Our client owns a large food market. Last summer, it burned down. The client submitted a claim under his business insurance policy from Farmers. The insurance policy included several different types of coverage, such as Business Property, Business Income, Extra Expense, and more. The insured had insufficient insurance limits under his Business Property to replace everything needed to reopen the market. Thus, he sought coverage for those items under Extra Expense coverage. By the plain and clear terms of the policy, these items were also covered under Extra Expense. But Farmers found an excuse to wrongfully deny the claim in a textbook example of how not to interpret and apply insurance policies in California.
I. The Policy Terms
Our client’s policy is a fairly standard business policy that purports to indemnify the insured for any business interruption (“BI”) losses, as well as any extra expenses (“EE” or “Extra Expenses”) to minimize the suspension of operations. Under the policy, an “Extra Expense” is an expense incurred to avoid or minimize the suspension of business and to continue operations” at either “the [insured] premises or at replacement premises or at temporary locations, including relocation expenses, and costs to equip and operate the replacement or temporary locations.” The policy lacks any language stating that if a cost necessary to return to business is also covered under another provision of the policy, like Business Property coverage, it is not covered under Extra Expense. But as discussed below, Farmers took that position anyway, and its position was wrong.
II. Formula For Interpreting Insurance Policies Under California Law
Generally speaking, there are three rules of policy interpretation and they should be applied in a particular order. If one rule fails to resolve the dispute, the next rule is examined. They are as follows:
A. The “Plain Meaning” Rule
Whenever possible, the terms of an insurance policy must be read in their “ordinary and popular sense” in the context of the policy as a whole.1 Absent evidence indicating the parties intended a special usage, words used in an insurance policy should be interpreted in their “ordinary and popular sense.”2 If the meaning a layperson would ascribe to the language of a contract of insurance is clear and unambiguous, a court will apply that meaning.3
B. The “Objectively Reasonable Expectations of the Insured” Rule
If the terms of an insurance policy are subject to more than one reasonable interpretation—some for and some against coverage—this rule applies to select which governs.4 Under this rule, an insured’s objectively reasonable expectations control. An insured’s objectively reasonable expectations are determined by a court, not what the insured says, and must be derived solely on the policy if possible.5 If the objectively reasonable expectations of the insured are in favor of coverage, coverage is interpreted in that way. For an insurer to take away or limit coverage expected by the reasonable and objective insured, the insured must use language that is “conspicuous, plain and clear.”6 An insurer’s unexpressed subjective intent or understanding is inadmissible to prove an intent different from the express terms of a written.7
C. The “Contra-Insurer” Rule
If the above two steps do not resolve the ambiguity, the language is generally interpreted in favor of coverage. Notably, many insurance professionals seem to believe that this is the first rule, not the last. But remember, an ambiguity only exists if there are multiple reasonable interpretations, some in favor of and some against coverage, and the contra-insurer rule only applies when the court cannot discern what an objectively reasonable insured would expect from the policy based on its terms.
III. Applying These Rules, Farmers is Wrong
Going back to our market client, Farmers admitted that the Extra Expense provisions, by their plain and clear terms, provide coverage for the items at issue. As made clear above, the analysis should end there, in favor of coverage. An insurer cannot contradict the plain and clear terms of an insurance policy based on some unwritten intent, or even based on a policyholder’s objectively reasonable expectations.8
However, Farmers did not stop the analysis there as the law requires. Farmers argued, without citing any law or policy provision, that Extra Expense coverage is not intended to cover items that are also covered under Business Property.9 But it does not matter what Farmers’ thinks the policy means if the language is plain and clear.
Let’s assume for the sake of argument, however, that a court would consider “intent” after finding the policy language plain and clear. If a court could do that, which it cannot, the court would not consider Farmers’ intent. It would consider only the objectively reasonable expectation of the insured. That expectation must be based on the policy. Here, since the policy plainly and clearly provides coverage, the insured’s objectively reasonable intent must be the same. Farmers cannot interpret the policy to provide less coverage than this unless the policy plainly, clearly and conspicuously takes that coverage away. As explained above, no such provision exists here.
IV. Concluding Thoughts
This coverage dispute is still active without resolution. We are hopeful that Farmers will play by the rules and change its position. Unfortunately, too many insurance companies do what they want to do and let the courts sort it out later, after the insured is worn down and their resources are depleted. Although insurance companies should know the law and apply it correctly, in reality the burden is often on the policyholder to know the law or obtain representation from one who does.
1 Bank of the West v. Sup.Ct. (Industrial Indem. Co.) (1992) 2 Cal. 4th 1254, 1258; see also Cal. Civ. Code §§ 1636, 1638, 1641, 1644, 1646.
2 Cal. Civ. Code § 1644; AIU Ins. Co. v. Sup.Ct. (FMC Corp.) (1990) 51 Cal. 3d 807, 821-822.
3 Montrose Chem. Corp. of Calif. v. Admiral Ins. Co. (1995) 10 Cal. 4th 645, 666-667.
4 Bank of the West, at 1265.
5 Cooper Cos. v. Transcontinental Ins. Co. (1995) 31 Cal. App. 4th 1094, 1104.
6 De May v. Interinsurance Exch. of Auto. Club of Southern Calif. (1995) 32 Cal. App. 4th 1133, 1137.
7 Sunniland Fruit, Inc. v. Verni (1991) 233 Cal. App. 3d 892, 898.
8 Id. at 898
9 Notably, Farmers’ failure to cite any supporting law or policy provisions in its denial letter is a violation of the California Fair Claims Practices Act. 10 C.C.R. § 2695.7(b)(1).