RISKVUE ARCHIVE | FEATURE STORIES

Allocation of Continuous Damage Losses, Part 2

By Stuart Cotton and Philip C. Silverberg

Allocation and First-Party Property Insurance

Inasmuch as allocation issues have largely involved third-party liability policies, allocation of similar claimed damage in the context of first-party property coverage has been debated only sparingly. Indeed, thus far, only a few cases have grappled with the specific issue of how alleged long-term—and ongoing—first-party damage should be treated vis-à-vis insurance policies in effect during the course of the “loss.” The question posed has been whether the pronouncements on the general subject of allocation in the context of liability insurance have applicability to first-party property insurance.

In Aluminum Company of America and Northwest Alloys, Inc., v. Accident and Casualty Insurance Company, et al.1 (Alcoa), the trial court squarely addressed the issue of allocation in the context of first-party insurance in an unreported decision.2 The subject of that action was environmental damage that allegedly occurred continuously over a lengthy period of time at the insured’s facilities. As is frequently the case with such claims, there was only limited evidence identifying particular “events” or time frames within which the contamination took place. Rather, the insured presented evidence of a “condition,” i.e., contamination, that was present at certain points in time. That evidence generally demonstrated that the contamination was the product of various and miscellaneous operations at the facility that often predated coverage and sometimes continued beyond the coverage period, while in other instances the operation ceased even before coverage began.

It was, of course, the insured’s mission to maximize coverage by advancing a theory under which the insurance in place would compensate it for the entire cost of remediating contamination, notwithstanding that the condition was, at the very least, partially the result of operations occurring prior to the inception of coverage— if, indeed, the damage from contamination was not already a fait accompli at the time coverage was procured. Concomitantly, of course, it was the insurers’ mission to limit responsibility under their respective policies to damage actually occurring during their coverage periods.

The debate, then, broke down into two distinct and diametrically opposed propositions: The insured argued that doctrines of joint and several liability applicable to third-party coverage were equally appropriate in the context of first-party coverage. Conversely, the insurers argued that because of the distinct differences in the nature of first-party property and third-party liability coverages, third-party doctrines were inapplicable and first-party insurers should be liable only for damage that was demonstrated to have occurred while their policies were in effect.

Alcoa provided a relatively useful vehicle to debate, under Pennsylvania law, which governed the controversy, whether the joint and several liability doctrine was generally applicable to third-party liability coverage.3 There were, as well, decisions under first-party insurance in which the courts of Pennsylvania had discussed allocations of loss occurring over a number of policy periods.4

The decision in J.H. France5 was the linchpin of plaintiff’s arguments in Alcoa. In that case, the Pennsylvania Supreme Court considered the proper method for allocating damages under third-party CGL policies. The court found that the “all sums” language contained in the CGL policies rendered each third-party insurer potentially responsible for all of the liability incurred by an insured resulting from a covered occurrence.6 While the court listed three other reasons for the application of joint and several liability (i.e., the progress of the loss was not “linear in character”; the insured did not have coverage during some of the years at issue; and the definition of “occurrence” under the CGL policies purportedly supported such an interpretation), the analysis was largely predicated upon the premise that the “all sums” language in the third-party policies served to make each insurer potentially liable for the entire loss.7 Thus, the insured could choose to seek coverage for the entire loss from any of its CGL insurers.8

The first-party insurers in Alcoa advanced a contrary view based on PECO.9 In PECO, a case decided by the Third Circuit Court of Appeals, the insured PECO Energy Company (PECO) sought coverage under its successive all-risk policies for theft loss of fuel. In September 1984 PECO had contracted with a trucking company, Diesel Services, Inc. (DSI), to haul PECO fuel oil to various generating facilities. In November 1985, PECO purchased one-year property policies from four independent insurance companies and certain syndicates at Lloyd’s of London (collectively, Underwriters). Between November 1986 and October 1991 PECO renewed its one-year policies with different insurers and underwriters on an annual basis.10

PECO submitted an insurance claim seeking coverage for alleged thefts of its oil by DSI. Underwriters rejected the claim. Although PECO lacked any direct evidence of the thefts, a jury found that DSI stole a total $1,229,029 worth of PECO’s fuel and determined that the theft was part of a “single continuous plan or scheme.”11 In allocating liability for the losses among the insurers, the district court determined that the occurrence took place during the 1990-1991 policy period and entered judgment solely against the 1990–1991 insurers.12 The Third Circuit reversed.

Initially, it was the Third Circuit’s view that the district court incorrectly interpreted the policies as “occurrence” policies rather than as “all-risk” policies. Such an interpretation would impose liability only against the insurer whose policy was in effect when the occurrence allegedly took place.13

The Third Circuit held that one insurer should not bear the burden of coverage for all the insured’s losses under an all-risk first-party policy because the insurer is liable only “for all losses which [the insured] suffered during the relevant policy periods, regardless of when the occurrence which triggered those losses took place.”14

In determining the appropriate allocation of liability among the insurers, including the deductible, the Third Circuit reasoned:

It seems to us that the most equitable and logical application of the policies’ language to the realities of this case is to take the loss sustained by [the insured] each year and determine what percentage of the total insured loss it represents. We then apply the percentage thus derived to the deductible for each policy year and the resulting figure is deducted from the loss for that particular year. The Underwriters of each annual policy are thus liable for a percentage of [the insured’s] total loss less that percentage of the stated policy deductible.

The Alcoa trial court approached the allocation issue based on certain premises, some of which were logical assumptions and others of which were facts that the court considered to have been established on the record. A critical element of the court’s reasoning was its finding that the contamination was “a result of a continuous progressive process, unbroken by any term of non-expansion. Although rates and direction of expansion may vary from year to year, yearly expansion is the inexorable rule in this case.”15 The court also concluded that although environmental contamination was not a purely linear process, “the use of an average as a surrogate for the amount of damage that actually occurred during a particular year is feasible.”16

The Alcoa trial court addressed the J.H.France case at some length, distinguishing damages that occur in the asbestos context from those stemming from environmental contamination. The most important distinction in the court’s view was that asbestos may have no adverse effect, notwithstanding years of ingestion, and then may suddenly create a myriad of problems not necessarily related to the length of the exposure or the volume of asbestos fibers ingested, but environmental contamination was different; each particle of a given contaminant discharged into the environment “equally damages the insured property either by increasing the concentration at a particular area (if movement of the pollutant is retarded) or by increasing the size of the impacted area (if the pollutant readily migrates).”17

Ultimately, the court rejected a joint and several liability approach and, instead, adopted a pro rata allocation based on each insurer’s time on the risk relative to the entire period during which the damage occurred. The court pointed to decisions in various jurisdictions where environmental contamination costs have been allocated among various parties.18

The court’s opinion reflected two alternative approaches leading to the same conclusion. First, it found the property damage at issue was divisible as a matter of law, and it was reasonable to expect that the insurer on the risk when damage occurred would have to pay for its remediation. As a corollary, the insured could not have reasonably expected that its insurers would cover the entire loss when much of the loss took place outside the policy period. When damage occurred during a period of non-coverage, plaintiffs would be obligated to absorb the cost themselves.

The court declared that the most reasonable way in which to allocate the plaintiff’s damages was to calculate each insurer’s proportional time on the risk relative to the total period during which damage allegedly occurred, and to hold each such insurer liable only for its proportional share.

As an alternative rationale, the court concluded that even if the environmental damage were considered indivisible, a similar pro rata allocation of damages would be appropriate. Distinguishing the third-party liability coverage cases in which the courts have found joint and several liability based on the “all sums” language, the Alcoa trial court pointed out that first-party property policies provide coverage only for a specifically stated period of time: “[w]hatever damage occurs during the policy period, therefore, is covered by that policy—damages occurring outside are not.”19

Unfortunately for the insurers, the lower court’s ruling on allocation did not stand up in the long run. The insured noticed an appeal to the state’s intermediate appellate court and, in a somewhat unusual development, the Supreme Court of Washington—the highest appellate court in the state, whose jurisdiction is purely discretionary—ruled that it would take the case as a direct appeal. Why the Washington Supreme Court considered a matter governed by Pennsylvania law to be of special importance is a bit of a mystery. Given the decidedly pro-insured bent of that court, the insurers were quite concerned, it turned out justifiably so.

As already indicated, the Supreme Court largely reversed the trial court’s determination on allocation. Its rationale was a curious one, and appeared not to be based on any of the aguments that the insured had advanced. Whereas Alcoa contended that all remediation costs should be reimbursed because it was allegedly impossible to differentiate pre-policy pollution damage from damage that occurred during years of coverage, the court, on its own initiative, relied instead on the broad wording of the policy. The court cited the “Perils Insured” clause—which applied to all physical loss or damage—and the definition of “Occurrence,” which was unaccompanied by qualifying language, and held:

[The policy] contains no limitation as to time of the physical loss or damage to property. There is no exclusion in the policy for physical loss or damage that may have begun spreading before the policy inception…. It seems clear from the policy language that any physical loss or damage manifesting itself during the time a…policy was in effect was covered by the policy, including pollution damage starting before the policy inception.

The Supreme Court also considered, but rejected, differences between third- and first-party coverage. According to the court, differences between asbestos personal injuries and environmental pollution were immaterial. The policy text controlled and the absence of limiting language was fatal; the court reversed the trial court and granted coverage for the insured’s total remediation costs. This allocation reasoning has not been followed in other first-party cases.

Conclusion

Although various other cases in which policyholders seek to recover from first-party carriers for the costs of environmental contamination are currently pending, in none of those matters have the specific allocation issues addressed in Alcoa been squarely faced. Undoubtedly, the issue will continue to be debated. Certainly, insurers will not accept the Alcoa Supreme Court decision as the last word. It remains to be seen what consensus courts will reach when confronted with progressive first-party losses. The outcome is presently unclear, and insurers will attentively monitor how the issue will be played out in other jurisdictions where the question is presented.

Notes
1 No. 92-2-28065-5 (Wash. Super. Ct).
2 Order denying Plaintiff’s CR 50(b) Motion Regarding Indivisibility of Property Damage. Alcoa (Learned, J. March 3, 1997).
3 J. H. France Refractories Co. v. Allstate Ins. Co., 626 A.2d 502 (Pa. 1993).
4 See, e.g., PECO Energy Co. v. Boden, 64 F.3d 852 (3d Cir. 1995).
5 J. H. France, 626 A.2d 502.
6 Id. at 507–08.
7 Id. at 508–09.
8 Id. at 507–09.
9 PECO, 64 F.3d at 852.
10 Id. at 854.
11 Id. at 855.
12 The court also applied a single deductible of $100,000 for a total liability of $1,129,029.
13 PECO, 64 F.3d at 856.
14 Id. at 857.
15 Order Denying Plaintiff’s CR 50(b) Motion Regarding Indivisibility of Property Damage at 3. Alcoa.
16 Id. at 4.
17 Id. at 6.
18 United States v. Charles George Trucking Inc., 34 F.3d 1081 (1st Cir. 1994) (contamination problem allocated among owners/operators, generators, and transporters); Owens-Illinois Inc. v. United Ins. Co., 650 A.2d 974 (N.J. 1994) (allocation based on time on risk and degree of risk assumed): N. States Power Co. v. Fidelity & Cas. Co. of New York, 523 N.W.2d 657 (Minn. 1994) (insurers of environmental risk responsible for damages during their policy periods as reflected by pro rata division based on time on risk).
19 Order Denying Plaintiff’s CR 50(b) Motion Regarding Indivisibility of Property Damage at 10. Alcoa.

ABOUT THE AUTHORS

Stuart Cotton and Philip C. Silverberg are partners in the firm of Mound Cotton Wollan & Greengrass, New York, NY.

Read Allocation of Continuous Damage Losses (Part 1)

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October 2005