A Claim on Quake Policy Is Shaky

QUESTION: I live in Southern California and plan to insure my house against earthquake damage. Since my lender doesn’t require me to have such insurance, am I correct in assuming that my lender would have no claims on any insurance settlement that I receive in the event of earthquake damage to my home?--R. V.

ANSWER: Not even lenders, insurers and lawyers specializing in this field are willing to go out on a limb and provide a blanket yes or no to your question. Applicable California laws haven’t been tested on this precise point, they say, and probably won’t be until the long-predicted major quake arrives.

But the consensus is that your chances of keeping the entire insurance payoff and doing with it whatever you please are very good if your earthquake insurance policy is kept separate from your homeowner’s policy.

Conversely, if you buy earthquake insurance from the same insurer that covers your house against such things as fire or wind damage and the earthquake coverage is added as a rider to that policy, prepare yourself for a legal fight if you have any ideas about walking away with the entire settlement and leaving the damaged house with the lender to worry about.

No one is certain who would emerge the victor in such a fight. But you would have two points in your favor.

First, as you state, lenders as a rule don’t require homeowners to carry earthquake insurance even though a new state law requires insurers to make it available to homeowners. So the lender’s claim on any settlement for earthquake damage would be tenuous, lawyers say.

Second, in the event of a default, lenders in California are prohibited from going after the borrower’s other assets to make up the difference between what is owing on a loan and the value of the property securing the loan, notes Los Angeles lawyer Ronald DeFelice, a partner in the law firm of McKenna, Conner & Cuneo.

DeFelice thinks that homeowners may be able to argue successfully that this law would prevent the lender from taking part or all of an insurance settlement even if the homeowner walks away from his or her payment and lets the lender foreclose on the damaged or ruined property. That is because the homeowner, not the lender, pays the earthquake insurance premiums and is not required by the lender to do so. But again, the law hasn’t been tested, DeFelice emphasizes. If you buy earthquake insurance from the same insurer that sold you your homeowner’s policy, you may face an additional hurdle if you hope to keep the whole settlement: Chances are that the insurer would make the settlement check payable to both you and your lender--and possibly even to a contractor planning to make the repairs and to the holder of any second mortgage on your house.

Before the check can be cashed, all parties cited have to sign off--just as is the case with settlements for fire damage to your house, for example. This way, the insurer and the lender can be sure that the money is spent to repair the house.

If the lender refuses to sign over the check to you because you don’t plan to repair the damage, you probably would wind up in court if you contested the decision. Likewise, if you fail to endorse the check because the lender makes a claim on all or part of the settlement and you don’t believe he should, the case also would probably wind up in court.

But, if you buy earthquake insurance from someone other than the firm providing the insurance required by your lender--that is, fire insurance--the lender would have no involvement in that policy, probably wouldn’t even know of its existence and thus seemingly would have no right to any settlement, says John O’Connor, chief executive of Glendale Federal’s Insurance Services subsidiary.

Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business Section, The Times, Times Mirror Square, Los Angeles 90053.