When Repurposing Your Buildings, Be Aware of the “Increase in Hazard” Clause in Your Property Policy

By: Timothy Tomasik & Edward J. Ozog

The COVID-19 pandemic is causing businesses to creatively repurpose their buildings and equipment to engage in new or different lines of business activities from those described to a property insurer when the business initially requested coverage. Recent examples of this activity include converting the United Center into a storage and distribution center and converting McCormick Place into a hospital. This article does not suggest you avoid a conversion; rather, we advise of a insurance implication when adapting buildings and equipment to meet the current crisis.

Neither the insured nor the insurer likely contemplated the change in use of the buildings when the respective property policies were issued. Changing a building use may result in a change in the building’s exposure to a loss, particularly a fire. However, loss by other perils may also be increased (for example, collapse where floors are overloaded with heavy equipment or merchandise). Property insurers insert an “increase in hazard” clause in the policy conditions to protect themselves in the event an insured changes the character of the risk assumed by underwriters after the policy is issued.

What Is the Increase in Hazard Condition Clause in a Property Policy?

The “increase in hazard” clause has been a part of accepted fire insurance policy forms since the late 1940s. The “increase in hazard” provision is a condition suspending or restricting coverage reciting:

• “CONDITIONS SUSPENDING OR RESTRICTING INSURANCE.
• 'Unless otherwise provided in writing added hereto this Company shall not be liable for loss occurring:
• '(a) while the hazard is increased by any means within the control or knowledge of the insured; * * *.”

When an insurer asserts the application of this provision, it claims that it has no responsibility for a loss because the coverage was suspended during the period the insured increased the hazard. It is well established that the clause is valid and enforceable.

How an Insurer May Apply the Condition

An insurer asserts the application of this provision after a loss occurs in response to a claim by the insured. The insurer will have an adjuster investigate the claimed loss and thereafter consider the facts. If the insurer believes there was an increase in hazard, it will provide in writing the reason(s) for the denial of the claim. The insurer denial letter will likely quote the policy language stating that the loss is not recoverable because the coverage was suspended during the period the hazard was increased.

The burden is on the insurer to prove the conditions or usage at the insured’s property constitute an increase in hazard justifying the suspension of coverage.

Any insured that changes the use of its buildings must consider whether it is increasing the hazard. If the provision is within your policy, the simplest way to avoid application of the provision is to advise your broker and request a temporary waiver of the condition or renegotiate the coverage for the new use of the building before a loss occurs.

What Is Considered an Increase in Hazard?

Activities that significantly change the type or quantity of material within a building may increase the hazard initially underwritten. Increase in hazard also refers to the use of the insured property. The mere presence of combustible liquids on premises will not necessarily result in a finding of increase in hazard, particularly if the chemicals were those ordinarily utilized in the business of the insured when coverage was procured. The issue is whether the chemical on the premises is “a customary hazard inherent in the insured’s business” when the insured applied for coverage. Materials or substances introduced to the property in violation of the law, statute, or ordinance may be a basis to claim increase of hazard.

An increase in flammable materials will likely constitute an increase in hazard if they are not customarily on the premises. However, the materials do not necessarily have to be liquids like gasoline. For example, oxygen bottles may present an increase in hazard, because oxygen bottles may either explode during the course of a fire or significantly increase the size of any fire. Thus, the character and quantity of the material introduced into the premises may substantially change the fire dynamics, constituting an increase in hazard.

Examples of cases where the increase in hazard condition has barred recovery include: a conversion of a frame building housing a barber shop into a cleaners; bringing fireworks into a hardware store for resale; converting a general warehouse into a cotton processing facility; and a grocery utilized as a night club involving sale of illegal whiskey and gambling. Storage of large amounts of flammable materials which increases the likelihood of fire or conduct which materially increases the prospect that a fire will occur constitute an increase in hazard.

Coverage May Be Suspended Even if the Increase in Hazard Has No Causal Relation to the Loss

The hazard provision has been applied to suspend coverage even if the increase in hazard was not causally related to the loss, while a few courts have held that there must be a causal link. In Illinois, there need not be a causal connection. One Illinois court has held that a temporary increase in hazard which ceases before the loss will not negate coverage.

Whether There Was an Increase in Hazard Is a Factual Issue

The question of whether there was an increase in hazard is factually specific and usually considered a question of fact for trial.

An initial factual issue relating to the application of the hazard clause is whether the insured has both control and knowledge of the increase of hazard. Neither control nor knowledge is an issue when an insured modifies the use of his building in response to the COVID-19 disruptions. We do not discuss the issues of knowledge and control in this paper, because it is assumed that the insured is intentionally changing the use and is therefore controlling the entire repurposing.

The increase in risk must be such that the insurer is not presumed to have assumed it contractually. Underwriting analysis and procedures may therefore become a part of the factual assessment of what the insurer knew or should have known when analyzing the risk. Property insurance is underwritten with certain general principles in mind that are condensed to the acronym “COPE” describing Construction, Occupancy, Protection, and Exposure. Each term describes an element of the risk assessment undertaken by the insurer.

The insurer predicates its assessment of the risk based on the disclosures made by the insured to obtain coverage. What the insurer knew or should have known based upon the insured’s disclosures, industry practice, and experience is material to proof that the hazard was not increased. However, the increase of hazard condition will not apply where the circumstances, including the presence of volatiles, existed at the time the risk was undertaken by an insurer.

Insureds may assert that the insurer’s conduct would not have been different even if the insurer had actual knowledge of the condition. The typical issues generated in defense of the application of the clause are whether the insurer would have written the coverage, changed the policy terms, or changed the premium. Other issues may include whether the change in usage or alleged increase in hazard was “immaterial” to the underwriting process and whether the insurer inspected the property prior to underwriting.

Another factual issue is whether there was an increase in hazard in fact. This argument may depend on expert testimony about such things as: the robust design of a building; the capabilities of the building’s fire protection system; whether the use creates any structural hazards such as overloading; and whether the circumstances or use are in violation of any building, fire, or life safety code. An insurer will investigate whether the change in use constitutes a violation of any building or life safety laws. An insured considering a change in use of a building should examine whether the new use triggers a building or life safety law.

The initial examples of the conversions of the United Center and McCormick Place are not likely to present significant insurance issues, because governmental authorities are involved in the repurposing. The authorities are probably paying close attention to existing building codes, including both fire and life safety issues. Moreover, the Army Corp of Engineers will likely conduct an engineering study to minimize risk of loss mindful of the building use. It is still wise to consult the property insurer, even if public authorities are involved in the repurposing.

Some Non-Apparent Reasons Why an Insurer May Assert the Hazard Condition

An insurer may have little choice to assert the increase in hazard provision if the repurposing of the building or change in condition places the risk in a category of insurance coverage that the insurer does not write. In the extreme circumstance where the insured purchased coverage from a “specialty” underwriter, the insurer may not be able to provide coverage if the business property is repurposed to a risk outside the charter of the specialty insurer.

Therefore, an insured cannot rely on the assumption that an insurer would accept any change in use or increase in hazard, even if the insurance is placed with a multi-national insurance conglomerate.

Is There a Notice Provision Within the Insurance Policy?

Property insurance policies may require the insured to give notice to the insurer in the event of a change in: hazard; vacancy or occupancy; or alterations to a building. However, the terms of the hazard condition are operative where the insured fails to give notice of the change in condition. The property policy will require mortgagees who become aware of changes in conditions to the property to give notice to the insurer of the change in condition. The insurer does not have to give notice to the insured of the suspension of coverage in the event of increase of hazard. Therefore, your property policy should be reviewed to determine if there is a notice provision relating to either alteration, construction, change in use, or increase in hazard.

The notice provision allows an insurer to make a judgment about the change in usage or proposed construction activity to determine whether the risk has changed. The notice provision should also cause the insured to investigate whether a change in coverage may be more advantageous. In the case of substantial building alteration, the insured should examine whether a builder’s risk policy is advisable. A builder’s risk policy will provide coverage for loss and damage to the work in process as well as provide compensation for loss that might otherwise be unattainable under the basic property insurance policy. The examination of available policy coverages may therefore work to the insured’s advantage by providing more and specialized coverage for comparable premium.

In limited circumstances, insurers might be construed to have waived or be estopped from asserting the increase of hazard condition within a policy where they are aware of the repurposing.

Comment About Sprinkler Systems and Increase in Hazard

Shutting off a sprinkler system or otherwise disabling it would likely constitute an increase in hazard. Further, an insurance policy may include a specific provision requiring an insured to maintain an operational sprinkler system. Thus, shutting off a system may void or suspend coverage under the increase of hazard clause or a sprinkler warranty provision.

Experience suggests that a loss will occur at the most inconvenient time for the most unlikely of reasons.

Conclusion

You should consider whether you are increasing the hazard insured when repurposing a building to meet the exigencies caused by this pandemic. Ask your broker whether your policy contains a notice clause requiring you to advise the insurer of the changes you are implementing. Inquire further whether your insurer will regard your change in operations as an increase in hazard. Consult with knowledgeable experts in fire and life safety about the changes to avoid a loss and the attendant costs and headaches involved in the preparation and submission of a claim. Examine your insurance coverage before a loss. The examination may result in obtaining broader coverage for the new use without appreciable change in premium.

If you have questions about insurance coverage for your business, or if you need assistance addressing the denial of a claim, contact Tomasik Kotin Kasserman, LLC at 312-605-8800.

Attorney Tim Tomasik has gained a reputation as an accomplished trial lawyer throughout over 28 years of practice. He has represented clients in a wide variety of complex cases involving medical malpractice, aviation litigation, mass disasters, and premises liability, and he has recovered hundreds of millions of dollars in verdicts and settlements. While serving on the Plaintiffs’ Executive Committee for 9/11 litigation on behalf of small businesses and insurance companies, he helped secure a $1.2 billion settlement for business interruption and property damage.

Attorney Edward J. Ozog has represented both insurers and insureds in coverage matters for more than 40 years. Ed was National Counsel for several international insurers where he provided advice in thousands of cases involving complicated coverage issues. Ed has tried many coverage cases, the longest of which was more than 200 trial days. After more than 30 successful years representing insurers, Ed decided to utilize his knowledge and experience to represent insureds in their evaluation of insurance coverage and the presentation of claims.