A Tale of Two Exclusions: Fungi and Bacteria & Cosmetic Damage

Reader Asks About: Fungi and Bacteria Exclusion

A Westchester producer writes: We have a client that plans to produce and sell maxi- pads in foreign countries. We’ve received two quotes. The first totally excluded losses in any way involving fungi or bacteria. The second has a more limited exclusion:

“Bodily injury” or “property damage” which would not have occurred, in whole or in part, but for the actual, alleged or threatened inhalation of, ingestion of, contact with, exposure to, existence of, or presence of, any “fungi” or bacteria on or within a building or structure, including its contents

Do you think the second is acceptable for our client inasmuch as our client’s exposure would not be fungi or bacteria on or within a building or structure, but rather fungi or bacteria on the maxi-pad? We’ve asked the carrier for an opinion, but they replied that they don’t respond to hypotheticals.

My thoughts: You’re right to be concerned about a fungi/bacteria exclusion for maxi-pads. In 1980, epidemiologists in Wisconsin and Minnesota reported an outbreak of toxic shock syndrome (TSS) apparently linked to use of tampons. TSS is a rare, life-threatening complication of certain types of bacterial infections. While the risk is much lower for maxi-pads, it’s still a risk.1 Obviously a claim involving TSS could be a serious one.

If your client had coverage under a policy with this fungi/bacteria exclusion, the insurer might very well deny coverage for a TSS claim based on the exclusion. The insured’s response might be that the exclusion is ambiguous and therefore it’s entitled to coverage based on the principle that ambiguities in insurance policies writ- ten by the insurer are resolved in favor of the insured.

I wouldn’t be happy blandly recommending a policy that may force the insured to sue for coverage when a serious claim pops up. You should let the insured know your concerns. If the insured is interested, he or she could get an opinion about the effect of the exclusion from an insurance coverage attorney. There are many experienced coverage attorneys in our area. Insurance companies use them all the time.

There’s another facet to your client’s insurance problems. Because the client will be selling products in foreign countries, the occurrence triggering coverage may occur outside the US or Canada. You’ll want to check the definition of coverage territory. Some policies provide worldwide coverage and some restrict coverage to claims that occur only in the US or Canada. The ISO CGL falls in between. Here’s the pertinent part of the coverage territory definition from the ISO form:

“Coverage territory” means:
a. The United States of America (including its territories and possessions), Puerto Rico and Canada…or c. All other parts of the world if the injury or damage arises out of:

(1) Goods or products made or sold by you in the territory described in Paragraph a. above…provided the insured’s responsibility to pay damages is determined in a “suit” on the merits, in the territory described in Paragraph a. above or in a settlement we agree to…

There are two points that should concern your client if the policy has such a provision. First: Were the goods or products made or sold by the insured in the covered territory? Second: What’s the implication of the “suit on the merits” requirement?

It’s very possible that the maxi-pads will be manufactured in a foreign country and shipped directly to foreign customers. It’s also possible that the sale will be made in a foreign country and not in the US or Canada. If that’s the case, the ISO CGL policy will not provide coverage. Such an insured needs a foreign package policy— good foreign forms are available from a number of US insurers.

Even if coverage under the ISO CGL applied because the goods were manufactured or sold in the US or Canada, cover- age may be lost if the original suit is adjudicated outside the policy territory. Many firms feel that they don’t have to worry about being sued in a foreign country because they have little or no property there that the plaintiff could attach to satisfy a judgment. This is not a good solution. US courts permit suits to enforce a foreign judgment. A suit in a US court to collect damages awarded in a foreign country is not covered by an ISO-type CGL—it’s not a suit on the merits in a court of original jurisdiction.

Cosmetic Damage Exclusion

Victor Borge, the late, great standup comedian/pianist, said that his father invented a cure for which there was no dis- ease. We may face a similar situation with new cosmetic damage exclusions.

AAIS and ISO have cosmetic damage exclusions in the works. AAIS has promulgated homeowners endorsements and is considering commercial property ones. ISO has filed a commercial property endorsement and expects to file its home- owners versions shortly.

In explaining the cosmetic damage problem, the American Association of Insurance Services (AAIS) noted that its member-insurers report receiving claims for as much as $100,000 each based on cosmetic damage to windows following wind and hail storms. The insurers report that damage consisted mostly of some small, barely perceptible shallow dents that do not alter the functionality of the window. In the insurer’s opinion, from just a few feet away the windows appear undamaged and would be described to be in excellent or like-new condition. Furthermore, any damage that was visible appeared to have occurred over a period of years.2

These can be problematic claims for an insurer. Property forms cover direct physical loss. There’s no discussion of whether the physical damage must affect the function of insured property or if dam- age that affects only the property’s appearance is sufficient to trigger coverage.

The cosmetic damage argument is really over the extent of cosmetic damage that’s required to trigger coverage. For example, a car struck by an unknown vehicle while parked on the street might require repairs costing more than $2,500 to restore its appearance. Despite the fact that the car remains fully functional, no auto insurer would deny a collision claim on the theory that the damage was only cosmetic. Similarly graffiti may not impair the function of a structure, but insurers regularly pay such losses.

Cosmetic damage claim dispute problems really turn on how much of the dam- age was pre-existing and how visible it must be to trigger a loss. Pre-existing dam- age arguments arise in many contexts; they’re not exclusive to cosmetic damage. How visible the damage must be to constitute an insured loss is a loss adjustment issue. Damage that’s “barely perceptible to the human eye” shouldn’t be sufficient to trigger coverage. I think these endorsements are overkill.

My problem with the new exclusions is that they may be interpreted to exclude losses that should be covered by insurance. That’s what happened with the pollution exclusion. The pollution exclusion was designed to eliminate coverage for the catastrophic exposure posed by Superfund sites. However it has also eliminated claims that have no catastrophic element.

In one case, overspray from a building that was being painted was blown onto a car dealer’s new cars stored in an adjacent field. The painter didn’t have insurance and the car dealer’s insurer denied coverage citing the pollution exclusion. That wasn’t the type of loss that insurers were thinking of when the pollution endorsement was introduced. In fact, the original pollution exclusion stated that it did not apply to “sudden and accidental” occurrences. Unfortunately, the “sudden and accidental” exception was broadly interpreted by some courts rendering the exclusion ineffective. The exclusion was revised to overcome adverse court decisions; the “sudden and accidental” exception that would have clearly covered the dealer’s loss was dropped. I’m concerned that the same sort of “exclusion-creep” will occur with the cosmetic damage exclusion.

At this time, the cosmetic damage exclusions are limited to certain specific types of property. AAIS’s homeowners exclusions eliminate coverage for cosmetic damage to exterior wall surfacing, roof surfacing, exterior door surfacing, and exterior window surfacing (HO 2002 07 13 Cosmetic Damage Exclusion). The ISO commercial property endorsement applies only to roof surfacing. (CP 10 36 10 12 Limitations on Coverage for Roof Surfacing.) The homeowners endorsements that ISO has in the works will come in two versions: one for roofs only and the other for roofs, siding, doors, and windows.

The AAIS form defines cosmetic dam- age to mean:

“Physical damage such as mar- ring, scratching, denting, pitting, discoloration, or other condition that affects the appearance of property, but that does not impair the property’s ability to keep weather-related or other elements from entering to the same extent that it did before the mar- ring, scratching, denting, pitting, discoloration, or other condition occurred.”

An insurer might argue that such wording excludes graffiti, Halloween- pranks, etc. The insured might counter that the legal doctrine of ejusdem generis (Latin for “of the same kind”) bars such a broad approach. Ejusdem generis is used to interpret contracts or laws containing lists of persons or things. For example, if an exclusion refers to automobiles, trucks, tractors, motorcycles, and other motor- powered vehicles, a court might rule, based on ejusdem generis, that such an exclusion would not apply to airplanes and boats, because the list named only land-based transportation.3 In regard to the cosmetic damage exclusion, an insured could argue that graffiti or Halloween-prank damage are of a different nature than the specifically listed types of damage and are there- fore not excluded by the “other condition” wording at the end of the list. But, once again, I don’t like insurance coverage that may require a lawsuit to collect the loss.

The ISO commercial property endorsement applies only to roof surfacing. It excludes cosmetic damage to a roof caused by wind or hail. Cosmetic damage is defined as marring, pitting, or other superficial damage that does not reduce the roof’s function as a barrier to the elements. ISO appears to have avoided the ejusdem generis fight, but there could be arguments over what constitutes “superficial damage.”

There are two parts to the endorsement. One eliminates coverage for cosmetic damage. The other changes the coverage for roof surfacing from replacement cost to actual cash value (ACV). Either or both can apply to the insured property. The change from replacement cost to ACV pertains to losses due to any peril, not just wind and hail.

The change to ACV for roofs is particularly troubling. ACV is usually calculated based on life expectancy of the damaged property. The life expectancy for some types of roofing is as little as 15 years. That means the insured could collect only one-third of the cost to replace such a 10-year-old one damaged by any covered cause of loss. That can make for a very unhappy insured, particularly one who had collected full replacement cost for previous claims.

Not every state has approved the endorsements and not every insurer is using them. The problem is centered in Tornado Alley.4 It may be that its use will be confined to companies doing business in those states. That would be good news for us in the Northeast. Might even give Victor Borge’s ghost a laugh. [IA]