Tightening Up Contracts in a Hardening Insurance Market

Insurance Law360
January 16, 2020

By Jason Reeves and Helen Campbell
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Over the past decade, as commercial property insurance rates softened, so too have terms and conditions. In some instances, attempts to broaden coverage have also had the effect of diluting the clarity and consistency of manuscript forms. The role that underwriters’ contract wordings managers once played in tidying up such issues was weakened when the new imperative was to sign up to a policy wording as presented or risk not having an offered line taken up.

The market is changing. As the property market continues to show signs of hardening, here are some fixes that underwriters may wish to consider.

Checks and Balances Through Valuation Limitation Clauses

In a soft market, clauses limiting recovery based on the property values declared to insurers all but disappear from commercial property policies in the London and Bermuda markets. The first clauses that typically fall by the wayside are conditions penalizing the insured for undervaluation of their property such as average and coinsurance conditions.

Next to follow are clauses which cap recovery for a piece of property to its declared value or with a small allowance for variance. In tandem with this, values conditions may be added to policies expressly stating that values declared are for premium purposes only.

Conditions that support the accurate valuation of insured property are important to ensure that an appropriate premium is being charged, but also to allow underwriters to effectively manage their aggregate exposure, especially for catastrophe perils such as hurricane, flood and earthquake. In a hardening market, a values-limitation clause such as the London Market’s Lloyd's Market Association 5060 is a very useful device to ensure better discipline in the reporting of scheduled values. While such a clause may not be suitable for large multilocation risks, it could certainly be considered for smaller enterprises and single location risks.

Denial of Access Time Element Clauses

The parameters for denial of access extensions such as interruption by civil or military authority and ingress/egress have steadily expanded during soft market conditions. A civil or military authority extension may simply require that an action of an authority in connection with an insured peril impairs access to property in order for business interruption cover to be triggered, without any requirement of actual physical loss to, or damage in the vicinity of, an insured location. Cover may be further extended to apply to business interruption losses resulting from denial of access to customer or supplier locations.

More restrictive wording options would provide cover only when access to a location is actually prohibited by an order of civil or military authority, such order being a direct result of physical damage of the type insured, to property of a type not excluded by the policy within a specified distance of the insured location.

Additionally, insurers might consider including a waiting period to limit exposure further. This waiting period might begin at the time of the physical damage; however, even more restrictive limitations would have the period commence from the time when the order comes into effect, or from the time the insured’s business is first impacted. As it stands now, some wordings may, unintentionally, offer civil authority coverage without a waiting period.

The sister clause to this is the ingress/egress extension and similar considerations apply. Instead of requiring an order of prohibition by an authority, a more rigorous trigger would require prevention of ingress or egress from an insured location. The word "prohibited" in this clause may impact the interpretation of the concept in the civil or military authority extension.

Catastrophe Perils — the Big 3

In an all-risks policy form covering the perils of flood, earthquake and named storm, certain restrictions limiting or reducing coverage for these perils may be included in the policy, such as sublimits, specific deductibles, additional exclusions and hours clauses. So, the narrower the definition of such perils, the broader the cover (because in an all-risks form, if a loss does not fall within the definition of flood, earthquake or named storm, but is not otherwise excluded, it is covered).

Over the past decade, many broker manuscript forms have been drafted to exclude any ensuing loss or damage from the definitions of the covered catastrophe perils such that the ensuing loss or damage is not subject to the restrictions applicable to those cat perils. In some instances, there is also the possibility of ensuing coverages such as business interruption being interpreted as separate from the catastrophe peril restrictions.

To overcome these potential issues, the only resulting loss that should be considered separately from the catastrophe peril, and therefore excluded from the scope of the defined peril, is physical damage by resulting fire, explosion or sprinkler leakage. Careful examination of the form is required as this restriction may be repeated within the sublimit and deductible sections as well as the definition itself.

On a connected note, a wording should clearly address whether storm surge is to be treated under the policy as flood or named windstorm, and care should be taken to ensure that storm surge resulting from a windstorm that does not meet the criteria for a named windstorm does not fall between the cracks and end up being treated as neither flood nor (named) windstorm.

Compliance With Building Laws

When considering coverage extensions providing for demolition costs and increased costs of construction due to building laws (often referred to as ordinance and law), ensuring that the cover applies only in respect of laws or ordinances already in force at the time of the physical loss or damage to the insured property is key to preventing increased costs driven by a large catastrophe such as a hurricane or flood.

There is the real possibility that a significant catastrophe event could prompt a government to implement stricter building requirements. This could increase aggregate exposure during a spike in claims. With heightened focus on climate change and the trend of increasing severity of catastrophe perils, this is an important consideration. This also has the potential to impact the incentive and speed of an insured’s response to repairs and replacement.

Other changes that have enhanced ordinance and law coverage during the soft market include the expansion of its application to directives and standards that do not necessarily have the force of law, and removal of exclusions precluding coverage of loss due to law or ordinance that the insured would have had to comply with even if the loss had not occurred.

Sometimes, ordinance and law extensions are further expanded to include business income losses related to downzoning, where an insured is unable to rebuild to the same size, occupancy or capacity as its previous structure due to zoning laws. Insurers should consider restricting such cover by sublimiting the cover or limiting the cover only to the period of recovery that would have applied if the rebuilding of the property to its previous specifications had been permitted.

Business Interruption That Does not Arise out of Physical Loss or Damage

As the traditional property insurance market softened, coverage extensions for financial losses stemming from events other than physical loss or damage were introduced. Cyber-related nonphysical damage is perhaps the most classic example, with cover being granted for an insured’s business interruption losses caused by a cyberattack.

Regardless of the debate over whether electronic data should be considered tangible property and whether loss, corruption or distortion of such data amounts to physical loss or damage, it is clear that such cover falls outside of the traditional property damage and bodily injury model, and underwriting considerations are significantly different than those relating to risks involving bricks-and-mortar, machinery and building contents.

Arguably, if such contingent business interruption cover belongs in a property form at all, it should certainly be treated very much as incidental and subject to sublimits that recognize this.

Another example of such cover is the special time element extension, common in occupancies such as hospitality, which covers an insured’s loss of bookings, reservation cancellations and business interruption caused by violent crimes on the insured’s premises or in its vicinity, contagious diseases, food or drink poisoning, and pollution of beaches or waterways within a 100 mile radius of the insured’s location.

The more remote such an event is from an insured business, the more difficult it can be to correlate and measure the alleged loss of income, thereby complicating rating. Instead of removing such extensions or applying a suitably small sublimit, insurers may want to consider defining and limiting the contingencies that can trigger cover and preclude coverage for additional aggravating costs such as fines or penalties, inspection, investigation and remediation.

Claims Preparation Costs

Coverage for claims preparation costs has been expanded in many wordings and has become a fertile source of fees for brokers and vendors. Wordings used during the soft market tend to contain few limitations on coverage for claims preparation fees. Insurers often have little oversight. Claims notices routinely report the claims preparation fee limit for reserving.

The line between claims preparation costs and claims advocacy/coverage litigation costs is often obscured. Some existing wordings provide scope to fund plaintiff lawyers’ advancing coverage arguments — and even litigation — on behalf of policyholders. At a minimum, claims preparation clauses should distinguish between claims advocacy and claims preparation. Claims preparation work should be audited like any other service the insurers fund. Reasonable hourly rates should be stipulated as insurers routinely do with their own vendors. Sensible sublimits should be adopted. And it is difficult to see how attorneys’ fees can be considered as a genuine claims preparation cost.

Jurisdiction and Dispute Resolution Processes

Some jurisdictions and dispute resolution processes provide more certainty than others. Certainty is in everyone’s interest. The unpredictable results posed by some law and jurisdiction clauses adversely impact the industry and, ultimately, its clients. Many claims professionals have encountered instances where sophisticated policyholders have advanced nonmeritorious claims in jurisdictions that lack certainty.

A true neutral dispute resolution process benefits everyone, so insurers should carefully consider the law and jurisdiction and dispute resolution clauses. This issue should be considered in the context of coverage for domestic and foreign risks.

Business Interruption and Waiting Periods

Waiting periods delaying the inception of time element cover help to ensure that the insured retains some part of the risk. In most claims, the insured begins sustaining business income losses on the date the physical damage occurs. But, circumstances where the date of physical damage does not coincide with the date of the commencement of the business interruption loss are not unusual. Including a waiting period that delays the trigger of coverage permits insurers to reduce risk exposure in the time element context.

Contingent Business Interruption

Contingent business interruption claims have increasingly become the focus of litigated time element disputes. A series of amendments could provide increased certainty for insurers, policyholders and brokers in this arena. For instance, many contingent business interruption disputes arise from the application of different sublimits for direct and indirect suppliers. Wordings should identify all direct and indirect suppliers. Where comprehensive lists are not feasible, wordings should include a definition of direct and indirect suppliers that is tailored to the specific business of the insured.

Nondisclosure Agreements

Insureds’ insistence on having their insurers and their vendors enter into restrictive nondisclosure agreements can often derail or delay the adjustment process. Such a demand is rarely warranted, is almost never practical, and is often unsupported by law or the applicable wording.

Insureds are required, by law and under most wordings, to provide materials for the adjustment of their claim. Where an insured’s business requires an NDA for claims adjustment, it should be built in to an endorsement at inception rather than addressed after a loss occurs. The unfettered provision of information by the insured to facilitate loss adjustment should be a minimum expectation by insurers.

Identification of Co-Insurers and Steering Committee

After a large loss occurs, identifying the composition of the insurance market that participated in the risk can be a challenge, particularly when brokers refuse to provide insurers with the mud-map. Markets should routinely be provided with a mud-map immediately after policy inception.

There is no legitimate reason for brokers to withhold this information following a loss. Provision of the market composition information, particularly on large complex risks, will accelerate the adjustment and decision-making process. Ideally, wordings should identify the steering committee and include provisions to pay for necessary travel by claims professionals.

Jason Reeves is a partner at Zelle LLP and Helen Campbell is the vice president of property contract wordings at Argo Insurance Bermuda.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.