Are you Considering Asserting the Arson Defense in a Commercial Insurance Matter?

You May want to consider invoking the appraisal clause of your policy before doing so

by:Steven J. Meils, CPA

It is National Arson Awareness and Prevention Week. You have just returned from the latest and greatest arson seminar put on by the insurance industry with a staff of experienced insurance defense counsel and their associated team of experts. The statistics are all still fresh in your mind: the estimated number of fires judged to be arson; the billions of dollars in related costs and, most importantly, the loss of innocent lives.

While you were gone, your claims manager put on your desk a file requiring your immediate attention. It is a report from your insurance defense counsel on a commercial insurance claim. He is reporting to your company the details of an arson fire and your insured’s possible involvement. The usual cast of characters has been assembled. Under the supervision of your legal counsel, your cause and origin expert determined that the fire was incendiary in origin. Your SIU has determined your insured had the opportunity; your forensic accounting firm has discovered more than sufficient motive on the part of your insured to have caused this loss; and, holy smokes, even the local fire chief has announced to the local media that this fire was the result of arson. Unfortunately, he is still not certain who committed this act. You just received your promotion. You are now the claims executive responsible for decisions in matters such as these. It is time to test your mettle. The case here seems compelling. You have those elements discussed in the arson seminar to successfully assert the arson defense in this matter.

Or wait a minute, here is another scenario. You didn’t just get your promotion; in fact, you have been a claims executive now over twenty years. You just got back from yet another arson seminar and have found on your desk the same matter. Oh my gosh, you think to yourself. Not another one of these damned arson files. You think back, and although it has been a while ago, you still feel the pain of that adverse jury verdict as though it were yesterday. There remains, however, a large gaping wound in your psyche. You did everything right in that matter; you had all the elements required to establish your defense, it’s just that the jury did not believe that the down-on-his-luck insured, although he had considerable motive, actually started that fire. They also believed that your company, in voiding his contract and in denying this claim, did not act in good faith, and so you were also dealt a blow for consequential and punitive damages that were far in excess of the claims initially made . It occurs to you that this jury was drawn from the same society who looks upon the act of arson so egregiously. Now again, you must make a decision.


You have now come across this article and a forensic accountant is suggesting that you may want to invoke the appraisal clause of a policy in which you are potentially going to assert an arson defense. Well hold on, if you are considering this defense, you have probably discovered circumstances much like the following:

The insured has been operating at a loss for some time prior to the date of the fire.

Profitable operations are nowhere in sight in the near future.

The insured may have been or likely will be in default on agreements such as building leases or bank financing.

Required payroll tax deposits or other payments may be in arrears.

Vendor payments are past due and vendors may have advised your insured that no further credit will be extended.

The insured’s balance sheet may reflect insolvency and/or minimal available working capital to meet approaching obligations.

This unfortunate financial condition you have discovered may have been caused by any number of factors: the loss of a major customer, the loss of key personnel, obsolescence of products due to changing technologies, poor management, or a lack of necessary market for the products and services offered. You may also have discovered that the insured is unable to personally contribute any more to the failing business and efforts to acquire bank or other financing were unsuccessful.

By denying a claim before clearly establishing values under your policies, you may, in effect, be obscuring the insured’s motives for having caused the loss. You may also be denying yourself an important opportunity to make an informed business decision. Let’s assume that on the evening before this fire, an insured is reviewing his policy declarations page and observes that he has $500,000 in business income coverage. The insured is not an insurance professional and believes that if a fire occurs this amount will be recovered. He then reviews his property insurance coverage and observes that there is $1,000,000 in coverage for his property at replacement cost. He realizes his equipment is old and may be worth only a fraction of this amount. Given the above-described financial circumstances, he may recognize that the only value he may recover for this property absent a fire is its value in a voluntary or involuntary liquidation.

The first line of defense against those who seek to profit from insurance recovery by arson or any other act, for that matter, is to tenaciously cling to the measurement provisions of those policies in a manner that prevents any element of profit. In a pearl of judicial wisdom the Supreme Court of the State of New Jersey, when adopting the broad evidence rule concerning property valuation, pointed out in its opinion that the measure of recovery for fire insurance losses under the indemnity contract should correspond with the pecuniary loss (money loss) sustained by an insured. “Under valuation denies the insured the indemnification due him under the policy, over-valuation tempts the insured to cause the very loss covered or at least to provide inadequate safeguards against the loss,” according to the court in Elberon Bathing v. Ambassador Ins. (1978) 77 N.J. 1, 389 A.2d 431.

Were such views not held by the courts, it is likely that there would be many more fires and many fewer business failures.

Why Appraisal?

If the financial circumstances of an insured are as severe as you may believe, when considering the arson defense, then those financial circumstances should be apparent to a panel of appraisers. Your appraiser may even be the forensic accountant upon whose opinions you are relying on in this matter. The business income loss provisions of your policies, if properly applied to circumstances such as those described above, should yield minimal losses of business income. If your appraiser is unable to obtain this result in appraisal, then perhaps it is time to reconsider your defense decision; your case may not be as strong as you believed. If, on the other hand, your appraisers come back with the anticipated result, then the substantial claims for consequential damages you may face down the road will appear all the more absurd.

Appraisal of Property Damages

Appraisers have wide discretion in the manner in which valuations are determined in insurance contracts. In circumstances such as these, you would likely ask appraisers to consider both valuations at replacement cost and at actual cash value. When considering the actual cash value of property under the financial circumstances described above, it may be reasonable for appraisers to consider the liquidation value of the property. If the appraisers and umpire are accountants or at least possess some reasonable level of business acumen they are far more likely to understand the implications of the financial condition of an insured in these matters than a jurist in the fog of litigation. I have testified on more than one occasion before those jurors and also have advanced my appraisal positions before a number of umpires in these valuation disputes. I’ll take appraisal on every occasion.

If your appraisal results indicate a large disparity between the replacement cost and actual cash value this should take you a long way towards establishing a motive if you decide to defend. If the appraisal result is not what you expect, once again you should re-evaluate your defensive decision.

Remember, the appraisal condition states that even if you invoke the appraisal condition, you retain your right to deny the claim. It is precisely for circumstances such as these for which that language is provided in the contract. With those appraisal results you will be in a better position to make an informed decision. Here are a few additional considerations:

Just as you have assembled your team to review and evaluate this matter, most likely your insured has also assembled a team of his own. Insureds are often well represented in cases such as these. It is likely that his or her representatives will look upon the circumstances a great deal more optimistically than you will. (Although an appraisal finding of no or only nominal business income loss may take some of the wind out of that sail.) Also, a great deal can happen in the one, two, three, or more years from the time you assert your defense until litigated. There may be adverse court rulings that make successful defense look less probable. Maybe an unexpected death in your team of experts. Perhaps a disgruntled employee, after some soul searching, comes forward to confess his involvement. It is likely that a business decision made then will be far more costly to your company than one made now.

It is not my intent to discourage those with strong convictions about a matter with which they are dealing from asserting the arson defense. These decisions often require stong convictions. There may be compelling reasons in other elements of your defense besides or in addition to motive causing you to suspect an insured’s involvement. If, however, there are nagging doubts about that involvement, then that’s perfectly understandable. Most of us prefer to think the best of our fellow man.

If under the extreme financial circumstances described above you accept liability, it would be highly unlikely that an insured could resume operations or actually replace the property destroyed. Your exposure may be limited to the actual cash values determined in appraisal. Now you should reasonably consider the costs of defense: attorneys’ fees, expert fees, and other court costs required in order to mount your defense. Consider, also, that the ante for actual damages will increase immediately to claimed replacement cost as this defense is asserted and your contract is voided. At trial, your insured will, without question, opine that he had every intention of replacing the property and resuming his disastrous operations, but for your unreasonable breach of contract. Now consider the possible exposure for consequential and punitive damages if your defense is unsuccessful. If, after consideration of these issues you elect to defend, well, good luck to you in your continued litigation. If on the other hand, you make a business decision, don’t feel badly. If still bothered by your decision, you may take solace from the fact that whether or not the insured caused the fire, if the appraisers achieved the appropriate measurement result, he or she did not profit from insurance recovery. This is in no way unreasonable; after all, this is the intent of the indemnity contract. In our system of free enterprise, there will inevitably be winners and losers. Insurance recovery should in no way diminish the losses of the losers unrelated to a fire.

As with all matters in these cases, you should consult with your legal counsel before implementing any course of action. Appraisal results are enforced in most states, but not in all. In a few states the courts have determined that appraisal cannot be demanded unless an insurer admits liability. Where permitted, however, appraisal can serve as an important tool to establish values in claims and in some cases to make better business decisions.

Steven J. Meils, CPA is a partner with the accounting firm of Buchanan Clarke Schlader, LLP, a national forensic accounting firm specializing in the measurement of financial damages. Mr. Meils has served as an appraiser in many commercial insurance disputes and is engaged to review the financial circumstances of insureds in arson investigations.