The earthquake that struck Northern California in August 2014 serves as a reminder of how quickly business policyholders can face devastating losses. In the aftermath of an earthquake, businesses may face pressing challenges, including restoring interrupted operations and repairing damaged buildings or equipment. To help ensure that they have maximized the financial resources available to meet those daunting challenges, companies should also be sure to consider whether their insurance policies afford coverage for earthquake-related losses. Furthermore, business policyholders not affected by an earthquake now may nonetheless wish to assess their property coverages to determine the degree to which they may have coverage for earthquake-related losses in the future and whether to purchase additional coverage.

The scope of each policyholder’s earthquake coverage and the prospects for success on its claim for insurance coverage will vary depending upon a number of factors, including the policy language at issue, the governing law, and the facts of a claim.

In this Alert, we (i) identify first-party property policies as the main source of coverage for earthquake-related losses, (ii) provide information regarding financial considerations involved in purchasing earthquake insurance, (iii) examine certain key issues related to the application of earthquake exclusions in property policies, (iv) describe types of losses that may be covered, and (v) suggest some initial steps policyholders should consider taking when confronted with seeking insurance coverage for earthquake-related losses.

First-Party Property Policies Provide the Main Source of Coverage for Earthquake-Related Losses

Multi-Peril and Stand-Alone Property Policies May Provide Earthquake Coverage
The first place for policyholders to look for coverage for earthquake-related losses is their first-party property policies. Such policies insure the assets of businesses. Regarding earthquake coverage, these policies may take the form of general “all-risk” or “difference-in-conditions” property policies that add earthquake coverage by endorsement or stand-alone earthquake insurance policies. Policyholders that do not currently have insurance specifically for earthquakes may wish to consider purchasing such coverage for future earthquake-related losses, taking into consideration the sometimes-significant premiums and deductibles associated with such insurance.

Purchasing Earthquake Insurance—Financial Considerations
If a business is seeking to purchase earthquake insurance, it should be aware that premiums can vary widely based upon a number of factors, including the level of earthquake risk, the property insured (including the age, design, materials, and condition of any structures), the scope of coverage provided, and the insurer. Typically, premiums are calculated on the basis of the value of the insured property, with the premium rate stated as being applicable to $1,000 of property value.[1] According to the California Department of Insurance, the average premium rate for policies providing earthquake coverage as part of a commercial multi-peril policy in that state in 2013 was $1.36;[2] thus, if a commercial policyholder purchased a multi-peril policy that included earthquake coverage for property valued at $1 million, applying the average 2013 California premium rate per $1,000 in insured property would result in a premium of $1,360.[3]

Policyholders should also be aware that earthquake insurance typically does not provide first-dollar coverage. Deductibles may range from 2 percent to 20 percent of the replacement cost of insured property, although deductibles are more typically in the range of 10–20 percent in locations with an increased risk of earthquakes.[4] Going back to the example of a policyholder with property valued at $1 million, if a deductible applicable to property losses for a particular policy was set at 15 percent, or $150,000, coverage would only be available under that policy for property losses in excess of $150,000.

Despite what may be substantial premiums and large deductibles, policyholders may nevertheless still find it to their advantage to purchase earthquake insurance. Whereas the 6.0‑magnitude Napa earthquake that occurred in August 2014 is estimated to have caused damage potentially exceeding $1 billion,[5] previous earthquakes have caused much more damage:  the 8.3‑magnitude 1906 San Francisco earthquake caused $524 million in combined earthquake and fire damage (unadjusted for inflation), although it is estimated that a similar earthquake in San Francisco today would cause more than $96 billion in property damage.[6] The Loma Prieta earthquake that struck the Bay Area in October 1989 caused an estimated $10 billion in total property damage, and the Northridge (Los Angeles) earthquake in January 1994 inflicted roughly $44 billion in damage (both numbers unadjusted for inflation).[7] Thus, although the United States has been fortunate in avoiding the proverbial “Big One” in recent times, the not-too-distant past cautions that future earthquakes could very well cause enormous levels of property damage.

Furthermore, although earthquakes are commonly associated with states like California, in actuality, the risk of earthquakes spreads across the United States. According to a recent report from the U.S. Geological Survey, 42 of the 50 states have “a reasonable chance of experiencing damaging ground shaking from an earthquake in 50 years.”[8] Moreover, the 16 states at the highest level of risk for earthquakes are not only on the West Coast but throughout the central and eastern United States.[9] Many readers in the eastern U.S. may recall feeling the tremors of the earthquake centered in Virginia in August 2011.[10] Also, it is worth recalling the New Madrid earthquakes of 1811 and 1812, which (1) struck Missouri, Tennessee, and neighboring states; (2) involved three quakes ranging from approximately 7.3 to 7.5 on the Richter scale; (3) caused damage across approximately 600,000 square kilometers; and (4) reshaped the land in the area surrounding the earthquakes.[11] In consideration of such past experiences, policyholders outside of states traditionally associated with earthquakes may wish to consider the benefits of obtaining earthquake insurance.

In addition, it is useful to consider the earthquake insurance market in a country with much more recent experience with devastating earthquakes than the United States. In Japan, in the wake of the 1995 Kobe earthquake and the 2011 earthquake and tsunami, the percentage of consumers purchasing earthquake insurance has increased for 11 consecutive years.[12] Furthermore, the area of the country with the highest percentage of earthquake insurance penetration is an area that was hit hard by the 2011 earthquake and tsunami.[13] The Japanese experience suggests that policyholders there learned to value earthquake insurance in the wake of catastrophic earthquake-related damage, and it may also counsel that policyholders elsewhere also consider purchasing such insurance before the next earthquake strikes.

Possibility of Coverage Despite Earthquake Exclusions
As a general matter, unless a policyholder has specifically purchased earthquake coverage, most first-party property insurance policies contain exclusions for losses related to earthquakes. The following are examples of earthquake or “earth movement” exclusions:

This policy does not apply to earth movement, including but not limited to, earthquakes, landslide, mudflow, earth sinking, earth rising, or shifting.

* * *

This policy does not apply to… earth movement, meaning earthquake, including land shock waves or tremors before, during or after a volcanic eruption; landslide; mine subsidence; mudflow; earth sinking, rising or shifting.

Policyholders and insurers often dispute whether such earthquake exclusions apply to a particular loss.  Several states apply an “efficient proximate cause” rule, such that earth movement exclusions do not apply unless an excluded peril, like an earthquake, was the single proximate cause of the policyholder’s loss.[14]

However, California policyholders should be aware that Section 10088 of the California Insurance Code narrows the application of the “efficient proximate cause” rule in that state, providing that policies with an earthquake exclusion do not provide coverage for earthquake-related losses if the earthquake was a proximate cause of the loss.[15] Thus, insurers will utilize Section 10088 as a basis to argue for the application of earthquake exclusions in a variety of circumstances. Significantly for policyholders, Section 10088 does not apply to coverage under a fire insurance policy for losses related to a fire following an earthquake.[16]

Application of an earthquake exclusion is necessarily fact-sensitive, particularly in states applying a version of the “efficient proximate cause” rule. Simply because an insured’s losses may be partially attributable to an earthquake does not mean that the earthquake exclusion applies. Policyholders should consider whether another risk, such as fire or the negligent design or construction of a building, was the proximate cause of loss. Policyholders should be prepared to challenge insurer attempts to escape coverage by relying upon an earthquake exclusion.

Know the Losses That Your Policy May Cover

Policies Cover More Than Just Property Losses
In order to maximize their insurance recovery, policyholders should compare their earthquake-related losses with the categories of loss covered by their policies:

• “Property Damage” coverage for any property that may be classified as “insured property;”
• “Business Interruption” coverage, which may cover the policyholder’s loss of earnings or revenue resulting from property damage caused by an insured peril (although insurers often dispute the proper quantification of the insured loss);
• “Contingent Business Interruption” coverage, which may cover the insured with respect to losses, including lost earnings or revenue, as a result of damage to property of a supplier, customer, or some other business partner or entity;
• “Extra Expense” coverage, which may cover the insured for certain extra expenses incurred by the insured in order to resume normal operations and to mitigate other losses from the insured event;
• “Ingress and Egress” coverage, which may cover the policyholder when access to a business premises or location is blocked for a time;
• “Civil Authority” coverage, which may cover the insured for losses arising from an order of a governmental authority that interferes with normal business operations;
• “Service Interruption” coverage, which may cover the policyholder for losses related to a power supply interruption;
• “Defense” coverage, which may cover the insured for defense costs incurred with respect to claims alleging that the insured is responsible for damage to covered property of others; and
• “Claim Preparation” coverage, which may cover the costs associated with compiling and certifying a claim for coverage.

Coverage for any one or more of the types of losses a policyholder may incur can provide valuable sources of recovery for a business and should be considered carefully. In addition, each of these types of coverage may be subject to differing limits of coverage as well as varying deductibles, meaning that even if an insured’s losses in one category are insufficient to exhaust a deductible and attach coverage, losses in another category may exceed a deductible’s limits or not be subject to a deductible at all.

Business Interruption Coverage
As noted above, an insured may have a claim for business interruption coverage when its income is adversely affected by an insured event such as an earthquake. Coverage for this category of loss may be vital to a business working to recover from an earthquake. Previous earthquakes demonstrate that an earthquake can cause huge business interruption losses.  According to one report, the 1994 Northridge earthquake caused an estimated $6.5 billion in business interruption losses,[17] as compared to an estimated $44 billion in property damage from that earthquake.  Moreover, estimates of business interruption losses caused by the 1995 earthquake in Kobe, Japan, reached $100 billion.[18] In light of such losses, business interruption coverage can be enormously valuable to policyholders affected by an earthquake.

In response to claims for such coverage, insurers often contest numerous issues. For example, insurers may take a narrow view of what constitutes an “interruption,” and they may also challenge whether the interruption to or reduction in an insured’s business was necessarily because of damage to the insured’s property. Insurers may also seek to dispute the amount of loss by arguing that the amount of lost profits that the policyholder is claiming is overstated because it does not take into account economic downturns, market trends, or other factors that the insurer may argue affected profits at the time of the interruption. There may be other limitations on coverage as well; for example, some policies limit the length of time for which business interruption coverage is available after the insured event occurs (i.e., the recovery period).

Nevertheless, policyholders whose income has been negatively affected by an earthquake should consider the availability of this potentially valuable coverage under their policies. In some instances, depending upon the amount of loss, available limits, and relevant deductibles, an insured may be entitled to a larger recovery for its business interruption losses than for its property damage losses.

In addition, although some policies require damage to “insured property” as a prerequisite to recovery of business interruption losses, other policies may include “contingent business interruption” coverage that permits an insured to recover losses that occur when a supplier, customer, or other entity has incurred property damage that results in an interruption to the insured’s business. The wording of an insured’s policy is critical to the availability of contingent business interruption coverage in such instances.

Advance Payments
Businesses may need an insurance recovery to resume normal business operations. Some insurance policies require that insurers make advance payments to cover losses as incurred while the full extent of the loss is being adjusted. Policyholders should review their policies to determine whether they provide for such payments.

Presenting a Claim for Coverage
Most policies identify specific procedures to be followed in presenting a claim, and some of these procedures may have timing deadlines associated with them. Failure to comply with these procedures may give insurers a basis to attempt to deny a claim otherwise covered under the policy.

An insured that has suffered earthquake-related losses should promptly collect and document its loss information, evaluate the information in light of the policy wording and applicable law, and present it to the appropriate insurers in a timely and coverage-promoting manner.

Evaluating Coverage for Earthquake-Related Losses
A policyholder’s right to recover losses related to an earthquake will depend upon the specific policy language at issue, the facts related to the insured’s claim, and the governing law. Careful and prompt evaluation of these issues can be crucial in determining whether a policyholder is able to recover. Additionally, policyholders may benefit from giving thought to the potential availability of coverage in advance of future earthquakes.

Notes:
[1] See “Earthquakes: Risk and Insurance Issues,” Insurance Information Institute (Aug. 2014). For the sake of comparison, the premium rate for commercial multi-peril policies that excluded earthquake coverage issued in California in 2013 was $1.13.

[2] See “Earthquake Premium and Policy Count Data Call; Summary of 2013 Residential & Commercial Market Totals,” California Department of Insurance (June 10, 2014), available at http://insurance.ca.gov.

[3] These numbers are only intended to be illustrative, and premium rates and deductibles could vary substantially based upon a number of factors, including those discussed above. Policyholders should consult with their brokers regarding the premiums and deductibles that may be available for earthquake coverage.

[4] See “Earthquakes: Risk and Insurance Issues,” Insurance Information Institute.

[5] See “PAGER - M 6.0 - 6.8 km (4.2 mi) NW of American Canyon, CA,” United States Geological Survey (2014, Alert Version 26), available at http://earthquake.usgs.gov.

[6] See “Earthquakes: Risk and Insurance Issues,” Insurance Information Institute.

[7] See id.

[8] See, “New Insights on the National’s Earthquake Hazard,” United States Geological Survey (Jul. 17, 2014), available at http://www.usgs.gov.

[9] See id.  The 16 states at highest risk are of experiencing an earthquake are Alaska, Arkansas, California, Hawaii, Idaho, Illinois, Kentucky, Missouri, Montana, Nevada, Oregon, South Carolina, Tennessee, Utah, Washington, and Wyoming.  Id.

[10] See Joel Achenbach, “5.8 Virginia Earthquake Shakes East Coast, Rattles Residents,” Washington Post (Aug. 23, 2011), available at http://www.washingtonpost.com.

[11] See, “Historic Earthquakes:  New Madrid 1811-1812 Earthquakes,” United States Geological Survey (2014), available at http://www.usgs.gov.

[12] See “Quake insurance buyers’ ratio hits new high in Japan,” Japan Economic Newswire (Aug. 25, 2014), via http://www.advisen.com.

[13] See id.

[14] See, e.g., State Farm Fire & Cas. Co. v. Von Der Leith, 820 P.2d 285, 291 (Cal. 1991); Safeco Ins. Co. v. Hirschmann, 773 P.2d 413, 414-16 (Wash. 1989); Murray v. State Farm Fire & Cas. Co., 509 S.E.2d 1, 12-15 (W. Va. 1998).

[15] Cal. Ins. Code § 10088 (2014).

[16] Id. § 10088.5.

[17] See “Business Interruption After Disasters: What Do We Know?” Peter Gordon (Jan. 16–17, 2014) (presented at the Northridge 20 Symposium), available at http://www.northridge20.org.

[18] See id.