A recent decision from the U.S. Court of Appeals for the Fifth Circuit spotlights an issue that has tremendous importance for policyholders: how to calculate the applicable deductible under property insurance policies where that deductible is presented as a percentage of the risk insured. Depending on how the deductible is calculated, a policy may provide millions of dollars in coverage — or none at all.
In McDonnel Group LLC v. Starr Surplus Lines Insurance Co., the Fifth Circuit grappled with the question of how to calculate a flood deductible under builder’s risk policies.[1] The decision provides guidance for other policyholders with similar deductible language in their policies — which has become common in many kinds of property insurance policies.
McDonnel Group v. Starr Surplus Lines Insurance
The issue of which deductible applies to a policyholder’s loss, and how to calculate that deductible, presents a threshold question in any coverage dispute and can mean the difference between whether a property policy will apply to a policyholder’s losses or not. The Fifth Circuit wrestled with the issue of deductible calculation in McDonnel Group v. Starr Surplus Lines Insurance.
In McDonnel, a hotel owner hired a general contractor to renovate its premises.[2] The contractor bought builder’s risk insurance policies to cover the renovation.[3] The policies also covered the hotel owner as an additional insured.[4] The policies listed the total value of the renovation project at approximately $86 million.[5] The policies also had a $10 million flood sublimit, subject to the following deductible:
5% of the total insured values at risk at the time and place of loss subject to a $500,000 minimum deduction as respects flood.[6]
During the renovation, the hotel flooded, suffering more than $3 million in damages due to heavy rain.[7] The policyholders submitted a notice of loss, but the insurers denied coverage, arguing that a flood deductible of approximately $3.4 million applied.[8]
In the insurers’ view, because the flood damage to the hotel — approximately $3.2 million — did not exceed their calculation of the flood deductible — approximately $3.4 million, they had no obligation to provide any coverage.[9] By contrast, the policyholders argued that a $500,000 flood deductible applied, meaning the insurers owed approximately $2.7 million in coverage.[10]
Understanding how the policyholders and the insurers arrived at such different numbers regarding the flood deductible requires a bit of math. The insurers applied 5% of the total value of the entire hotel renovation project, or approximately $3.4 million.[11] By contrast, the policyholders applied 5% of the policy’s $10 million flood sublimit, or $500,000.[12]
The parties cross-moved for summary judgment regarding the correct amount of the flood deductible, which the U.S. District Court for the Eastern District of Louisiana granted in the insurers’ favor, holding that the correct amount of the flood deductible was approximately $3.4 million.[13] The district court also held that the policy’s meaning was clear and unambiguous.[14]
The Fifth Circuit’s Decision
On appeal, the Fifth Circuit reversed and remanded, holding that the flood deductible was ambiguous.[15] Specifically, the Fifth Circuit held that the policyholders’ calculation was reasonable because the flood deductible stated that it was 5% of the total “insured” values at risk — meaning the total value for which the policyholders actually purchased coverage, or the $10 million flood sublimit.[16]
By contrast, the court noted that similar flood deductibles in other policies applied a percentage to the total “insurable” values at risk.[17] This difference in wording meant that those deductibles applied to the total value that the policy could have insured, or the entire value of the insured project.[18]
However, the Fifth Circuit also held that the insurers’ calculation of the flood deductible was also reasonable, because other references to the “total insured value” in the policies referred to the value of the entire project.[19]
Because the policyholders and the insurers each presented a reasonable calculation, the Fifth Circuit ruled that the flood deductible was ambiguous and remanded the case to the district court to determine whether extrinsic evidence — beyond the four corners of the policy — could resolve the ambiguity.[20]
Implications of the Ruling for Other Policyholders
McDonnel thus represents a win for policyholders in a long line of cases addressing property insurance percentage deductibles, and can also provide guidance for other insureds seeking to protect their interests. With property policies, policyholders should have a legal review of the method of calculating the deductibles.
Any language that requires the application of a percentage to the total insurable value may allow the insurer to later claim that the percentage should apply to the value of the entire insured project, which could be a very large number and prevent the coverage from attaching in the first place, if the policyholder’s losses do not exceed the specified percentage.
If possible, policyholders should change that language to the total insured value and further indicate that this percentage applies to any sublimit of coverage, as opposed to the entire value of the insured project. Policyholders should also review the definitions in the policy and other, similar references to ensure consistency.
Extra legal review on the front end, at policy inception or renewal, can save headaches on the back end — and prevent your insurer from crunching the numbers in a way that wipes out your coverage.
This article was also published in Law360.
[1] McDonnel Group, LLC v. Starr Surplus Lines Insurance Co. , No. 20-30140 (5th Cir. Sept. 24, 2021).
[2] Id. at 3.
[3] Order, McDonnel Grp., LLC v. Starr Surplus Lines Ins. Co., No. 2:18-cv-01380, at 2 (E.D. La. Feb. 11, 2020). Two insurers each agreed to cover half of the renovation project. Id.
[4] The policies also covered the hotel owner as an additional insured. For ease of reference, this article will refer to the hotel owner and general contractor together as the “policyholders.”
[5] McDonnel Grp., LLC v. Starr Surplus Lines Ins. Co., No. 20-30140, at 6 (5th Cir. Sept. 24, 2021).
[6] Id. at 7.
[7] Id. at 3-4.
[8] Id. at 4.
[9] Id.
[10] Id.
[11] At the time of the flood, the contractor had only completed approximately 80% of the renovation, so the total value of the entire project was approximately $69 million – 80% of approximately $86 million. Id. at 7 n.7 (emphasis added).
[12] Id. at 7 (emphasis added).
[13] Id. at 4.
[14] Id.
[15] Id. at 6.
[16] Id. at 10 (emphasis in original).
[17] Id. (emphasis in original).
[18] Id. (emphasis in original).
[19] Id. at 11.
[20] Id. at 13.