Insurance companies are increasingly denying claims based on engineering reports that there is “no functional damage” (damage which impairs the functionality of the roof) and that the damage is “cosmetic only.”  For example, if a hail storm comes through and wreaks havoc on a metal roof to a home, it might still be functional even though it’s covered with dents.  I’ve commented previously on this issue, but my general view is that the whole idea of denying a claim because there is no “functional damage” is just absurd absent a specific provision in the policy that disallows damage that is “cosmetic only.”  I bet an adjuster who’s car that gets beat up with hail would be quick to make a claim for the dents to his car, even though he or she could certainly still drive it just as he/she did before.

In any event, the point of this post is to highlight a recent case out of South Dakota that addressed this very issue – – Lead GHR Enters. v. Am. States Ins. Co., 2014 U.S. Dist. LEXIS 137830 (S.D. Sept. 30, 2014).  In Lead, like most policies, the insuring clause provided that the insurance company would insure the policyholder against “direct physical damage.”  The insured’s metal roof was dented by hail, but the insurance company denied the claim on the basis that the roof suffered no “functional damage.”  In considering the issue, the District Court judge described the insurer’s position as “tenuous at best” and ultimately concluded that the dents were certainly “direct physical damage.”

Perhaps most importantly, the Lead court also concluded that the insurance company’s disingenuous coverage position could subject it to liability for bad faith and punitive damages, holding that a “denial of coverage based on a purposed lack of functional damage [was] an unreasonable basis on which to deny coverage” and sufficient to allow a jury to conclude that such constitutes a “reckless disregard for its obligations under the insurance policy.”

The co-author of this blog, Parks Chastain, recently blogged about an Oklahoma case that held that an honest disagreement does not provide grounds for a bad faith judgment.  I generally agree,  but the key phrase is “honest.”  Is it truly an honest and reasonable disagreement or is it really an unreasonable interpretation of a policy provision or perhaps blind reliance on a biased expert?  The Lead case demonstrates an insurance company can’t blindly accept an engineer’s report that damage is cosmetic only and then deny the claim entirely.  Insurance doesn’t work like that – – insurance carriers have an obligation to indemnify their insureds against direct physical loss.  And dents in metal roofs constitute “direct physical loss” every time.