You Can Fight That 20% Hit on Partial Loss Claim

Next time your insurer offers to settle a claim involving a partial loss to your business property, check to see whether the company wants to deduct 20% from the settlement for “profit and overhead payable to a general contractor,” or words to that effect.

If so, kick and scream--because you might just win this fight. The state Department of Insurance, uncertain whether insurers may properly withhold such payments, has the practice under investigation, and although the department won’t say what it intends to do, it’s a good bet that the practice won’t fly in California.

For one thing, a U.S. court has already ruled against the practice in a Pennsylvania case involving State Farm Insurance Co. California law differs in important ways, but that might not matter.

The heart of the problem is in the fine print of your insurance policy.

These days most business owners buy “replacement-cost” insurance coverage on their business property. Such policies obligate the insurer, in the event of a claim, to pay “actual cash value” until the policyholder repairs a damaged building, and to pay all repair costs once completed. Where policies don’t define actual cash value, courts in states such as Pennsylvania take the phrase to mean the costs of repair or replacement less depreciation.

In California, however, the courts equate actual cash value with fair market value, by which they mean the price at which a willing seller would yield the property to a willing buyer.

This makes things simple in claims involving total losses. It complicates claims involving partial losses. For example, you can’t know the fair market value of part of a building. And fair market value may not reflect the actual cost of repair or replacement.

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Given the confusion, when a business owner submits a claim, some insurers pay the total cost of repairs, including contractor profit and overhead, without quibbling. Others pay contractor overhead and profit only when a contractor finishes the work.

Following the 1994 Northridge earthquake, some California homeowner insurers followed the latter practice in claims involving quake-damaged homes. They made good the shortfall if the homeowner hired a general contractor and completed the repairs, but not otherwise.

Some insurers of business property do the same thing, citing the principle that a policyholder cannot receive benefits to which he or she is not entitled.

“You can’t use an insurance policy to create a windfall,” as Cary Cheldin, president of Crusader Insurance Co. of Woodland Hills, puts it. “The point of insurance is to make the policyholder whole after a loss. But an insurance company can’t give a policyholder more money than the policyholder has actually lost.”

Put another way, you can’t get rich off of your insurer.

Insurers take this to mean that they needn’t pay claim costs not actually incurred by the policyholder. Some go further, however. In settling a claim involving, for example, a building damaged by fire, they routinely withhold 20% for contractor profit and overhead unless a general contractor actually oversees the repairs. Insurers don’t balk over such costs on claims involving total losses. But some do on claims involving partial losses.

In the 1994 case of Gilderman vs. State Farm, a Pennsylvania couple, challenged this practice on two grounds. State Farm sought to settle the Gilderman claim with a payment from which it deducted 20% for contractor profit and overhead.

The Gildermans argued that, as they had paid an additional premium for replacement-cost coverage, they stood to lose the benefit of their insurance if they elected not to repair their house. They also argued that in the absence of policy language to the contrary, State Farm could not take actual cash value to mean anything less than actual repair costs, including contractor profit and overhead.

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Put another way, they argued that actual cash value means repair costs--and repair costs necessarily include contractor profit and overhead.

The trial court sided with State Farm, but on appeal, the Pennsylvania Superior Court agreed with the Gildermans. “Repair or replacement costs logically and necessarily include any costs that an insured reasonably would be expected to incur in repairing or replacing the covered loss,” the court said.

Although California law differs, the Department of Insurance has the Pennsylvania ruling--and the claims practices of some insurers in this state--under study.

“Is the practice kosher in California? That I don’t know,” says Robert Hagedorn, the department’s assistant general counsel. “We’re aware of the Pennsylvania decision and aware of the practices of California insurers, and we’re looking into them.”

Adds David Stolls, chief of the department’s claims services bureau: “Under present law we feel it permissible for an insurance company to withhold certain portions of repair costs until the property is actually repaired.

“But we’re also finding some cases in which insurance companies are making deductions across the board--undocumented, arbitrary deductions for such things as depreciation. Sometimes these deductions aren’t justified.”

Depending on the results of its study, the insurance department may amend its fair claims practices guidelines or ask the Legislature to clear up the confusion.

For their part, insurers could of course rewrite their business policies to make it clear that they will pay the costs of contractor profit and overhead only if actually incurred by the policyholder.

To be sure, this would limit their risk. But in the insurance world, the higher your risk, the higher your premium. So any business owner who accepted the change could demand a cut in premium too.

Whether that happens or not, business owners might well challenge the practice. Another well-established principle in the insurance world is that the courts will side with the policyholder against ambiguities in an insurance policy. So the good bet is that insurers would lose.

Freelance writer Juan Hovey can be reached at (805) 492-7909 or by e-mail at [email protected]