The following is a paper on the Mark IV Industrial Special Risks Policy presented by Claim Solutions Pty Ltd to the Victorian Branch of the Australian Insurance Law Association on 28 May 2009.
INTRODUCTION
Civil war, Ionising radiation, usurped power, confiscation of property due to Nationalisation, rebellion, flood, action by sea, tidal wave or high water, developing flaws and error in design! These are just some of the exclusions mentioned in the Industrial Special Risks Policy. Fortunately we have not been confronted with all of these but we have faced many of them. Over the next 40 minutes we will discuss the benefits and perils covered by an Industrial Special Risks Policy, the Bases of Settlement, extensions and endorsements.
The Industrial Special Risks Policy has stood the test of time.
Our Company is Claim Solutions. The name is intended to convey that we find the right solution for the right claim. We have been involved in the preparation of claims for many years and a high proportion of these claims were made under Industrial Special Risks Policies or policies based on the Industrial Special Risks wording. The comments we make today are based on this experience.
WHAT IS IT?
The Industrial Special Risks Policy is a clever piece of policy drafting which responds to a multitude of risks. It is the rule book, the guide book which governs whether a claim is covered and if so the amount which should be paid.
The ISR has become a standard on which many pack policies are based and it has been the reference when a badly worded pack policy has been disputed.
The Industrial Special Risks Policy is often described as an "All Risks" policy i.e. it insures "All Risks" unless they are excluded. This is in contrast to an "Insured Perils" policy which specifies the risks which are covered e.g. fire, storm, tempest, theft, etc.
There have been numerous drafts of the Industrial Special Risks Policy the first being introduced by the Insurance Council of Australia in the 1970's. Today the most commonly used is the Mark IV version which was introduced by the ICA as an advisory wording in 1987. An updated cover i.e. the Mark V Industrial Special Risks Policy was introduced in 1991 but did not gain popular appeal.
We will focus on the Mark IV cover.
WHO IS IT USED FOR?
The Industrial Special Risks Policy is used for larger commercial property risks (as opposed to liability or life risks). It is generally used for risks with an asset value in excess of $5-10 million.
WHAT DOES IT COVER?
As the Industrial Special Risks Policy is an "All Risks" policy, to understand what is covered, we need to understand what is excluded. There are two categories of exclusions; property exclusions and perils exclusions.
Property Exclusions
There are 17 Property Exclusions. Abridged, these are: -
1. Property in Transit.
2. Money whilst being carried by professional money carriers, stolen from an unlocked safe or a safe opened with a key, where the loss is not discovered within 5 working days, where the loss arises from kidnapping, etc.
3. Jewellery, furs, bullion, precious metals or precious stones other than stock.
4. Locomotives, rolling stock, watercraft, and aircraft other than as stock.
5. Registered vehicles and/or trailers.
6. Livestock, animals, birds or fish.
7. Standing timber, growing crops and pastures.
8. Land.
9. Bridges, canals, roadways and tunnels, railway tracks, dams and reservoirs.
10. Docks, wharves and piers not forming part of a building.
11. Mining property located beneath the surface of the ground unless expressly stated in the policy.
12. Property during the course of, and as a result of, it's processing.
13. Gates, fences, retaining walls, textile awnings, blinds, and property in the open air.
14. Property undergoing construction where the value of the work exceeds 10% of the Limit of Liability or $500,000 whichever is the lesser and empty premises undergoing demolition.
15. Oil and gas drilling and/or production rigs whilst offshore.
16. Machinery Breakdown with the proviso that subsequent damage is covered.
17. Any boiler, economiser or pressure vessel where the damage is from explosion, rupture, collapse, etc.
Many of these property exclusions have exceptions or provisos which limit the application of the exclusion so it is important to review the full version of the exclusions which appear in the policy.
Many of these property exclusions exist as there are alternative covers which may better respond to the risk e.g.
1. The property in transit exclusion exists as this risk may be better insured under a Marine cover.
2. The property exclusion for registered vehicles exists as this risk would be insured under a Motor Vehicle policy.
3. Growing crops may be best suited to a specific crop or farm cover.
4. Machinery Breakdown may be best suited to a specific policy for this risk.
Perils Exclusions
There are 9 Perils Exclusions. Abridged, these include damage caused by:-
1. The war risks i.e. war, invasion act of a foreign enemy, hostilities, civil war, rebellion, revolution, insurrection, military or usurped power, confiscation, nationalisation, requisition by Government, Public or Local Authority.
2. The nuclear risks i.e. ionising radiation, nuclear weapons materials.
3. Flood, water from or action by the sea, tidal wave or high water.
4. Moths, termites, other insects, vermin, rust, corrosion, variations in temperature, wear and tear, error in omission or design, normal settling, faulty materials or faulty workmanship. This exclusion does not apply to subsequent loss caused by an unexcluded peril.
5. Incorrect siting of buildings.
6. Theft of property in the open air, unexplained inventory shortage, spontaneous combustion.
7. Fraudulent, dishonest acts, embezzlement, strikes, labour disturbances, erosion, subsidence, kidnapping, bomb threat. This exclusion does not apply to subsequent loss caused by an unexcluded peril.
8. Legal liability.
9. Consequential Loss due to lack of performance.
The most common Perils Exclusions we see applied are perhaps the flood exclusion and the wear and tear exclusion. The floods in Katherine, Townsville, Mackay, Emerald and again currently in Qld and northern NSW, to name but a few, highlight each time the flood versus storm scenarios and generate a lot of hydrologist reports.
The ‘wear and tear' exclusion generally arises every time a problem occurs in a manufacturing process. It is the screw that failed in the silo and the conveyor belt that wore through but it does not extend to the subsequent damage. So the collapsed silo and the stock with rubber conveyor belt particles and consequential loss is covered.
CAUSE, CAUSE, CAUSE
The single, most important, element of determining whether an exclusion applies (and therefore what is covered) is CAUSE. Without a clear indication of the cause it is difficult, if not impossible, to determine whether the policy covers the loss.
Sometimes the cause is clear.
Sometimes the cause is unclear. The cause may be obscured by the damage itself. It may be technical in nature and specialist consultants may be required to examine property.
LOSS
Having identified the cause and determining that it is not caught by the Property and/or Perils Exclusions we can consider the Loss.
The Industrial Special Risks Policy dissects the loss into two components; Section 1 - Material Loss or Damage and Section 2 - Consequential Loss.
SECTION 1 - MATERIAL LOSS OR DAMAGE
This section of the policy begins with an Operative Clause. After establishing cause and running the gauntlet of the exclusions we must now satisfy the criteria in the operative clause to make a successful claim under the Industrial Special Risks Policy. This clause states: -
"In the event of any physical loss, destruction or damage (hereinafter in Section 1 referred to as 'damage' with 'damaged' having a corresponding meaning) not otherwise excluded happening at the Situation to the Property Insured described in Section 1 the Insurer(s) will, subject to the provisions of this Policy including the limitation of the Insurer(s) liability, indemnify the Insured in accordance with the applicable Basis of Settlement."
Let's break it down ...........
1. In the event of physical loss, destruction or damage
This is not always straight forward.
2. Not otherwise excluded
We have already discussed the exclusions. The inclusion of this phrase in the operative clause demonstrates the cover is an "All Risks" policy.
3. Happening at the Situation
The Situation is listed in the Schedule which accompanies the policy. Care must be taken to ensure The Situation is listed correctly.
4. To the Property Insured described in Section 1
This generally includes Buildings, Stock and Contents. Property is defined in the policy and includes property owned by the insured, for which the insured is legally responsible or has assumed responsibility to insure.
5. The Insurer will indemnify the Insured in accordance with the Basis of Settlement.
We need to understand the Basis of Settlement.
BASIS OF SETTLEMENT
The policy provides a basis of settlement for many categories of property. The two main categories are: -
1. Buildings, machinery, plant and all other property and contents.
"a. On buildings, machinery, plant and all other property and contents (other than those specified below): the cost of reinstatement, replacement or repair in accordance with the provisions of the Reinstatement and Replacement and Extra Cost of Reinstatement Memoranda as set out herein."
2. Stock being raw materials, work in progress and finished goods.
"b. On raw materials, supplies and other merchandise not manufactured by the Insured: the replacement cost at the time and the place of replacement or, if such property is not replaced, the value thereof at the time and place of the damage.
c. On material in process of manufacture: the replacement value of the raw materials and the value of labour and other overhead charges expended thereon at the time and the place of the damage.
d. On finished goods: the replacement value of the raw materials and the value of labour and other overhead charges expended thereon before any allowance for profit or the cost of re stocking such goods, whichever is the lesser."
The first category, i.e. buildings, machinery, plant and all other property and contents, is subject to the Reinstatement or Replacement Memoranda. This Memoranda indicates the insured is entitled to the cost of reinstatement, including repair of property damaged and replacement of property destroyed, to a condition equal to but not better or more extensive than its condition when new, provided a number of conditions are met. One of these conditions is the replacement cost must be expended i.e. the property must be physically replaced. If these conditions are not met the Basis of Settlement reverts to Indemnity Value immediately prior to the damage. Indemnity Value may be lower than Replacement Value. While not defined in the policy, it is generally considered as the value considering the age and condition of the damaged property. It is often determined as the replacement value less a depreciation factor or the second hand value.
Stock, on the other hand, is not subject to the Reinstatement or Replacement Memoranda. This means that the goods do not have to be replaced for the Basis of Settlement to apply. Early settlement of a stock claim can provide important cash flow for an insured who has suffered a loss.
The Basis of Settlement also covers patterns, moulds, glass, director & employee clothing and tools of trade, and empty premises awaiting demolition.
ADDITIONAL BENEFITS
The Industrial Special Risks (ISR) policy contains 7 standard additional benefits. Summarised these include:
1. Architects', surveyors', and other fees for estimates, plans, specifications, quantities, tenders and supervision.
2. Any fee payable to any Government or other Statutory Authority.
3. Costs of extinguishing the fire.
4. Temporary protection and safety of property pending repair or replacement.
5. Replacing locks.
6. Removal, storage and disposal of debris; demolition, dismantling, shoring up, propping, underpinning or other temporary repairs.
7. Clothing and tools of trade belonging to directors and employees.
These benefits are not subject to the test for co insurance and they often have limits in the Schedule of Insurance. For instance removal of debris has a limit per occurrence and employee property may have a limit per person subject to an overall limit.
There are many other benefits that can be endorsed to the standard policy.
EXTRA COST OF REINSTATEMENT
An important feature of the Industrial Special Risks Policy is that it includes cover for Extra Cost of Reinstatement (Memoranda to Section 1). In some instances local or statutory authorities require an Insured to upgrade its property beyond the reinstatement value to comply with regulations. Provided an appropriate sub-limit is specified in the schedule this section covers the upgrading costs.
Generally such costs will include upgrades to meet Building Codes such as use of asbestos materials and disabled access or occupational health & safety requirements including the number of toilets or wash basins and placement of same.
UNDER-INSURANCE
The Industrial Special Risks Policy contains a co-insurance clause. If the Declared Value on property is less than 80% of its replacement value as at the renewal date of the policy an underinsurance penalty will apply. This means that the insured will have to fund part of the loss themselves. It is important to make an insured aware of any underinsurance penalty as soon as possible after a loss occurs. This may affect whether an insured elects to reinstate.
SECTION 2 - CONSEQUENTIAL LOSS
We have identified the Cause, satisfied ourselves that none of the exclusions apply, satisfied the criteria in the Operative Clause of Section 1 of the cover and quantified the Material Damage claim in accordance with the appropriate Basis of Settlement along with additional benefits, Extra Cost of Reinstatement and any endorsed cover/wordings.
Damage to property often causes a Loss of Profit or Economic Loss. This is the subject of Section 2 of the Industrial Special Risks Policy. Like Section 1, Material Damage, Section 2 - Consequential Loss also has an operative clause which contains criteria which must be satisfied to enable a claim.
The Operative Clause states: -
"In the event of any building or any other property or any part thereof used by the Insured at the Premises for the purpose of the Business being physically lost, destroyed or damaged by any cause or event not hereinafter excluded (loss, destruction or damage so caused being hereinafter termed 'Damage'), and the Business carried on by the Insured being in consequence thereof interrupted or interfered with, the Insurer(s) will, subject to the provisions of this Policy including the limitation on the Insurer(s) liability, pay to the Insured the amount of loss resulting from such interruption or interference in accordance with the applicable Basis of Settlement."
Breaking this down into parts:
1. In the event of any building or any other property
Property is defined in the policy. In general terms we may think of it as the type of property insured under Section 1 i.e. buildings, contents and stock.
2. Used by the Insured
This is an interesting phrase. Note the "Property" does not have to be owned by the Insured but only used by the Insured. This is a much broader concept of property than that introduced in Section 1.
3. At the Premises
This is quite clear. The property must be on the Premises. The Premises or The Situation should be defined in the Schedule of Insurance.
4. For the Purpose of the Business
This is also clear. The property must be used for business purposes. We have never had a problem satisfying this criteria.
5. Being physically lost, destroyed or damaged
Nothing new here, we have already been through this in Section 1.
6. By any cause not hereinafter excluded
We are also already familiar with these concepts from Section 1.
7. And the business is interrupted in consequence of the damage
This is a new concept. The interruption must be as a result of the damage. There must be a nexus between the damage and the interruption. This often causes considerable debate.
8. The Insurer will pay the amount of loss in accordance with the Basis of Settlement.
The Operative Clause outlines what is known as the Material Damage Proviso i.e. there must be damage to property used by the insured to allow a Consequential Loss to be considered.
We need to understand the Basis of Settlement.
BASIS OF SETTLEMENT
Section 2 of the Industrial Special Risks Policy contains 4 Items each with its own Basis of Settlement. These are: -
Item 1 - Gross Profit.
This covers the Loss of Gross Profit associated with a Reduction in Turnover and Extra Costs incurred to minimise or avoid a Reduction in Turnover. The insured must specify a Declared Value to effect this cover. If the Declared Value is inadequate an underinsurance penalty applies. The claim is reduced in proportion to the extent of underinsurance. This is quite a severe test. It is actually a more severe test than the underinsurance clause in Section 1 of the policy. This seems unjust considering that it is often more difficult to determine the Declared Value on Gross Profit than the Declared Value on Property.
Item 2 - Claim Preparation Costs.
This covers reasonable Claim Preparation Costs necessarily incurred to prepare a Material Damage and/or Consequential Loss claim. A sub-limit usually applies to this item.
Item 3 - Payroll.
This covers a Loss of Payroll associated with a Reduction in Turnover. A Declared Value is required for this cover to be taken.
Item 4 - Additional Increase in Cost of Working.
This provides further cover for additional costs. A sub-limit is usually specified for this item.
Claim Solutions provide full day seminars on the Basis of Settlement under Section 2 so it is beyond the scope of this talk to provide a detailed explanation of the Basis of Settlement for all of these items.
As we have outlined there are many obstacles in order to make a successful claim for Consequential Loss. The main one is the "Material Damage Proviso" i.e. there must be damage to property used by the insured at the premises to enable a Consequential Loss to proceed. In some circumstances this proviso is removed.
WHEN THE MATERIAL DAMAGE PROVISO IS NOT REQUIRED
The following extensions fall under the Memoranda to Section 2.
Public Utilities Extension
Generally Utilities are considered as gas, water and power. It is interesting that many policies still refer to them as "Public" utilities when all of them were privatised many years ago. In more recent times we have seen policies which use the heading "Private/Public Utilities".
The Utilities Extension is included in the ICA/NIBA advisory, Mark IV, Industrial Special Risks Policy. It provides that loss resulting from interruption to the Business due to damage to property at any electricity station, gas works or waterworks of a public supply situated on or immediately adjacent to the Premises shall be deemed to be loss due to Damage to Property Used by the Insured at the Premises.
This expands the geography contained in the operative clause of Section 1. The standard clause is quite restrictive as, at best, the utility needs to be immediately adjacent to the Premises. Endorsed wordings can be quite broader encompassing utility suppliers anywhere in Australia.
Premises in the Vicinity (Prevention of Access)
The Mark IV Industrial Special Risks Policy also includes a Prevention of Access clause which removes the Material Damage Proviso hurdle.
It is designed to respond to Consequential Loss when property in the vicinity of the Premises is damaged by an unexcluded peril and the damage hinders the use of or access to the Insured's property.
Damage at the Insured's Premises is not required for a claim to proceed.
We have often been involved in discussions concerning what "in the vicinity" and/or "hinders the use of or access to" means.
It is also often difficult to determine how long a business is adversely affected as a consequence of damage to external property.
Customers' and Suppliers' Extension
The Customers' and Suppliers' extension is not part of the ICA/NIBA advisory Mark IV Industrial Special Risks Policy wording but is often included in endorsed wordings. This also overrides the Material Damage proviso.
It covers loss resulting from damage at customers' and/or suppliers' premises.
MEMORANDA & CONDITIONS APPLICABLE TO BOTH SECTIONS
The Industrial Special Risks Policy contains a section headed "Memoranda Applicable to all Sections" and "Conditions - Applicable to All Sections". It is beyond the scope of this presentation to discuss all the Memoranda & Conditions, however, there are several clauses which are worthwhile mentioning.
Adjustment of Premium
Many clients do not realise that the premium they pay for their policy is adjustable. They are required to specify a Declared Value on Property, Gross Profit and possibly Payroll. If, at the end of the renewal period, these values are found to be overstated they are entitled to a refund of premium. On the other hand, if they are understated they are must pay an additional premium. If clients were aware of this clause it may be possible to encourage them to over insure, obtain a refund of premium at the end of the renewal period and avoid the risk of underinsurance.
Termination of Cover Under Section 2
Paraphrased Condition 13 of the policy indicates that the Consequential Loss cover ceases if the insured ceases to carry on business, is placed in liquidation or becomes bankrupt.
Insureds must be made fully aware of this clause if they are considering discontinuing their business as such a decision may preclude them from making a claim for Consequential Loss over the insured indemnity period.
Progress Payments
It is important to recognise that it is a condition of the policy that progress payments be made to the insured based on the loss adjusters report. Progress payments are the life blood of a business. Without cash flow a business cannot survive and the failure to make adequate progress payments is one of the most common complaints made by Insureds. There are many ways in which progress payments can be released for example:
(a) Determining the indemnity value of property and making a progress payment towards this value pending quantification and verification of the replacement value.
(b) Prompt quantification of a clients claim for stock, which we saw was not subject to the reinstatement and replacement conditions.
(c) Preparation of progress claims for Consequential Loss.
(d) Building and major property reinstatement quotations often include a timeline of when invoices will be raised eg. Percentage of completion. Claims are often based on these.
ENDORSEMENTS
Today we have spoken about the advisory Mark IV Industrial Special Risks Policy wording. The only clause we have mentioned which is not included in this wording is the Customers'/Suppliers' Extension. It is important to recognise that we are often faced with wordings which are heavily endorsed with clauses which sometimes broaden the cover and on other occasions may narrow the cover.
Susan used Swine Flu earlier as an example to work through the policy's many property and peril exclusions. We saw that it is not covered under the advisory wording. If an insured requires cover the wording needs to be endorsed to include an appropriate clause for infectious diseases.
Other endorsements we often see included in the Industrial Special Risks Policy are: -
(a) Severance Pay. If a company suffers a loss and is required to dismiss a large proportion of its employees it may be faced with a large exposure to termination payments. Additional cover may be required.
(b) Expediting expenses. This provides an additional cover for extra labour and freight costs associated with reinstatement of property.
(c) Gross Rentals. Used when the main income is rental income not Gross Profit.
(d) Gross Revenue Specification
(e) Undamaged Foundations
(f) Loss of Land Value
There are numerous clauses which can be added to an Industrial Special Risks wording.
CONCLUSION
The Industrial Special Risks Policy is a clever piece of policy drafting which addresses the measurement of property and consequential loss associated with many types of risks. It was compiled by people with many years experience in the insurance industry and it reflects their intention of loss, damage and payment. It is a remarkable document. It conveys the intention of the Insurer.....but no matter how well it was drafted and while every effort may have been made to use the right words to convey clarity there will always be room for interpretation.
The intention of the policy drafter with all his/her experience may not match the interpretation of the reader facing loss.
It is also important to acknowledge that the policy results in the payment of money and this financial interest often exaggerates the disparity between intention and interpretation.
As a result there is not always but sometimes discussion, debate, argument, disagreement between the parties to the policy. This is not necessarily a reflection on the insurance industry but more a reflection of the limitations of the English language and the impact of financial interest. It is reality.
There are two ways to minimise disagreement in the application of insurance policies like the Industrial Special Risks Policy.
The first is, as far as possible, to ensure the policy is written with absolute clarity, where no word is wasted and where the right word is used on every occasion.
The second is to accept that no matter how careful the policy drafter may be there may remain scope for interpretation. We need to recognise this grey area, ensure all parties are aware of them and manage their expectations.
This is a gathering of the Australian Insurance Law Association and it is people such as you that can recognise and address the issues associated with drafting and interpreting a policy so that those faced with a claim can resolve them promptly, amicably and efficiently. A claim is a change to show consumers the value in the product they have purchased.
There is such a thing as a good claim.
In the interest of encouraging clarity in claims we maintain an insurance knowledge base which we call Insuropedia. It is free to register and members can share their experiences in relation to claims, intentions and interpretations. The site can be found at www.insuropedia.com .
Author
Claim Solutions Pty Ltd
Insurance Policy
Country: - Australia
Policy Description: - Mark IV Industrial Special Risks Policy
Insurer: - Various
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