Low, Ball & Lynch’s

WEEKLY LAW RESUME

 Issue:  March 11, 2004    By: Raymond Coates

Property Insurance - Replacement Cost Policy - Earthquake Damage

        Fire Insurance Exchange v. Superior Court

Court of Appeal, Second District

(March 2, 2026)

Replacement cost coverage broadens the benefits available to an insured.  In this case, the issue was whether it covered the cost for land stabilization and construction upgrades made necessary by changes to the building codes as a result of an earthquake.

A group of homeowners whose homes were damaged or destroyed in the 1994 Northridge earthquake sued Fire Insurance Exchange (FIE) to recover damages for alleged breach of contract, insurance bad faith, fraud and negligence.  They alleged they had homeowner policies with guaranteed replacement coverage.  They incurred costs in repairing or rebuilding their homes for land stabilization and construction upgrades necessary due to building code changes.  The trial court found the policy to be ambiguous and determined there was coverage for damage to the land and the building code upgrades.  FIE filed a petition for writ of mandate.  The Court of Appeal issued an order to show cause.

The Court of Appeal granted the writ in part and denied it in part.  As to the issue of coverage for damage to land, the Court disagreed with the trial court.  It felt the absence of insurance coverage for damage or injury to the land was clear in the policy and should be enforced.  The policy provided coverage for the dwelling, structures and personal property.  While there is California case law holding that an insurer must repair the soil to a property so long as it is required in order to repair the structure, the decisions so holding did not have similar policy language to the policy in this case.  The FIE policy specifically stated it did not cover the land on which the dwelling was located or the cost to restore, replace or rebuild it.  This language was repeated throughout the policy.  Even though replacement of the home required repair of the land, the language of the policy was not susceptible to an interpretation including coverage for repair of the land.  The Court therefore held the trial court erred in rejecting the plain, unambiguous language of the policy.

However, with regard to the increased cost of repair or replacement of damaged or destroyed buildings, when the increased cost was caused by the need to conform to changes in the building code, the Court felt the trial court decision was correct.  The policy contained a specific exclusion for loss caused by enforcement of an ordinance or law regulating construction, repair or demolition of a building.  The Court noted the guaranteed replacement cost coverage provision guaranteed 100% replacement of a structure with "equivalent construction" and use on the same premises or the amount actually spent to repair or replace the building intended for the same occupancy and use, whichever was smaller.  The Court felt that "equivalent construction" meant material of like kind and quality.  The Court felt that the use of the phrase "equivalent construction," without any modifying phrase indicating that there would be no allowance for the increased cost caused by ordinance or law, rendered the phrase ambiguous.

In reviewing the policy, the Court noted that the ordinance or law exclusion was listed in a section of the policy enumerating exclusions.  It thus was reasonable to interpret it as describing a peril, not a type of damage or loss.  The Court noted that some courts have agreed with this interpretation, and other have disagreed, finding the language of the exclusion to refer unambiguously to increased cost made necessary by changed building codes.

However, because the exclusion was susceptible to more than one meaning, the Court found it to be ambiguous.  The Court felt that the location of the exclusion in a long list of excluded perils, combined with the words "caused directly or indirectly by," indicated that its intended function was to exclude a peril, not to place a limitation on replacement cost.  An insured might reasonably construe the exclusion as referring to perils such as forced demolition or repair of dilapidated, encroaching or nonconforming buildings or parts of buildings by civil authorities.

The Court felt that the replacement cost coverage was intended to cover the cost to construct, at current prices, a building with utility equivalent to a building insured, using modern materials and current standards, designs and layouts.  A reasonable insured would expect coverage for a home of substantially similar construction that was the functional equivalent of the home lost.

Finally, the Court noted that the policy contained a value protection clause which provided annual increases in policy limits to reflect changes in costs of construction.  The Court said this also led to its conclusion that one would expect increased costs of construction due to building code enforcement to be covered as a result.  The Court therefore concluded that the policy was ambiguous because an insured might reasonably expect coverage for the cost of a replacement home of substantially similar construction that was the functional equivalent of the home lost or destroyed even if changes in the building code resulted in higher loss settlement than the cost to repair or replace the home with material of like kind and quality.  The petition for writ of mandate was granted with respect to the finding of coverage for the cost to restore or replace or rebuild the land.  The petition was denied with regard to the issue of increased cost due to changes in building codes.

COMMENT

This case is worth reading because of its analysis of guaranteed replacement cost policies.  The section of the opinion dealing with exclusions should be read by those who draft policies, since the language of the opinion discusses how to construe such exclusions.

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