On January 5, 2012, the Ninth Circuit asked the California Supreme Court to decide two insurance law issues that arose in a flood coverage dispute. In the matter of Sierra Pacific Power Company v. Hartford Steam Boiler Inspection and Insurance Company, the Ninth Circuit reached conflicting conclusions on two distinct issues.

These issues are:

  1. Whether, under California insurance law, a building ordinance or law exclusion, found in the Perils Exclusions section of a property insurance policy, effectively excludes coverage for increased costs caused by complying with ordinances and regulations if the underlying loss was caused by a covered peril.
  2. Whether, under California insurance law, the costs of obtaining building permits or conducting required environmental impact studies are considered costs excluded by a building ordinance or law exclusion, or whether these costs are better considered as part of the replacement cost under the policy.

This case arises from a dam break on New Year’s Day in 1997. A flood destroyed a dam used in connection with a hydroelectric facility in Farad, California. The Ninth Circuit explained that if the policy excludes increased costs due to building ordinances, the Building Ordinance Exclusion is the only potential source of that limitation. The Supreme Court has not indicated whether such an exclusion, which is located in a list of perils exclusion and purports to exclude increases in the loss rather than the costs to repair or replace, is effective to limit an insurer’s liability.

It will be interesting to see how the Supreme Court of California rules. We expect a decision sometime in March 2012 and will update the blog when it is released.