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Vol. 6, Iss. 8
October 11, 2017

Is An Assault On The Flood Exclusion Coming?:
The Impact Of ISO’s Post-Katrina Amendments


The financial impact of Hurricanes Harvey and Irma – not to mention human -- will be monumental. Putting aside that you can’t find two loss estimates that are the same, the soothsayers’ numbers share thing in common – amounts in the many tens of billions of dollars.

When it comes to sources of money to restore Harvey and Irma’s destruction, insurance will be far and away the most sought-after. These payments can be large, made quickly and directly to those in need and with no repayment obligation. This cannot always be said about other sources of recovery funds, such as government and charities. The ability of obtain financial relief, under insurance policies, is clearly on the minds of many of those affected in Texas, Florida and other states.

Many of these hurricane claims will be complex. By their nature property policies can be complex – sometimes more so than liability policies – and the facts will matter a lot. But the facts at issue in hurricane claims can be subject to dispute – especially since there may have been no witnesses to the damage.

In the past couple of weeks there have been countless articles penned by lawyers discussing some of the coverage issues that may arise in Harvey and Irma claims. These have mainly involved commercial claim scenarios, with an emphasis on business interruption. But the claims that are going to get the most attention are those arising under homeowner’s policies. The number of such claims will dwarf all other types. In many cases businesses will be better able to absorb a denial of coverage than a homeowner. And homeowner’s claims have an emotional element that is lacking in commercial situations.

When it comes to homeowner’s policies, the flood exclusion (“water” or “water damage” exclusion to be technical) will take center stage. In general, homeowner’s policies provide coverage for wind damage but exclude flood damage. Therefore, in many claims, the question of what caused the damage – wind or water – will be pivotal. If it was wind only, then a homeowner can avoid the impact of the flood exclusion. If it is not clear, or if there is no dispute that damage was caused solely by flood, then the flood exclusion will be a hurdle to potential coverage.

In these cases, the flood exclusion will find itself on Dr. Quincy’s table and get the same dissection that it did following 2005’s Hurricane Katrina.

In Katrina claims, clear Mississippi law addressing the flood exclusion, and impact of the so-called “anti-concurrent causation” clause, was wanting. This lack of guidance was a cause of the extensive litigation over coverage. But, conveniently, the supreme courts of both Texas and Florida have recently provided guidance on wind versus water claims under property policies. See JAW The Pointe, LLC v. Lexington Ins. Co., 460 S.W.3d 597 (Tex. 2015) and Sebo v. American Home Assurance Co., 208 So. 3d 694 (Fla. 2016). These recent decisions may go a long way to help cut down on litigation to resolve disputes over Harvey and Irma claims.

ISO Amends Its Flood Exclusion

There will be plenty of similarities between Katrina claims and those arising from Harvey and Irma. But one issue will be unique. This time around, expect to see arguments made that Insurance Services Office’s 2011 amendments to the flood exclusion, contained in the organization’s homeowner’s policies, affects certain claims. This issue was addressed in a recent article by Bob Rutter, of Cleveland law firm Rutter & Russin, LLC, posted on the firm’s website. I’ll let Mr. Rutter explain the issue:

In May 2011, the Insurance Services Office (ISO) issued a new standard HO3 policy form. The HO3 is the most commonly used residential policy form in the United States. This edition of the HO3 expanded the water damage exclusion by explicitly exempting coverage for “storm surge.” Prior editions of the HO3, many of which are probably still in use, did not specifically exclude storm surge, so policyholders sometimes successfully argued that damage caused by storm surge was not excluded, and was therefore covered, under their version of the HO3 form. This argument is now bolstered by the new HO3 form. A policyholder can argue that if the prior HO3 form already clearly excluded storm surge, then why did ISO amend the form to list it separately. This may be enough to convince a court that since the old version of the HO3 form does not specifically exclude storm surge, it must not be excluded. Not being excluded equals being covered under “all-risk” property insurance policies.

Rutter and Russin are not the only ones to argue that ISO’s amendments to the flood exclusion could mean that, what’s now excluded was, by implication, intended to be covered under earlier policies. A white paper by California attorney Charles Miller – posted on the website for United Policyholders (an insurance consumer-advocacy group) -- posits that ISO’s addition of “storm surge” to the flood exclusion in 2011 gives rise to an argument that the earlier flood exclusion was ambiguous or the industry did not intend to exclude storm surge from earlier policies.

ISO, for its part, writing in its 2010 filing circular for its 2011 homeowner’s policy, described the impact of the flood exclusion amendments being as none: “There is no change in coverage relative to the intended design of the above referenced water exclusion endorsements.”

By way of background, ISO’s changes to its flood exclusion in fact date back to 2008, specifically acknowledged in a filing circular to have been on account of certain decisions in Katrina coverage cases. ISO discussed these cases and noted that appeals courts found the flood exclusions to be unambiguous. Nonetheless, ISO stated that it was amending the flood exclusion to “reinforce the scope of the provision.”

Specifically, in 2008, ISO introduced endorsements that amended its “water damage” exclusion, including changing its name to “water” exclusion. These amendments included such things as adding “storm surge” to the list of excluded types of water.

The now-named “water” exclusion was also amended to state that it applies regardless of whether excluded water “is caused by an act of nature or is otherwise caused.” In addition, the exclusion was amended to state that it “applies to, but is not limited to, escape, overflow or discharge, for any reason, of water or waterborne material from a dam, levee, seawall or any other boundary or containment system.” Among other things driving these changes were disputes in Katrina litigation whether “flood” included man-made flood, since so much damage was caused by the levee breaches is Louisiana.

This last amendment could be relevant in some Harvey claims, since water was released from overfilled reservoirs to prevent even further flooding. Putative class actions have already been filed by individuals and businesses who allege that the so-called controlled releases were the cause of the flooding that affected them.

In 2011, ISO’s 2008 flood exclusion endorsements were given a seat at the grown-up table and incorporated into the terms and conditions of its homeowner’s policies. So clearly the significance of this issue will be tied to the extent that homeowner’s policies, in effect today, contain a form issued prior to 2011. This is hard to know. In general, it is not unusual for insurers to issue policies that do not include the most current edition of a form.

In Mr. Miller’s paper, written in response to so-called Superstorm Sandy, he addresses the principal issue that will be at the heart of determining the impact, or not, of these ISO flood exclusion amendments on Harvey and Irma clams. Specifically, will courts adopt the argument that, by changing a policy exclusion, insurers must have meant that, whatever is now being excluded, had previously been covered?

Courts nationally have addressed this issue and cases go both ways. Mr. Miller acknowledges as much. He concludes that the “better-reasoned decisions” are those that allow a court to consider a subsequent policy provision when interpreting a prior version of it. However, Mr. Miller cites no reasons for his conclusion.

On one hand, the issue should be stopped before it even starts. If a court determines that the flood exclusion in a pre-2011 policy form is unambiguous – as several appeals courts did in Katrina cases -- then resort to extrinsic evidence, such as the changes made in the 2011 form, should be impermissible off the bat.

However, if the question needs to be answered, the decisions that have addressed it will be carefully scrutinized. Of these decisions, expect to see Pastor v. State Farm, 487 F.3d 1042 (7th Cir. 2007) get much attention. Not only is the Seventh Circuit influential, but the decision was written by its recently-retired scion, Judge Richard Posner. Posner’s opinions are respected. [As part of preparing for an interview that I did of Judge Posner in 2014, I calculated that in about 1,700 cases courts cited to a Posner opinion with the added notation “(Posner, J.)” to make the point of its author. And in about 1,000 cases, courts did the same, but by expressly stating that a case it was citing to was penned by Posner.]

At issue in Pastor was a provision in a State Farm automobile policy that provided that the insurer will “pay you $10 per day if you do not rent a car while your car is not usable.” If you do rent a car, then State Farm pays a portion of the rental charge. A State Farm insured sought to represent a class of all State Farm insureds who, during a certain period, received payments for damage to their cars but, despite not renting a car, did not receive payment pursuant to the $10 per day clause.

At issue in the class certification process was the manner in which State Farm defines a “day.” Pastor argued that a “day” meant any part of a day. Her own car had been out of use for about an hour while she had its windshield repaired. State Farm argued that a “day” means 24 hours. In support of her interpretation, Pastor argued that, because State Farm made explicit in a subsequent version of the clause that “day” means 24 hours, the insurer made a “confession” that her interpretation of the original clause was correct. State Farm, on the other hand, maintained that the change was simply a clarification.

Judge Posner saw no “confession” by State Farm’s change in its form. Moreover, he held that “to use at a trial a revision in a contract to argue the meaning of the original version would violate Rule 407 of the Federal Rules of Evidence, the subsequent repairs rule, by discouraging efforts to clarify contractual obligations, thus perpetuating any confusion caused by unclarified language in the contract. Rule 407 is not limited to ‘repair’ in the literal sense. (several citations omitted). It was applied to the meaning of an insurance clause in Hickman v. GEM Ins. Co., 299 F.3d 1208, 1213-14 and n. 9 (10th Cir. 2002). . . . Pastor wants to use the evidence that State Farm, to avert future liability to persons in the position of the plaintiff, changed the policy, to establish State Farm’s ‘culpable conduct.’ That is one of the grounds that evidence of subsequent corrective action may not be used to establish.” Id. at 1045.

Hickman v. GEM Ins. Co., the decision cited by Posner, involved claims that a medical benefits insurer wrongfully refused to fully pay certain hospital room and board charges. The Tenth Circuit declined to consider evidence of an insurer’s later handling of hospital room and board charges on the basis that it was inadmissible as a subsequent remedial measure under Rule 407 of the Federal Rules of Evidence.

More recently, in Reynolds v. University of Pennsylvania, 483 Fed. Appx. 726 (3rd Cir. 2012), the Third Circuit addressed a dispute over the characterization of a degree from the University of Pennsylvania. A student in Penn’s Executive Masters in Technology Program was denied the right to claim the status of a Wharton School alumni. At the time that the student enrolled, the EMTP website stated that he was entitled to do so. The trial court declined to admit evidence that Penn made changes to the website to state that EMTP graduates are “honorary” members of the Wharton alumni network. In affirming, the appeals court relied on both Hickman and Pastor to conclude that the website changes were inadmissible under Rule 407.

There are more cases than these on whether Rule 407 precludes evidence of a so-called subsequent remedial measure outside of the bodily injury arena. Admittedly this is not meant to be, nor could it be, an exhaustive analysis of the issue. Policyholder attorneys will, of course, see the landscape differently. Much more discussion and analysis of this issue can be expected as coverage litigation over Harvey and Irma claims is inevitable. There are just too many claims, too many different loss scenarios and too much at stake to prevent that. If the ISO-change argument, as it should be, is not stopped in its tracks, based on the pre-2011 flood exclusion being unambiguous, then the impact of the 2011 changes is an issue that is likely going to be addressed in certain flood claims. But ISO’s statement that it intended no change in coverage, and the purpose of FRE 407, precludes any consideration of the change.

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