Oil Spill - Insurance Implications

"Hurricanes and Oil Don't Mix"
Insurance Implications of the Gulf Oil Spill

(Editor's note:This article is a product of the Independent Insurance Agents and Brokers of America and is used with permission)

Most times "Oil and water don't mix"...until now. With hurricane season just underway and oil still gushing into the Gulf of Mexico, it might only be a matter of time before oil and water do mix to create a potential insurance claim. So, if oil ends up in/on your insureds' property, is it covered?

First, it is important to note that insurance policies differ. Therefore, the discussions herein are restricted to standard ISO coverage forms. Insurance practitioners and policyholders must consult the specific policy which insures the damaged property in order to make a final determination as to whether or not there is coverage. Also, in many instances, coverage will be fact dependent and the necessary generalizations in a coverage discussion such as this may or may not apply to your insured's specific circumstances and policy forms.

Fundamental to any direct property damage claim is the requirement for damage to covered property by a covered cause of loss. (Note: Some indirect coverages such as business income may only require damage to property - not necessarily covered property - to trigger coverage.)

Numerous coverage provisions of the current ISO HO 00 03 Homeowners policy and the ISO CP 00 10 Commercial Property coverage form could come into play in a hurricane, such as direct property damage, loss arising from orders of civil authority, additional living expenses, business income and extra expenses, debris removal, and so forth.

However, all these coverage provisions require that there first be damage by a covered cause of loss. Therefore, the key to determining whether or not any of these various coverage provisions would apply to a hurricane-and-oil loss would hinge on what role the hurricane played in putting oil into or onto an insured's covered property.

Since damage by a hurricane has a water component and a windstorm component, each requires examination.

Coverage for direct damage caused by waterborne oil

This would be the result of the classic "storm surge" that every coastal resident is all too familiar with. During a press conference on the eve of the 2010 hurricane season, NOAA Administrator Jane Lubchenco commented that "if there is a hurricane in the Gulf of Mexico, and it makes landfall someplace on the Gulf Coast, it is possible that some of the oil that's on the surface might be transported through the storm surge on the coastal area as high as the storm surge goes."

In addition, while a meteorologist would have to gauge its feasibility, it's conceivable that a hurricane could deposit oil farther inland in the form of heavy rains.

Coverage Under ISO HO and CP Forms. In the wake of litigation following Hurricane Katrina, ISO revised the water damage (so-called "flood") exclusions in the Homeowners, Dwelling, Commercial Property, and BOP coverage forms. The revised language is presently added to existing coverage forms by way of mandatory endorsements for each type of policy. In the future, the new language will be incorporated into the body of each policy at the next revision.

Below is the new water damage/flood exclusion (emphasis added for later discussion). This exhibit is from the HO 16 10 01 09 which is mandatory for the HO 00 03 and HO 00 05. There are different versions of this same Water Exclusion Endorsement promulgated for use with the other HO forms, as well as for Dwelling, CP, and BOP forms. The other versions differ only in the reference to specific provisions in the existing forms to which the exclusion applies. The essential scope of the new water damage exclusion is the same for all coverage forms.

water exclusion endorsement

SECTION I - EXCLUSIONS

A.3.Water Damage is replaced by the following:

3.Water

This means:

a.Flood, surface water, waves, including tidal wave and tsunami, tides, tidal water, overflow of any body of water, or spray from any of these, all whether or not driven by wind, including storm surge;

b.Water which:

(1)Backs up through sewers or drains; or

(2)Overflows or is otherwise discharged from a sump, sump pump or related equipment;

c.Water below the surface of the ground, including water which exerts pressure on, or seeps, leaks or flows through a building, sidewalk, driveway, patio, foundation, swimming pool or other structure; or

d.Waterborne material carried or otherwise moved by any of the water referred to in A.3.a. through A.3.c. of this Exclusion.

This Exclusion (A.3.) applies regardless of whether any of the above, in A.3.a. through A.3.d., is caused by an act of nature or is otherwise caused.

This Exclusion (A.3.) 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.

However, direct loss by fire, explosion or theft resulting from any of the above, in A.3.a. through A.3.d., is covered.

All other provisions of this policy apply.

Copyright ISO Properties, Inc.

Regarding the issue of oil which has been deposited by the storm surge, section A.3.d. now clearly excludes damage by "waterborne material carried or otherwise moved by any of the water..." For insurers who have not adopted the revised water damage exclusionary wording related to "waterborne material," damage done to covered property by the oil might be covered under the exception to the pollution exclusion - discussed in the next section below.

Otherwise, this would appear to exclude claims arising from waterborne oil. In addition, note that the exclusion applies whether caused by an act of nature "or is otherwise caused" (e.g., by an oil rig mishap). The exclusion goes on to say that it applies to discharge of waterborne material from any other boundary "or containment system" (e.g., an underwater well?). Finally, any resulting "direct loss by fire, explosion" is covered; however, in this case, the waterborne material, at best, resulted from fire or explosion, not vice versa.

It is important to note that the Water Damage exclusion is found in the so-called "anti-concurrent causation" (ACC) section of the policy exclusions. Therefore, where water has been pushed ashore by the force of the windstorm (as a "storm surge"), the damage done by the water is still excluded, as stated in the introduction to the ACC exclusions [emphasis added]: "We do not insure for loss caused directly or indirectly by any of the following. Such loss is excluded regardless of any other cause or event contributing concurrently or in any sequence to the loss. These exclusions apply whether or not the loss event results in widespread damage or affects a substantial area."

Coverage Under NFIP Flood Forms. Since the standard ISO policies exclude damage from both "water" ("flood") and "waterborne material," it is important to examine how the NFIP flood policies (Dwelling Form and General Property Form) address the issue of pollutants such as oil which are often present in a flood. In fact, flood waters are frequently a witch's brew of all sorts of pollutants, including sewage, household, lawn care and industrial chemicals, automotive fuels and lubricants, medical waste, garbage, and myriad other kinds of gunk.

In the Dwelling Form, the only exclusion in Section V - Exclusions that references pollution is the following:

Exclusions. F. We do not pay for the testing for or monitoring of pollutants unless required by law or ordinance.

In Section III - Coverage D Increased Cost of Compliance, the following pollution-related exclusion is included, related to testing and monitoring, etc. of pollution:

Exclusions. 5.b. The cost associated with enforcement of any ordinance or law that requires any insured or others to test for, monitor, clean up, remove, contain, treat, detoxify or neutralize, or in any way respond to, or assess the effects of pollutants.

In the General Property Form, there is no pollution exclusion in Section V - Exclusions. However, in Section III - Other Coverages, there is a sublimit of $10,000 for pollution damage, as follows:

3. Pollution Damage

We will pay for damage caused by pollutants to covered property if the discharge, seepage, migration, release, or escape of the pollutants is caused by or results from flood. The most we will pay under this coverage is $10,000. This coverage does not increase the Coverage A or Coverage B limits of liability. Any payment under this provision when combined with all other payments for the same loss cannot exceed the replacement cost or actual cash value, as appropriate, of the covered property. This coverage does not include the testing for or the monitoring of pollutants unless required by law or ordinance.

As in the Dwelling Form, the General Property Form also has a pollution exclusion in Section III - Coverage D Increased Cost of Compliance, related to testing and monitoring, etc. of pollution that is identical to Exclusion 5.b. above.

In the Dwelling Form, damage to covered property from a flood that is otherwise covered by the flood policy is not impaired by the presence of pollutants such as oil from the oil spill in the Gulf. In addition, testing or monitoring of pollutants which is required by a law or ordinance is also covered. For claims covered under Coverage D Increased Cost of Compliance (ICC), the testing, monitoring, clean up, etc. that is required by ordinance or law is not covered. Note that ICC only has a limit of $30,000.

Under the General Property Form, there is no pollution exclusion for damage to covered property, but there is a sublimit of $10,000 for damage by a pollutant where a flood caused the discharge, seepage, migration, release, or escape of the pollutant - in this case, oil from the Gulf. It is unclear exactly how a claims-adjustment expense specifically related solely to damage by the pollutant (oil) can be determined in situations like a storm surge. However, to the degree that such costs can be isolated and assigned to the presence of a pollutant such as oil, the sublimit of $10,000 would apply.

Coverage for direct damage caused by windborne oil

It is plausible that a strong hurricane or a waterspout could pick up a quantity of oil and deposit it miles inland, onto or into a home or business. The coverage analysis now revolves around the pollution exclusion since windstorm itself is a covered peril in the ISO Homeowners, Dwelling, Commercial Property/Causes of Loss, and BOP forms. However, damage by pollution is excluded unless the release, escape, migration, etc. of the pollutant is caused by a specific named peril.

The Special Causes of Loss pollution exclusion in these coverage forms (e.g., HO 00 03 and CP 10 30) is essentially the same, with minor variations. The following policy excerpt incorporates the primary language of the Homeowners and Commercial Property pollution exclusions to illustrate the similarities and minor differences:

Exclusions.

"Discharge, dispersal, seepage, migration, release or escape of pollutants unless the discharge, dispersal, seepage, migration, release or escape is itself caused by a Peril Insured Against named under Coverage C." [HO 00 03}...or "by any of the 'specified causes of loss' ." [CP 10 30].

Therefore,it could be argued that fire, explosion or windstorm caused the pollutant (oil) to be released, escape, migrate, etc., and therefore any damage done by windstorm-deposited oil would be covered. Note, however, that this exception to the pollution exclusion would not apply to damage done by water (i.e., the storm surge), due to the "anti-concurrent causation" language in the water damage exclusion previously discussed. Also, keep in mind that, aside from the dispersal by windstorm, this presumes that the originating cause of the spill was explosion or fire.

And, while there is no pollution exclusion in any of the Named Peril coverage forms (HO 00 02, HO 00 04, etc., and CP 10 10 and CP 10 20), since these forms cover fire, explosion or windstorm, damage done by the oil which was deposited on the covered property as a result of fire, explosion or windstorm could be covered due to the doctrine of proximate cause. Since the pollution exclusion is not contained in the "anti-concurrent causation" section of the exclusions, the doctrine of proximate cause can be applied to loss situations.

Coverage for indirect or consequential losses

In the standard ISO property coverage provisions in personal lines and commercial lines, indirect or consequential losses such as business income and extra expense, additional living expenses, civil authority, debris removal, pollution cleanup, etc. are triggered if there is first direct damage by a covered cause of loss.

For example, there have already been reports of condo rental cancellations by vacationers and hotel cancellations by conventioneers. These cancellations arise from the uncertainty of future conditions, so the resulting loss of income is not due to direct damage on premises by a covered peril.

As discussed earlier, where the direct damage coverage form excludes such damage by oil related to the action of a hurricane, then there would also be no coverage for any indirect or consequential losses that might otherwise be afforded by a particular policy.

But, where a particular coverage form provides direct damage coverage for oil damage related to a hurricane, then the precondition of damage by a covered cause of loss has been met. At that point, the other conditions precedent to coverage can be analyzed as they normally would. For example, even if the cause of loss is covered, if a dwelling is still "fit to live in" or a hotel building is still "tenantable," there may still be no coverage.

Last Updated: June 4, 2010.

This article is a collaborative effort of the VU faculty, lead by Mike Edwards, CPCU, AAI, and assisted by Bill Wilson, CPCU, ARM, John Eubank, CPCU, ARM, and David Thompson, CPCU, AAI.

Copyright 2010 by the Independent Insurance Agents and Brokers of America. All rights reserved.

Includes Copyrighted Material of Insurance Services Office, Inc. With Its Permission. Copyright Insurance Services Office. 2010

NOTE: Policy coverages and circumstances can change at any time, so the information above may not be accurate at the time of reprinting or subsequently to that time. IIABA does not assume and has no responsibility for liability or damage which may result from the use of any of this information. The most current, up to date version of this article can be found at IIABA's Virtual University at http://www.iiaba.net/VU or email bill.wilson@iiaba.net.