Dilemmas/Complexities Faced by Insurers in Disaster Claims

The Great San Francisco Earthquake of 1906 offer a clear case study on this. The tragic dilemma faced was that if insurance claims were not paid the city would be lost. If paid, many insurers could become insolvent. It was found that around 28,000 buildings were destroyed, and out of the total population of 4 lakhs, more than 225,000 people became homeless. Giving a powerful signal to insurers the City’s Real Estate Board passed a resolution that the calamity should be spoken of as ‘the great fire’ and not as ‘the great earthquake.’ (San Francisco Chronicle, April 25, 1906). Hence the citizens took great care to refer to the “fire,” not the “earthquake” because most of those insured had only fire cover. This was owing to the fear that there could be fine print excluding damage by earthquake hidden in the policy. Some insured were reported to have deliberately put fire during the chaos to their own quake-damaged houses, in an effort to perfect their insurance claims.

So, the question was whether the 137 insurers and 17 reinsurers that had underwritten over $250 million of San Francisco property risks escape liability on the ground that the city’s devastation had been caused by an excluded peril? The earthquake had struck shortly after 5 am on April 18. The tremors caused stoves and chimneys to topple, gas lines to break, fuel and chemical tanks to rupture and electric wires to fall. Some reports, may be wrongly, had concluded that no more than 10% of the damage was caused by the quake and the immediate fires. However, there were many “fires” across the city – 35 to 40 of them. It was possible that many of the fires involved the intervention of some human agency—arson, dynamiting, back-firing, or plain inadvertence and negligence. In 1906 most homes were made of wood, and had wood/ coal stoves, brick chimneys.

The earthquake happened at about 5:15 a.m., so people shocked at the tremor could not go back to sleep and put on their stoves to prepare breakfast. The fire so started spread all over the house as the chimneys were blocked/ knocked off. It was thus even called “Ham and Eggs Fire.” It eventually burned over a very large area of the city. Many of these fires joined into a mega fire that became a wall of flame over a mile-and-a-half wide, with smoke up to five miles high, visible across the entire San Francisco Bay. The water mains had broken in about 300 places, leaving the city without the resources to quench the fire. The fire largely burned itself out on April 21.

 Behaviour of Insurers

1.      Legends were made because of some insurers such as Cuthbert Heath of Lloyd’s who had sent a cable to his office in San Francisco to the effect that they offer to pay all policyholders in full irrespective of the terms of their policies. It is said to have paid $100 million, a staggering sum in those days. It created a massive goodwill for Lloyd's.

2.      Some other insurers, particularly from Europe, “infamously” offered 75% compromises, or denied coverage, or abandoned the California market altogether.

3.      35 insurers deferred to a selected group of adjusters called the “Committee of Five” to take call on the liability to be paid, if at all.

4.      Fireman’s Fund, the main California-based insurer, lost its Head Office along with the records and other assets it contained. The Fund paid all its reserves to the affected insureds, then solicited new subscriptions from its shareholders, formed a new corporation, and caused the corporation to issue stock to claimants for their remaining losses. Observers hailed the company’s reorganizing for the benefit of its policyholders, rather than “folding [its] tent for good.”

All these were after intense pressure put by politicians and vocal policyholder groups, backed by the media. Ultimately it appears that around some 90% of the sum insured was paid. The Insurance Information Institute states that insurers settled approximately 100,000 claims. At least 12 US insurers and one Austrian and one German insurer went bankrupt. The amount paid in claims was roughly 100 times the amount paid for fire insurance policies that year. The earthquake effectively wiped out the industry profit earned over the preceding 47 years. However, it may be noted that such earthquakes happen once in 100 years or more. In fact, there has been no repeat of it in San Francisco. Given the nature of fire surpluses made in normal years (if proper risk premiums are charged), it would have possible to have evened out the losses after a few decades.

The majority of fire policies, it was seen, did not have exclusions for fire caused by earthquake. However, it was feared that insurers could invoke the “fallen building” clause: “If a building, or any part thereof, fall except as a result of fire, all insurance by this policy on such building or its contents shall immediately cease.” Almost every policy had notification and proof of loss clauses, which was proving to be a difficult if not impossible to comply with because when the building burnt, all records were also lost. It was noteworthy that none of the insurers appear to have used express earthquake exclusions, if any, they had in their policies, for damages caused by fire.

There was all round condemnation of 59 insurers who allegedly denied claims in full or paid paltry indemnity. Some other insurers made offers to settle claims on compromise, often at 75%. The Hamburg-Bremen Fire Insurance Company came in for special criticism because it was reported that while it was denying claims in California on a wholesale basis, it kept telling customers/investors in New York that funds were being sent to pay off the San Francisco claims. However, an unprejudiced study stated that “Hamburg-Bremen . . . settled its claims at 75 per cent.” However, as claims were denied by insurers from Europe, the Mayor of the City along with a policyholder committee made trips to Europe in 1906 to fight for settlements, and even cases were filed in the courts of Germany and Austria.

An important case was that of Levi Strauss Realty v. Transatlantic Fire Insurance Company of Hamburg, (1906). To avoid any accusation of bias, the judge was brought from the East of US (Washington), and jurors from northern California. The policy at issue, like most that had been issued in 1906, had no express earthquake exclusion. However, the lawyer for the insurer cited a provision in the California Civil Code, which excuse non-performance of obligations due to an “irresistible, superhuman cause.”  The Judge ruled that this law gave no excuse for avoiding an obligation to pay money, and directed the jury to return a verdict to pay $10,000 plus $58.33 in interest. The local press praised the decision as “admirable” and “clear-cut,” and a warning to the “cold-feet,” and the “crooked,”. However, it was a useless victory as the insurer had no assets in California and the insured would have to file a case all over again in Germany, under the German Law.

Badly drafted policy wording was also common. The Williamsburgh City Fire Insurance Company of Brooklyn, New York’s policy stated that “This company shall not be liable for loss caused directly or indirectly by invasion, insurrection, riot, civil war, or commotion, or military or usurped power, or by order of any civil authority; or for loss or damage occasioned by or through any volcano, earthquake, or hurricane . . . or when the property is endangered by fire in neighbouring premises, or (unless fire ensues and in that event for the damage by fire only) by explosion of any kind. . . .”

It appeared that the insurer had a strong defense because all the fires and ensuing damage caused “directly or indirectly” by the quake, or at least “occasioned” by it. However, courts did not agree. In the case Henry Hilp Tailoring Co. v. Williamsburgh City, the Judge initially ruled that if the quake caused a fire that spread from other property to the claimant’s property, the policy exclusion applied and judgment should be for the insurer. However, the Judge finally interpreted the policy more favourably to the insured. In Baker & Hamilton v. Williamsburgh City, he acknowledged that a quake might “indirectly” cause the inception of a fire. He seized on the distinction in the policy drafting between the phrase “caused directly or indirectly by” for the civil unrest exclusions and the phrase “occasioned by or through” for the natural calamities. The court reasoned that there must be a reason for the different phrases, and reasoned that: “[I]t was the intention of the defendant to exempt itself from liability [only] if an earthquake should be the immediate, proximate, and direct cause of a fire which destroyed the property.” This meant that the policy excluded only fires “immediately, proximately and directly” caused by the earthquake. If the fire did not start inside a building due to the earthquake, or was a fire involving human acts such as arson or dynamiting, an insured could get the claim.

On appeal, the Ninth Circuit in the case of Williamsburgh City v. Willard, affirmed the judgment. The court cited the judge’s opinion in Baker & Hamilton and agreed that, since the insurer used the phrase “caused directly or indirectly by” for one set of perils, the phrase “occasioned by or through” for earthquakes must mean something different—and so its effect has to be limited to fires caused “directly” by a quake. Since in Willard’s case the earthquake “did not produce a fire on the insured premises,” it was at most an indirect cause, and coverage was not excluded. The U.S. Supreme Court declined to hear an appeal for the Ninth Circuit’s decision.

However, some cases were won by the unpopular insurers. In one such success was the issue was prompt notice and not cause of the loss. In the case San Francisco Savings Union v. Western Assurance Company of Toronto, the proof of loss was to be submitted within sixty days after the fire, but the insured delayed in making it for 180 days. No reasons were offered by the insured for the delay, except a possible plea that the notice clause was only an advisory condition and that the insurer had not been prejudiced by the delay. However, the court, decided that the sixty-day requirement as an absolute condition, not a covenant, and decided in favour of the insurer.

A favourable verdict was also got by the insurer in the case Richmond Coal Company v. Commercial Union Assurance Company. The policy excluded “loss caused directly or indirectly by . . . earthquake, . . . or (unless fire ensues, and, in that event, for the damages by fire only) by explosion of any kind.” The judge found that if the earthquake caused a fire and that fire eventually reached and destroyed the insured’s property, then the entire loss was excluded. Unfortunately for the insurer, this victory was reversed on appeal. The Ninth Circuit rejected the verdict, saying that the court did not “give any consideration” whether “new or intervening causes” had interrupted the chain of causation from the earthquake-caused fires. These intervening causes might have included “explosion, back-firing, dynamiting, the course or force of the winds” or other “attending circumstances.” The case was remanded for retrial.

In another case German Savings & Loan Society v. Commercial Union Assurance Company, the policy wordings were the same as that in the Richmond Coal case. In the trial the insurer stated that a fire “caused by said earthquake shock” reached and destroyed the insured property. The insured however had given evidence that an explosion occurred nearby, at a time when the earthquake-caused fire was not close at hand, and that an independent fire caused by that explosion caused the damage. In rebuttal, the insurer offered evidence that the explosion came after, or was itself the result of, the earthquake-caused fire. After this court found that an explosion could interrupt the chain of causation from the earthquake-caused fire only if a separate fire was “originated by and ensuing upon explosion.” If the earthquake-caused fire triggered the explosion the exclusion would still apply and hence the verdict was in favour of the insurer.

Interestingly a case was filed in Germany against a German insurer. In Borgfeldt v. North German Fire Insurance Company, the policy excluded “loss caused directly or indirectly” by various types of civil unrest, “or [unless fire ensues, and, in that event, for the damage by fire only] by explosion of any kinds or from any cause or the bursting of a boiler, or earthquake, or hurricane.. . .” The German court found that the insurer had without perhaps sufficiently considering the consequences, introduced into the clause words taken from the standard policy, “‘bursting of a boiler, earthquake, hurricane.’ By so doing it had resulted in the contents of the parenthesis also to apply to these causes.” Thus, the destruction of Borgfeldt’s San Francisco property by a fire, even one directly caused by the quake, was held to be covered by the policy. It was hailed by a court in the US that the court in Germany was fair to all nationalities.

History repeats itself

Live Mint (https://www.livemint.com/Politics/FFgdQuiX8PuHiXZw5EiwTI/Kashmir-flood-relief-Supreme-Court-asks-insurance-firms-to.html) reported that the Supreme Court upheld a decision of the Jammu and Kashmir High Court that directed insurers to quickly settle claims of those affected by the recent floods in the state, citing humanitarian grounds. The high court, which was functioning from the house of one of the judges, ordered insurance companies to pay 95% of the cover in case of policies that are less than ? 25 lakh and 50% in policies above that. Although the outlay for settling claims would be around ? 500-700 crore, applying the formula of the high court would increase it to more than ? 4,000 crore as was pleaded by the attorney general in the SC. The Chief Justice however, said any intervention by the Supreme Court will adversely affect the people who have already suffered because of the natural disaster. It was noteworthy that Live Mint in another post quoted Assocham that floods in J&K had caused an immediate loss of ? 5,400-5,700 crore to the state’s economy, with heavy damages to trade, hotels, restaurants, horticulture and handicraft, according to initial estimates.

It is therefore a foregone conclusion that the authorities, courts and policyholder groups expect insurers to be proactive when disasters strike. A response such as that Lloyd’s made in 1906 will raise credibility for insurers, subject to required understanding of facts and all insurers and reinsurers taking a common view under the aegis of the GI Council.