Homeowners Insurance

People purchase homeowners insurance (HO) to protect some of their most important assets, their home and its contents, assets they almost certainly could not afford to lose. Generally people borrow money to purchase their home and the lender requires insurance to protect its financial interest in the property. The Insurance Services Office (ISO) Homeowners Policy (HO) incorporates property insurance, comprehensive personal liability insurance, additional living expense coverage, replacement cost coverage, and medical expense coverage for others in one convenient package.

The ISO has modified and updated the HO forms several times since its introduction. We are using the most recent HO 2 version as sample material presented in this chapter. Appendix A at the end of the book reproduces the complete policy.

Policy revisions accomplish several purposes. In some instances, court decisions were inconsistent with the drafter's original intent and the ISO modified the wording to achieve the insurer's aims. In other instances, societal changes required adding contract language including the controlled substance exclusion that eliminates coverage for liability arising from the use of controlled substances.

While we use the ISO forms for sample material in this book, other rating agencies use different forms with different provisions. Also, some insurance companies use their own forms. Our purpose definitely is not to promote memorizing one rating agency's policy forms. Rather, the educational purposes of presenting this material include:

Explaining one widely used method of providing an important element of economic security to U.S. society.

Demonstrating the drafter's precise use of English to form a complex contract.2 Illustrating the impact of court interpretations on contract language.

Illustrating the application of contract provisions commonly found in many U.S. insurance policies in addition to the HO.

Explaining a critical risk management function. For risk managers to fulfill their responsibilities competently, they must be able to interpret insurance contract language.

Illustrating some of the principles of insurance discussed in Chapter 2 by showing how they are incorporated in an actual insurance policy.

Students have told me that learning the meaning of the HO is a desirable and important byproduct of this educational experience because most expect to purchase this type of insurance.

This chapter does not provide exhaustive coverage of the HO because this is not necessary to achieve the educational goals of this introductory textbook. We cover only the main features of the policy. For exhaustive coverage of the HO and many other property and liability insurance policies, see the Fire, Casually and Surety Bulletins published by the National Underwriter Company of Cincinnati, Ohio (http://www .nationalunderwriter.com/). This service contains detailed explanations of the most recent versions of insurance policies and recent court decisions affecting their interpretation.

The ISO homeowners insurance program uses the following six forms:

1. HO 1: Basic3 2. HO 2: Broad 3. HO 3: Special 4. HO 4: Contents Broad (coverage for renters) 5. HO 6: Unit Owners (condorninium type coverage) 6. HO 8: Modified

ISO forms HO 1, FIO 2, HO 3, and HO 8 are used to insure an owner's interest in a home and its contents and provide personal liability coverage. The scope of the coverage is broader in HO 3 than in HO 2, which in turn provides more coverage than HO 1. Because of its narrow scope, the HO 1 form is no longer sold in many locations. The HO 8 form covers houses having a replacement cost greater than market value. This result is most likely to occur in older homes having plaster walls and hardwood floors. Such homes are usually found in older neighborhoods. If these homes were destroyed, they could be more economically replaced using modern construction techniques (such as drywall and plywood) without loss in usefulness. HO 8 provides for functional replacement rather than replacement with material of "like kind."

The HO 4 form covers the contents and personal liability of renters. Apartment renters need coverage for their personal property and need the liability coverage provided by the HO 4 form. The HO 6 form covers the property interest, contents, and personal liability of people owning a unit in a condominium or a cooperative building, The HO forms cannot be used to cover mobile homes or house trailers. The ISO makes available other, more limited forms for this property.

SPECIFIED PERILS

If any property loss (dwelling or contents) is covered under HO 2, the loss must have a specified peril as its proximate cause. The property section of HO 2 provides coverage only if a loss is caused by one of the following perils:

1. FIRE OR LIGHTNING

Fire means a hostile fire, one not contained in its proper place. The word fire is ordinarily used and commonly understood by people. Yet when found in an insurance policy, it takes on a specific and restricted meaning.

Lightning is a powerful discharge of natural electricity. Direct losses from lightning are sometimes hard to prove, especially when the only damage that occurs is to television sets and other appliances.

2. WINDSTORM OR HAIL

HO 2 provides protection against tornadoes and all other sources of violent wind damage. The coverage excludes damage to the interior of the buildings or contents if no damage is first sustained by the exterior of the building. Thus, damage sustained because a window is left open is excluded.

3. EXPLOSION

Explosion is a difficult term to define; it is not defined in the policy. There may fire or loud noise and violent expansion of gases accompanying an explosion. When a combination of some or all these events causes damage, for instance, when a water heater explodes, HO 2 covers the damage.

4. RIOT OR CIVIL COMMOTION

War, civil war, and insurrection are not covered but lesser hostilities are covered, For example, this peril provided coverage for any insured homes damaged in the Los Angeles riots of 1992.

6. AIRCRAFT AND VEHICLES

Aircraft damage includes damage caused by spacecraft falling on a house and damage done by sonic booms or model planes.

HO 2 (but not HO 3) excludes losses to fences, driveways, and walks caused by vehicles operated by an occupant of the house.

7. SUDDEN AND ACCIDENTAL SMOKE DAMAGE

The definition of sudden has been interpreted differently by various courts. In some cases it has meant an unforeseen event of short duration. Other courts have omitted reference to the duration of the event. Thus, the smoke damage caused by a smoldering electric blanket may be covered under this provision, as may damage resulting from faulty cooking appliances. If firefighters cause water damage putting out the smoldering blanket, this too would be covered because the proximate cause of the loss would be the smoldering blanket or stove.

8. VANDALISM OR MALICIOUS MISCHIEF

If others willfully and intentionally damage the homeowner's property, there is coverage for vandalism. In the HO 2 contract, the coverage for these two perils is suspended if the house has been vacant for 60 consecutive days before the loss. Vacant means the insured’s and their possessions are absent from the house. When an insured takes a vacation with plans to return home, the house is unoccupied rather than vacant and the coverage remains in effect.

In an interesting case touching on this point, a court found the damage caused to the interior of a house when a deer crashed through windows both on entering and leaving was not covered under this section of the policy. In reaching its decision, the court stated: "The animal was incapable of forming the requisite intent of committing a wrongful act that would result in senseless damage."

9. THEFT

Theft means the crime of removing property without the owner's permission. Theft generally does not include losses by fraud or mysterious disappearance of property. Three exclusions to theft coverage are in the HO, including theft committed by an insured. Additional restrictions apply if the theft occurs off the residence premises including in a college dorm or apartment.

10. FALLING OBJECTS

The building must sustain exterior damage before interior damage is covered. If a tree limb were to fall and break through the roof, coverage would be provided for the roof and damaged contents. If the homeowner drops a television destroying the television and a chair, no coverage is provided.

11. WEIGHT OF ICE, SNOW, OR SLEET

This provision is more useful in Minnesota than in Florida. Yet if four feet of snow were to fall on an insured house in Florida and cause damage, HO 2 would cover the loss.

12. ACCIDENTAL DISCHARGE OR OVERFLOW OF WATER OR STEAM

Loss caused by accidental discharge from plumbing, appliances, sprinkler systems, or air conditioners is covered. Damage to these items is insured if the damage is caused by an insured peril as desist vacant for more than 60 consecutive days before a loss is excluded, as is mold damage and damage attributed to the malfunction of a sump pump.

13. SUDDEN AND ACCIDENTAL TEARING APART, CRACKING, BURNING OR BULGING

The provision covers the explosion of water heaters, heating systems, air conditioners, or sprinklers, but losses resulting from freezing are covered separately.

14. FREEZING

If the building is occupied or even if the building is unoccupied as long as a serious attempt is made to heat it and damage is caused by frozen pipes that burst, HO 2 provides coverage.

15. SUDDEN DAMAGE FROM ARTIFICIALLY GENERATED ELECTRIC CURRENT

Coverage is provided for electrical appliances excluding damage to tubes, transistors, and similar parts. If a surge of power was sent through the electric lines and burned out a motor, there is coverage. Short circuit damage may also be covered in some cases.

16. VOLCANIC ERUPTION

Residents of Oregon, Washington, and California may be pleased to learn some volcanic damage is covered. Damage done by explosion, lava flow, or volcanic ash would be covered , earthquake damage is specifically excluded. When Mount St. Helens erupted, several questions were raised concerning HO insurance coverage. The new form resolves these issues. Simplifying a complex issue, in general, the above ground damage caused by a volcano may be covered, but the seismic (below ground damage) is excluded from coverage.

The ordinance or law exclusion eliminates coverage for additional expenses if current zoning laws or building codes prevent rebuilding a structure comparable to the damaged home. For an additional payment, this exclusion can be removed by endorsement.

To illustrate the meaning of this exclusion, consider the facts of a legal case arising from the damage inflicted by Hurricane Andrew. In December 1993, the Circuit Court of the 11th Judicial District in Dade County, Florida ruled that the language of the ordinance or law exclusion found in the HO (and reproduced earlier) was "ambiguous." According to the principle that ambiguities found in insurance contracts are construed against the drafter, the court had to interpret the contract in the insured’s' favor, thereby disallowing the exclusion. The court then required insurers to pay for total losses when undamaged portions of homes had to be rebuilt under the provisions of the current (in 1993) South Florida Building Code. A relevant provision of this code requires elevating (above the flood plain) a building sustaining damage from flood waters equal to 50 percent or more of the repair or replacement cost, before the building can be certified for reoccupancy. Many of the houses damaged by Andrew fell in this category because they were ruined by a 12 foot wall of water called a storm surge. The lower court's finding of ambiguous language was later overturned a appellate level. However, if the lower court's ruling had been sustained, insurers would have been responsible for totally rebuilding some structures, elevating even houses built on a slab foundation. This discussion illustrates the type of loss insurers believe the ordinance or law provision excludes.

MOLD

In recent years litigation relating to loss caused by mold has received media attention. Some of these cases have involved claims of millions of dollars of damages, but it is too early to assess their impact on the insurance market. Among the questions being raised in courts is whether mold damage resulted from insurers' improper claims settlement practices (undue delay in paying for covered losses), construction defects, or neglect of insured’s to protect property.

Mold is a type of fungi. About 100,000 different kinds of mold exist. Some molds produce mycotoxins that can kill humans and many people experience allergic reactions to molds. Indoors, mold is likely to grow where there is moisture and warmth such as in basements and bathrooms. Mold can grow in drywall, carpets, or furniture upholstery.

Considering the mold exclusion found in HO 3 is instructive The wording in the foregoing box suggests the following sequence:

1. The insurer grants coverage for direct physical loss to the property, 2. The insurer then excludes coverage for several specified losses. 3. The (5th) exclusion eliminates coverage for mold. However, the policy then modifies this exclusion to grant coverage for mold under specified conditions.

Discussing this topic illustrates the old saying "The big hand gives it to you, the little hand takes it away." It might be added, "Another little hand gives it back, sometimes." This discussion also suggests why insurance policies have become so complex. The interplay between insurers, insured’s, and plaintiffs' attorneys makes great demands on the courts to interpret policy language.

OTHER EXCLUSIONS

The earth movement exclusion and the water damage exclusion eliminate coverage for catastrophic perils. The neglect exclusion provides an incentive to protect undamaged property from loss. It is designed to minimize the morale hazard. The war exclusion relieves the insurer from another catastrophic loss exposure. The intentional loss exclusion relieves the insurer of liability if a loss is caused intentionally by an insured. Even "innocent" insured’s are excluded from Coverage. In some jurisdictions courts provided protection for innocent coinsureds when one spouse deliberately burned a house covered in a divorce settlement.