Why Insurers Can't Wall Off Drywall

(MoneyWatch)  With a few exceptions, insurers tend to avoid paying claims when they are not clearly liable, fearing shareholders more than policyholders. Their response: "So sue me!" And more often than not - under contract law - they either prevail or force the claimant to settle. That was the usual outcome with the "wind versus water" suits filed by Gulf Coast residents after 2005's Hurricane Katrina.

But that may not be the case with the infamous Chinese drywall, Charles Miller, a principal of the Insurance Law Center in Berkeley, California warned the National Association of Insurance Commissioners. And if he's right, they might be better off paying what could be up to $15 billion in claims now for damaged homes, and getting back the money later if judges rule in their favor.

Let's backtrack: tons of Chinese drywall was shipped to the U.S. for construction, some of it going to the already hapless victims of the Gulf Coast hurricanes in Florida, Alabama, Mississippi and Louisiana. Soon these residents noticed that their homes smelled bad, silverware tarnished at an alarming rate, electronic devices flipped out, air conditioners rattled, and their children coughed. When the Chinese drywall dampened it smelled like rotten eggs and apparently contained sulfur.

Policyholders whose homes were wrecked by this drywall filed claims with their insurers, but even Citizens Property, Florida's state-run insurer of last resort, was unsympathetic, as was State Farm and several other home insurers. Insurers have an "environmental," "contamination" or "pollution" exclusion in the fine print of homeowner policies and, as a Citizens spokesman points out, "We provide insurance, not a warranty." In other words: go after the Chinese.

However, Miller says the insurers may not be home free. Recently courts have ruled that the pollution exclusion in homeowners policies applies to traditional environmental damage, and "the release of gases inside a residence is not considered traditional environmental damage."

So who's right? The issue is likely headed to the courts, and the courts, like politics, are local. Many of the cases will - unfortunately for insurers - be filed in states that they themselves have labeled "judicial hellholes." Good luck.