Can the Indirect Consequences of an Indirect Loss be Insured

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by Christopher J. Boggs, CPCU, ARM, ALCM

Ordinance or law losses are indirect losses flowing out of a direct property loss. Essentially, the application of building codes can turn an otherwise partial loss into a total loss; and sometimes the local building code can cause loss where none existed. Such is the case in a personal lines ordinance or law loss in which I recently became involved.

Local ordinances or laws can increase the cost of rebuilding and time required to rebuild the damaged house following a “major damage” loss. As detailed in “Local Governments Increase Homeowners’ Loss – Personal Lines Ordinance or Law,” there is no one definition of “major damage;” each jurisdiction codifies its own rules regarding what triggers the ordinance or law requirement and what must occur once triggered.

It’s the differences in jurisdictional application of ordinance or laws that create problems for agents. First, the agent must undertake to ascertain the particular jurisdiction’s laws; second, he must plan insurance coverage accordingly. Neither requirement is necessarily easy to accomplish; nor does successful accomplishment of both guarantee that every ordinance or law-induced loss will be covered by the policy.

Sometimes, all the agent did is all that he could have done. Doing everything right may still leave the client subject to a very expensive uninsured loss. Not every possible loss can be anticipated; neither can every possible loss be covered.

The Loss That Triggered Jurisdictional Involvement

Fire damage to the single-family residence surpassed the jurisdictional definition of “major damage,” triggering the application of current building codes to the damaged house. The codes require that the dwelling be torn down and rebuilt to comply with current building standards. (Remember, ordinance or law coverage only pays the cost to rebuild the structure to comply with the building code at the time of the loss, not when the codes in effect when the structure is rebuilt.)

In addition to the house, there is also a detached garage on the premises. The garage suffered no damage other than some smoke stains on the outside walls which can likely be easily cleaned. However, the local codes say that since the house has to be torn down, so too does the garage – even though not damaged.

Since the garage is detached, the reconstruction of the house does not involve the garage; but it must still come down. Is the garage covered under personal lines ordinance or law policy provisions? How will the policy respond to this indirect consequence of an indirect loss?

How Ordinance or Law Applies

The short answer to the above questions – NO! There is no coverage for the garage provided in the ordinance or law wording and the policy will not pay for its destruction, removal or reconstruction. For coverage to apply, the ordinance or law loss must result from direct damage to the structure itself. Further, it’s not just the presence of damage that triggers coverage (as the smoke stains constitute damage), but damage to such a degree that the structure must be torn down and rebuilt.

To cross the requisite jurisdictional threshold generally requires that the amount of damage exceed some percentage of the structures “value.” Each jurisdiction uses its own definition of “value,” some mean replacement cost, others actual cash value and many use market value. Regardless of the particular jurisdiction’s definition, it is not likely the cost to clean up smoke damage will eclipse that value.

Plus, it is not the damage to the garage that is necessitating its destruction; it’s solely the actions of the government. The local jurisdiction has ruled, through interpretation of local building codes, that without the presence of the house, the garage no longer “fits” the neighborhood and must be torn down. The garage would have been allowed to remain (grandfathered) only as long as the house was there.

Ordinance or law coverage in the homeowners’ policy requires that the damage ultimately lead to the structure’s destruction be from a covered peril. Governmental action is excluded with but one exception that does not apply in this loss situation – the destruction of a structure to stop the spread of a fire. In this case, the local government is seizing this garage and requiring its destruction simply because it doesn’t meet neighborhood sensibilities.

Ordinance or Law Provisions and the Garage

In many states, Insurance Services Office’s (ISO’s) homeowners policy allows the insured to apply up to 10 percent of Coverage “A” (Dwelling) to the increased cost incurred as a result of the enforcement of an ordinance or law. However, the three ordinance or law cost descriptions include limits on the protection within the description. The ISO policy wording follows:

11.a. You may use up to 10% of the limit of liability that applies to Coverage A for the increased costs you incur due to the enforcement of any ordinance or law which requires or regulates:
(1) The construction, demolition, remodeling, renovation or repair of that part of a covered building or other structure damaged by a Peril Insured Against;
(2) The demolition and reconstruction of the undamaged part of a covered building or other structure, when that building or other structure must be totally demolished because of damage by a Peril Insured Against to another part of that covered building or other structure; or
(3) The remodeling, removal or replacement of the portion of the undamaged part of a covered building or other structure necessary to complete the remodeling, repair or replacement of that part of the covered building or other structure damaged by a Peril Insured Against.

Provision “11.a.(1) pays the increased cost to demolish, renovate and/or repair THAT part of the building actually damaged by a peril insured against. The only damage to the garage is the smoke damage and the discoloration of the smoke is not the reason the garage must be removed. This only pays for the part that was damaged by a covered peril and must be removed and rebuilt to current code because of that damage. Coverage is not extended to any undamaged section of the structure under this provision.

The cost to tear down and remove the undamaged part of the structure is the focus of part “11.a.(2).” But again, the ordinance or law protection extends only if the undamaged part of the structure must be torn down because the damaged part of the structure triggered jurisdictional involvement and the enforcement of the local building codes. If provision “11.a.(1)” above does not apply, neither does this one. Again, the garage is not extended coverage under this provision within the ordinance or law protection.

Finally, “11.a.(3)” states that the policy will pay to rebuild the undamaged part of the structure to current building code. Remember, the undamaged part was torn down because of direct damage to the structure. Again, since the garage is not being torn down as a result of direct damage to the structure, but because of a governmental action, this part extends no coverage to the garage.

Without any direct damage to the garage by a covered cause of loss necessitating its destruction under local building codes, there can be no ordinance or law protection extended from the policy.

Can Coverage be Found

Unfortunately, there is no coverage in the ordinance or law section in the homeowners’ policy nor in any endorsement to the ordinance or law section promulgated from ISO. The loss to the garage is not caused by a peril insured against; rather it is caused by a specifically excluded cause – governmental action.

Lacking any direct damage, the agent could not have done anything within the standard market to acquire coverage for this loss. There may be coverage in the non-standard market for such a claim, but at what cost and under what terms?

Final Point

Notice in the above ordinance or law policy wording that only 10 percent of Coverage “A” is given to cover all the costs associated with an ordinance or law loss:

  • The cost to rebuild the damaged part of the structure to current building code;
  • The cost to tear down and remove the undamaged part of the structure; and
  • The cost to rebuild the undamaged part of the structure to current building code.

Ten percent of a policy with $300,000 Coverage “A” limits is only $30,000. That is likely not nearly enough to pay all these expenses following an ordinance or law loss. Agents should consider increasing this by endorsement (by use of the HO 04 77, state specific or insurer proprietary endorsement).

Other Articles on Personal Lines Ordinance or Law

Four prior articles have been written covering this subject. Following are the links to these posts.

Ordinance or Law for Homeowners Series

  1. How Local Government Can Increase Homeowners Loss – Personal Lines Ordinance Or Law
  2. How Local Government Increases Homeowners’ Losses – Part II
  3. Local Governments Increase Homeowners’ Loss – Part III
  4. A Letter To Your Homeowner Clients – Ordinance Or Law Exposure

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  • July 20, 2009 at 2:53 pm
    william j odom says:

    chris- thank you for your usual totally awesome treatment of this particular subject.

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