Water, Water Everywhere ... But is it Covered?

Policyholder Advisor & Alert

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PUBLISHED ON: June 17, 2011

The ubiquity of floodwater this spring in this country and in Japan should serve as a warning to businesses that do not have flood insurance to consider getting it. Flood insurance will protect a company's own property, and they also protect its profits when its customers or suppliers suffer flood damage. Fortunately, even businesses without flood insurance that were recently damaged when the Army Corps of Engineers opened flood gates in Louisiana may be covered.

Many American businesses have prepared insurance claims for lost profits resulting from the tsunami in Japan, only to have their insurance company deny coverage because they do not have flood or earthquake insurance. The claims are made under the contingent business interruption coverage found in many commercial property policies, which insure against lost income resulting from damage to the property of suppliers or customers. One requirement of that insurance is that the damage would have been covered if it had happened to the policyholder's own property. Businesses which do not have flood or earthquake insurance for their own property are probably not covered for losses arising out of the disaster in Japan.

However, not having flood insurance does not necessarily mean there is no coverage in every instance when property is inundated by water. In Southeast Missouri and Louisiana, the Army Corps of Engineers deliberately opened floodgates and breached levees, inundating lightly populated areas in an apparently successful bid to relieve pressure on the Mississippi River to forestall flooding in New Orleans, Baton Rouge and other densely populated areas. Thus, in a sense, some areas have been subjected to man-made flooding, and would have been spared absent human action. Indeed, property owners claiming to represent more than 60,000 acres in the floodway have sued the federal government, claiming that an intentional breach to the Bird Point levee violated their Fifth Amendment rights, prohibiting the government from seizing property without just compensation.

Whatever constitutional questions it raises, the intentional release of water will also have insurance implications. The distinction between water damage caused by the deliberate act of government authorities, and that which results solely from the wrath of Mother Nature may provide a lifeline for some businesses when they argue against the application of flood exclusions in their property policies.

In the wake of Hurricane Katrina, policyholders argued against the application of flood exclusions on the ground that the proximate cause of damage was human negligence, not storm surge. Those arguments were rejected by the United States Court of Appeals for the Fifth Circuit on the grounds that even if human folly played a role, there was a storm surge which fell squarely within flood exclusions in many policies. The court also predicted that under Louisiana law the so-called anti-concurrent causation clauses found in most policies would be enforced to bar coverage as long as an excluded flood occurred at any step in the causal chain-reaction leading to a loss.

In an attempt to avoid the same fate as the victims of Katrina, businesses without flood insurance that have suffered from the recent flooding may be able to argue that the damage was caused solely by intentional human conduct, and therefore falls outside the scope of exclusions. This will be an issue of first impression for the courts in Louisiana, Missouri and neighboring states, but policyholders and insurance companies alike will be able to find support in cases from other jurisdictions addressing analogous situations. For example, some courts have held that a flood and surface water exclusion does not apply to damage caused by a backed-up storm sewer system, even where the problem resulted from excessive rainfall, reasoning that water loses its character as surface water when it is channeled through a pipe. Victims of deliberate flooding could likewise argue that the river water does not take on the character of floodwater once it has been channeled and deliberately disposed of in an area that would not otherwise have flooded. On the other hand, a recent, unreported Massachusetts superior court decision held that a flood exclusion barred coverage when a municipality intentionally released water from a dam.

Although the extent of coverage for flood-related losses is often uncertain, policyholders should carefully consider the language of their policies and the circumstances of their losses, and not simply accept a denial of coverage.