California court rules state insurance policy on smoke damage is unlawful

A California judge has ruled the state's bare-bones home insurance program's handling of smoke damage claims is unlawful, a decision that could have wide-ranging implications as insurers increasingly deal with the aftermath of wildfires.

Home insurance broadly covers fire damage, but there is a growing dispute over what damage must be covered when flames don’t torch the property. The decision Tuesday by Los Angeles Superior Court Judge Stuart M. Rice is a victory for homeowners in a state where the risk of catastrophic wildfires has intensified alongside a brewing home insurance crisis.

The specific case involved Jay Aliff, who sued in 2021 over the insurance payout for his house near Lake Tahoe, which was damaged in the November 2020 Mountain View fire. His lawsuit challenged the California Fair Access to Insurance Requirements Plan, or the FAIR Plan, the state’s high-risk insurance pool or the last-resort option for those dropped by private insurance companies.

With high premiums and basic coverage, the FAIR Plan was designed as a temporary safety net until policyholders could find a more permanent option. Today, it has become the default option for many, with the number of residential policies reaching 550,000 in March, more than double from 2020, state data shows.

Reports from other urban wildfires, in which building materials, appliances, cars and more burn at incredibly high temperatures, show increased levels of heavy metals including lead and polycyclic aromatic hydrocarbons (PAHs) such as benzene that are tied to negative health risks. But insurance companies haven’t standardized testing for those contaminants.

The FAIR Plan has been scrutinized for years over allegations of summarily denying smoke damage claims unless there’s proof of permanent physical change, even though the California Department of Insurance has long determined that that threshold is illegal.

Aliff's lawsuit claims that FAIR Plan at the time offered a fraction of the money he expected to cover the costs to remediate the damages, citing a partial denial letter that said the fire debris could be cleaned up –- and therefore didn’t qualify for coverage as a “direct physical loss” to the home.

“The things that burn are terrifying like lead, cyanide. It’s not possible to get that out with Swiffer,” said Aliff’s attorney, Dylan Schaffer, referring to the brand of disposable mops.

Schaffer, who is also the attorney in a number of other lawsuits against the FAIR Plan related to the smoke damage issue, said the new court ruling was a game-changer in California insurance law at a time when thousands of homeowners in the recent Palisades and Eaton wildfires are still fighting for coverage.

“It is the most important decision in California insurance law in decades,” Schaffer said. “It draws a line in the sand as it relates to where carriers can start carving out their liability and avoiding liability.”

The ruling said the way the FAIR Plan limits smoke damage coverage to its definition of “direct physical loss” was a violation of the law, stating that “this language limits coverage reasonably expected by an insured in a manner which is not conspicuous, plain and clear.”

The judge also said it was unlawful that the FAIR Plan required smoke damage to be “visible to the unaided human eye” or capable of being “detected by the unaided human nose of an average person” rather than "the subjective senses of (the insured) or by laboratory testing.”

“Being unable to resort to their own senses or laboratory tests, it is entirely unclear how an insured could determine whether a particular loss is covered or not,” the court decision noted.

FAIR Plan spokeswoman Hilary McLean said in a statement that the insurer has been working with the state insurance agency to update its policy language and has already eliminated the so-called sight and smell test.

“Our goal is to continue providing fair and reasonable coverage for wildfire-related losses while maintaining the financial integrity of the FAIR Plan for all policyholders," McLean said in a statement.