stated that under Louisiana law “all risks” policies extended cover to all fortuitous losses, ie, risks that were not usually contemplated by the parties entering into the contract, unless there was a specific exclusion. In this case, coverage would be presumed unless there was a specific exclusion for the type of water damage that the insured had suffered. Since Louisiana law applied the doctrine of “efficient proximate cause”, the court had to consider whether the exclusions were wide enough to include man-made causes arising from negligence or deliberate acts, or whether it should be restricted to flood resulting only from naturally occurring events. The court observed that exclusions must be narrowly construed. In the policies the word “flood” had been used as a noun, but its precise meaning was ambiguous. Certainly the words immediately following “flood” in the exclusion were all synonymous with events.
The judge noted that although the wording of the ISO Exclusion was ambiguous, the State Farm and the Hartford policies successfully excluded coverage for negligent acts and omissions with very little effort. The State Farm “lead in” provision made it clear that regardless of the cause of the flooding (ie, whether or not it arose out of human negligence or not), there was no coverage and that all flooding was excluded from the scope of the policy. The Hartford policy left “nothing to the imagination” and acted as a specific exclusion for flood damage caused by negligently maintained levees. The court said that such a clear statement of exclusion from coverage in the Hartford policy must be enforced. Therefore if a consumer had read the wordings of all of the policies, he would reasonably be expected to have chosen the other ISO Exclusion policies over the State Farm or Hartford policies, since if the policies were compared it would be reasonable to assume that the ISO Exclusion policies only excluded coverage for natural acts, unlike the other two policies. The court stated that to find that the ISO Exclusion in itself excluded negligent acts would be to reward and encourage the use of vague language.
Although the court applied the Louisiana Civil Code and was interpreting a number of insurance policies where consumer protection was foremost in its mind, its decision may have potential implications for reinsurers who have reinsured Katrina flood damage risks. If the provisions of the reinsurance contracts were back-to-back with the terms of underlying insurance policies and incorporated the ISO Exclusion wording without any additional wording, reinsurers may find that they are bound to indemnify the underlying insurers. This may be despite the intentions of the insurer and the reinsurer at the time that the contract was placed that all flood damage (not just natural) was excluded.
The fact that the ISO Exclusion was drafted by an interstate American body but failed to specify that flood damage arising out of manmade causes is, perhaps, of even greater concern. Before accepting a risk, reinsurers should take care when reviewing underlying insurance policies – particularly those covering all risks – to ensure that all intended exclusions are specifically set out. Reinsurers should not simply rely on the fact that wording is widely used by a particular country’s insurance market and has been designed by a body committed to protecting insurers’ interests.