A Major Problem with the Mk.IV Advisory ISR Policy

Posted on by Stephen Tomlinson

Overview

This article considers the Mk.IV Advisory ISR policy and how its indemnity clauses make no reference to events occurring “during the Period of Insurance”. While this omission was addressed in the Mk.IV Modified ISR policy, many ISR policies transacted in Australia:

  1. continue to use the Mk.IV Advisory ISR policy; or
  2. are based on the Mk.IV Advisory ISR policy and repeat this omission.

In my view, the Mk.IV Advisory ISR policy was never intended to operate differently from the vast majority of Property policies. To the extent that the Mk.IV Advisory ISR policy has been interpreted differently, this has been based on an incorrect interpretation of the policy’s “operative clause”. This is a problem which has created a significant coverage gap and has a simple solution, but remains unaddressed by the insurance industry.

1. The Mk.IV Advisory ISR: “insured events” and the “Period of Insurance”

The Mk.IV Advisory and Mk.IV Modified ISR policies both have the same “operative clause”:

Whereas the Insured named in the Schedule has paid or agreed to pay to the Insurer(s) specified below the Premium shown on the Schedule, now the Insurer(s) agree(s), subject to the terms, Conditions, Exclusions, Memoranda, Warranties, limitations and other provisions contained herein or endorsed hereon, to indemnify the Insured as specified herein, against loss arising from any insured events which occur during the Period of Insurance stated in the Schedule or any renewal thereof. [emphasis added]

However, The Indemnity clauses in Sections 1 and 2 of the Mk.IV Advisory ISR make no reference to the “Period of Insurance”. For example, The Indemnity in Section 1 of the Mk.IV Advisory ISR reads as follows:

THE INDEMNITY
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 on the Insurer(s) liability, indemnify the Insured in accordance with the applicable Basis of Settlement.

In Understanding the ISR[1], Manning identifies a problem with this indemnity clause:

[The Indemnity] makes no reference to the damage occurring during the Period of Insurance. Underwriters soon learned that this created a deficiency in the Policy from their perspective, in that claims have been made and paid where the occurrence giving rise to the damage occurred during the Period of Insurance but the Damage occurred after the Policy had expired. [emphasis added]

These claims arose because of how the words “any insured events which occur during the Period of Insurance” in the operative clause of the Mk.IV Advisory ISR policy were interpreted.

2. Vintix v Lumley General Insurance

Manning refers to Vintix Pty Ltd v Lumley General Insurance Ltd (1991) 6 ANZ Insurance Cases 61-050[2] (‘Vintix‘) as an example of a claim where the occurrence giving rise to the damage occurred in a different period of insurance to the damage.

In Vintix, Giles J considered that the proximate cause of the damage in that claim was an earthquake which occurred on 28 December 1989, while the damage upon which the claim was based resulted from heavy rains that occurred six weeks later in February 1990. But the issue of which policy responded, i.e.

  1. the policy in force during the proximate cause event, or
  2. the policy in force when the damage occurred,

was not at issue in Vintix. Furthermore, Vintix did not involve a Mk.IV ISR policy. Vintix’s usefulness is therefore limited to an example where damage occurred subsequently to its proximate cause.

For completeness, Vintix was appealed to the New South Wales Court of Appeal: see Lumley General Insurance v Vintix Pty Ltd (1991) 6 ANZ Insurance Cases 61-087[3]. While determining proximate cause wasn’t relevant to the issues before the court (since the policy covered both “earthquake” and “storm and/or tempest and/or rainwater”), two judges considered that rain was the proximate cause of damage, while the other judge considered earthquake to be the proximate cause.

3. What does the Mk.IV Advisory ISR mean?

I have not been able to find any Australian cases where a court has considered the Mk.IV Advisory ISR policy and what is meant by:

  1. its operative clause referring to “insured events which occur during the Period of Insurance”; and
  2. its indemnity clause being silent about the Period of Insurance.

To the extent that claims have been “made and paid” (to use Manning’s words) under Mk.IV Advisory ISR policies based on when the proximate cause occurred, this seems to be based on a misunderstanding of the words “insured events” as they are used in the operative clause. Because the totality of insurance theory, insurance law and other passages in the Mk.IV Advisory ISR policy – as considered in 3A., 3B. and 3C., below – strongly suggest that the “insured events” in the operative clause of the Mk.IV Advisory ISR policy (and the Mk.IV Modified ISR policy) are:

  1. under Section 1 of the policy, “damage” (i.e. physical loss, damage or destruction); and
  2. under Section 2 of the policy, “Damage” (i.e. loss, destruction or damage caused by any cause or event not excluded).

3A. The ISR: a policy of indemnity

The ISR policy is a policy of indemnity, and the insured only suffers loss when damage occurs. Until the damage occurs, the insurer has no obligation to indemnify the insured. In Globe Church Incorporated v Allianz Australia Insurance Limited (2019) 99 NSWLR 470 at 209, the majority (Bathurst CJ, Beazley P and Ward JA) held that:

Absent a provision in an indemnity insurance policy that makes lodgement of a claim a condition precedent to liability, the concept of a promise to indemnify (to make good the loss or to hold harmless against loss) in the context of a property damage insurance policy is such that the promise is enlivened when the property damage is suffered. Unless it be necessary for there to be a claim on the insurer to give rise to the liability, it is at the point of property damage that the insured has not been held harmless against the loss… [emphasis added]

In its “Observance of Terms and Conditions” clause, the Mk.IV Advisory ISR policy makes the “due observance and fulfilment” of the policy’s conditions and other terms of the policy conditions precedent to the insurer’s liability (“insofar as the same are capable of being construed as such”). If the insured did not exercise “due observance and fulfilment” of the Notification of Claims condition, then the insurer’s promise to indemnify would only be enlivened upon satisfactory notification. But the responding policy would still be that which was in force when the damage occurred.

3B. Other ISR policies and questions of intent

This issue with the Mk.IV Advisory ISR policy does not arise in the Mk.IV Modified ISR policy. In the Mk.IV Modified ISR policy, The Indemnity clauses in Section 1 and Section 2 were amended to contain the words “during the Period of Insurance”. For the Mk.IV Modified ISR policy, its Section 1 indemnity clause is as follows:

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 during the Period of Insurance 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 on the Insurer(s) liability, indemnify the Insured in accordance with the applicable Basis of Settlement. [emphasis added]

The drafters of the Mk.IV Modified ISR policy made this change to remove any ambiguity about how the Mk.IV Modified ISR policy would operate. Interestingly, the drafters of the Mk.IV Modified ISR policy did not change the Operative Clause of that policy. Since it is highly likely that they would have considered the Operative Clause in conjunction with The Indemnity, the fact that they did not amend the Operative Clause suggests that:

  1. they considered its “insured events” to be “damage” under Section 1 and “Damage” under Section 2; and
  2. adding “during the Period of Insurance” to The Indemnity was strictly a clarification, rather than a significant change in how the policy would operate.

Separately, in the Mk.V Advisory ISR and Mk.V Modified ISR policies, the Extent of Cover clauses are explicit that “the Insured will indemnify the Insured against Damage occurring to Property Insured during the Period of Insurance”.

While I haven’t read every Property insurance policy, the overwhelming majority of such policies are explicit that they are enlivened by damage which occurs during the period of insurance. The Mk.IV Advisory ISR is highly unusual in that its indemnity clauses do not have this requirement. This invites the following questions:

  1. was omission of the words “during the Period of Insurance” from The Indemnity clauses an oversight from the drafters of the Mk.IV Advisory ISR policy? Or,
  2. did the drafters of the Mk.IV Advisory ISR policy intend for the policy to operate differently from the overwhelming majority of Property policies? If this was their intention, it is hard to believe that they would not have made that intention explicit.

As such, the omission of the words “during the Period of Insurance” from The Indemnity clauses of the Mk.IV Advisory ISR policy appears to be an oversight.

3C. The Property Insured

In the Mk.IV Advisory ISR policy, the clause titled “The Property Insured” provides that the definition of Property Insured is based on “the occurrence of any damage”, not the occurrence of an event (not otherwise excluded) which may cause damage:

THE PROPERTY INSURED
All real and personal property of every kind and description (except as hereinafter excluded) belonging to the Insured or for which the Insured is responsible, or has assumed responsibility to insure prior to the occurrence of any damage, including all such property in which the Insured may acquire an insurable interest during the Period of Insurance. [emphasis added]

If the Mk.IV Advisory ISR policy was intended to respond to the insured peril, then this should read “prior to the occurrence of the insured event”, or similar. It would be unfair for the insurer if property could become Property Insured after an event not otherwise excluded occurs, because the occurrence of such an event materially changes the risk.

3D. Summary

There is a significant and obvious conflict between:

  1. the strong arguments that the “insured events” in the operative clause of the Mk.IV Advisory ISR policy are intended to be “damage” and “Damage” under Sections 1 and 2 of the Mk.IV Advisory ISR, respectively; and
  2. claims that have been “made and paid” under Mk.IV Advisory ISR policies based on when the insured peril occurred.

4. Coverage gap created by the Mk.IV Advisory ISR

It is dangerous for insureds, their advisers and insurers to be relying on Mk.IV Advisory ISR policies given this conflict and uncertainty about policy response. Furthermore, this issue is not strictly limited to Mk.IV Advisory ISR policies: many broker-branded ISR policies and manuscript ISR policies are based on the Mk.IV Advisory ISR.

A potential coverage gap arises if an insured moves from a Mk.IV Modified ISR policy to a Mk.IV Advisory ISR policy for the subsequent policy period. For example, consider a scenario where:

  1. an event not otherwise excluded occurs one day before the insured’s Mk.IV Modified ISR policy (or any other Property policy which is enlivened by damage during the period of insurance) is due to expire; and
  2. the insured moves to a Mk.IV Advisory ISR policy (or an ISR policy based on the Mk.IV Advisory ISR) and damage occurs during that period of insurance.

If the Mk.IV Advisory ISR is treated as being enlivened by events not otherwise excluded during the period of insurance, then neither policy will respond to this damage or the resultant business interruption loss. If the policies provided equivalent coverage and the insurers of both policies were the same, then the insurers may agree to cover the loss and it is only a timing issue as to which policy responds. But if the policies would respond differently or the insurers are not the same, then it is not simply a timing issue: there is a real possibility of a disputed claim because the liability of the insurers may differ. Insureds, brokers and insurers should not find themselves in this position.

5. The solution: amend wordings without “during the Period of Insurance”

The solution to this problem is straightforward: Mk.IV Advisory ISR policies, and those based on such policies, should be amended to match the Mk.IV Modified ISR policy so that they operate similarly to the overwhelming majority of Property policies. Specifically,

  1. in The Indemnity in Section 1 of the Policy, the words “during the period of insurance” should be added after the word “happening”; and
  2. in The Indemnity in Section 2 of the Policy, the words “during the period of insurance” should be added after the word “damaged”.

While the solution is straightforward, implementation is not. While insurers are treated as the authors of insurance policies at law, insurance brokers are often responsible for those policies in practice. Furthermore, insurance brokers often:

  1. oppose changes to those insurance policies; and
  2. oppose insurers applying endorsements to amend them,

even when those changes or endorsements are eminently sensible. It is a sad reflection on the Australian insurance industry that this has been a known problem for over 30 years, that there is a straightforward solution for it, and that the problem persists. Insureds deserve better.

Footnotes

  1. Manning, A., Understanding the ISR Policy – Volume 1: The Mark IV, Mannings of Melbourne Pty Ltd, 2005, page 54.↩
  2. Alternatively, Vintix Pty Ltd v Lumley General Insurance Ltd (1991) 24 NSWLR 627↩
  3. Alternatively, Lumley General Insurance v Vintix Pty Ltd (1991) 24 NSWLR 652↩

Securities and the ISR Policy

Posted on by Stephen Tomlinson

Overview

This article considers the tangibility of securities and how securities are treated under the ISR policy. “Dematerialisation” and “immobilisation” have changed the nature of securities, yet the ISR policy and the attitudes of many insurance professionals have not evolved. There are clear problems with insuring securities under the ISR policy and an equally clear solution: the Crime policy.

Tangible property and basis of settlement clause (e)

The definition of Property Insured in the Mk.IV Modified ISR policy requires property to be “tangible”, though this requirement is strangely absent from the Mk.IV Advisory ISR. Furthermore, in the Mk.IV Modified ISR, basis of settlement clause (e) is as follows:

(e) On computer systems records, documents, manuscripts, securities, deeds, specifications, plans, drawings, designs, business books and other records of every description:
The cost of repairing, replacing, reproducing or restoring same, including information contained therein or thereon but excluding the value to the Insured of the said information or, if repair, replacement, reproduction or restoration is not carried out with reasonable despatch, the replacement cost of materials as blank stationary at the time and place of the damage.

There are two obvious problems with this provision:

  1. there is cover for computer systems records, i.e. data. Since data is not tangible property, cover for computer systems records conflicts with the requirement that Property Insured be tangible; and
  2. there is cover for “securities”. Like data, a security is intangible property: it is an interest in property such as a stock or bond. That interest may be recorded in a document such as a certificate. But since basis of settlement clause (e) excludes “the value to the Insured of the said information”, the policy does not intend to indemnify the insured for the loss of the value of the securities themselves. Rather, the policy covers the physical certificate which evidences ownership of the securities. The policy would therefore be clearer if “securities” was replaced with “certificates of securities”, something which is addressed in the SECURXS4 endorsement.

The SECURXS4 endorsement

A common endorsement for ISR policies is the SECURXS4 Securities endorsement which removes “securities” from basis of settlement clause (e) and provides its own basis of settlement for “Securities”:

SECURXS4 Securities
Basis of Settlement (e) is amended by deleting the word “securities”. In the case of Securities (which shall mean certificates of stock, bonds, coupons and all other types of securities), the basis of valuation shall be:
(a) if, with the approval of the Insurer(s), the Securities can be replaced, the cost of replacement paid or payable by the Insured; or
(b) if the Securities cannot or are not to be replaced by the Insured, the greater of:
(i) the price for which the Insured purchased them, and
(ii) the closing market value on the last business day prior to the date of discovery by the Insured of the loss or destruction of the Securities or, if the time of discovery by the Insured is after the close of the market, their closing market value on the day of discovery by the Insured of the loss or destruction of the Securities.
(c) in the case of a loss of subscription, conversion or redemption privileges through the loss of any Security, the value of such privileges immediately preceding the expiration thereof,
such valuation being in the currency in which the loss was sustained. Losses sustained in currencies other than Australian dollars shall be settled by converting the amount of loss to Australian dollars at the market rate as set by the Reserve Bank of Australia at the time of settlement of the loss or such other rates as may be expressly agreed with the Insurer(s). If there is no market price or value on the relevant day stated herein, then the value shall be agreed between the Insured and the Insurer(s) or, in default thereof, the Insured and the Insurer(s) shall submit to arbitration and be bound by the decision of the Umpire.

The SECURXS4 endorsement refers to “certificates of stock, bonds, coupons and all other types of securities” [emphasis added]. Here, the words “certificates of” apply to “all other types of securities”, such that “damage” (i.e. physical loss, damage or destruction) of a certificate is required for indemnity.

Since the SECURXS4 endorsement indemnifies the insured for the cost of replacement (or alternatives based on the value of the securities), rather than the cost of replacing the certificate, there is – prima facie – greater cover for the insured and exposure for the insurer.

The NEGINXB4 endorsement

Relatedly, the NEGINXB4 endorsement is as follows:

NEGINXB4 Money – Extended Definition
The definition of Money extends to include travellers cheques, securities and negotiable instruments.

The NEGINXB4 endorsement presents its own problems because it is not explicit whether:

  1. securities and negotiable instruments are covered; or
  2. certificates of securities and certificates of negotiable instruments are covered.

The NEGINXB4 endorsement has been cited as relevant to the theft of certificates of securities, with the September 1986 theft from the Hospital Superannuation Board office in Hawthorn (a suburb of Melbourne) used as an example. There, thieves stole “Aussie Mac” bonds which had a face value of $3,000,000. These bonds were “bearer bonds”, i.e. negotiable instruments that could be redeemed through banks or brokers, and could not be cancelled.

1986, however, was a different time and things have changed…

Is anybody still holding certificates of securities?

In modern times, the vast majority of securities have been:

  1. “dematerialised”, i.e. they exist only as electronic records; or
  2. “immobilised”, i.e. physical certificates (where they exist) are held in a central vault, with ownership transferred electronically.

To the extent that physical certificates are still used, securities exchanges in advanced economies are implementing dematerialisation to reduce costs, reduce risk and provide shorter settlement periods.

It is not uncommon for ISR policies to have the SECURXS4 endorsement and a sub-limit in the Schedule against “Securities”. But for the vast majority of insureds, that endorsement and its sub-limit won’t achieve anything because the insured doesn’t hold physical certificates of securities.

In Australia in 2026, certificates of securities are only likely to exist for:

  1. physical share certificates issued by unlisted companies and private equity that are not part of a centralised registry; and
  2. promissory notes or commercial paper, i.e. physical documents that may be issued for private debt transactions.

The problems with insuring securities under an ISR

From an insurer’s perspective, cover for certificates of securities is problematic because:

  1. certificates of securities are highly liquid and portable. This makes them susceptible to theft and disappearance in ways that other tangible property (e.g. buildings, machinery) is not; and
  2. under the SECURXS4 endorsement, the basis of settlement is:
    1. the replacement cost; or
    2. the closing market value.

For the securities identified above (i.e. those of unlisted companies, promissory notes and commercial paper), these securities are not traded such that the insured and insurer would need to agree a value. For many securities, this will not be straightforward. If the insured and insurer cannot agree, then the SECURXS4 endorsement provides for arbitration. But arbitration provisions are void under section 43 of the Insurance Contracts Act 1984 (Cth).

From an insured’s perspective, cover for securities is significantly restricted by Perils Exclusion 7(a)(i) which excludes physical loss, destruction or damage occasioned by or happening through:

“fraudulent or dishonest acts, fraudulent misappropriation, embezzlement, forgery, counterfeiting data corruption, unauthorised amendment of data and erasure by electronic or non electronic means involving the Property Insured by the Insured or any employee(s) of the Insured acting alone or in collusion with any other person(s)”.

These are likely the greatest risks for securities, followed by these acts being perpetrated by parties without a connection to the Insured or its employees.

Conclusion

Given dematerialisation, immobilisation, the nature of securities, the limitations of the SECURXS4 endorsement and Perils Exclusion 7(a)(i), securities should not be covered under ISR policies. Rather, securities should be insured under a Crime insurance policy. Crime policies address the most significant risks to securities, such as theft, disappearance, forgery and fraudulent transfer, both by employees of the insured and third parties. Furthermore, Crime policies can cover securities against physical perils, though insureds should review the terms of the policy to understand the cover.

In 2026 and beyond, there is no good reason for insureds (or their brokers) to continue covering securities under an ISR policy. If the ISR policy is to evolve in the 21st century, removing cover for securities so that such property can be appropriately insured under a Crime policy would be but one step among many.

Not all ISR sub-limits are equal (or “cumulative”)

Posted on by Stephen Tomlinson

Introduction

The Mk.IV ISR policy is not explicit about how its Limit of Liability and Sub-Limits of Liability (collectively, “limits”) apply. Like many aspects of the Mk.IV ISR policy, an understanding of how limits apply is often acquired through experience. This article, however, uses examples to show how limits should apply.

A Mk.IV ISR example: Premises in the Vicinity (Prevention of Access)

Let’s say:

  1. damage occurs to property in the vicinity of the insured location (the “Premises”);
  2. damage from that peril is insured under the policy, if such damage occurred to Property Insured;
  3. the damage prevents access to the Premises; and
  4. there is interruption with the Business in consequence of the damage.

Under the “Premises in the Vicinity (Prevention of Access)” memorandum, these circumstances are “deemed to be loss resulting from Damage to property used by the Insured at the Premises”, which enables the insured to claim business interruption loss under The Indemnity in “Section 2 – Consequential Loss”. That indemnity is subject to the “limitation on the Insurer(s) liability” and the amount of loss is calculated “in accordance with the applicable Basis of Settlement”. Accurate use of singulars and plurals is not a strength of the Mk.IV ISR, since the applicable Bases of Settlement could be:

  1. Loss of Gross Profits;
  2. Claim Preparation Costs;
  3. Pay-Roll; and
  4. Additional Increase in Cost of Working.

So, what is the “limitation on the Insurer(s) liability”? Well, let’s say the policy has the following Sub-Limits of Liability:

  1. Premises in the Vicinity (Prevention of Access): $250,000;
  2. Claim Preparation Costs: $1,000,000; and
  3. Additional Increase in Cost of Working: $1,000,000.

While Loss of Gross Profits and Pay-Roll (assuming Pay-Roll is insured separately) would have declared values, they do not have Sub-Limits of Liability.

If Loss of Gross Profits and Pay-Roll were claimed up to their declared values as a result of a Premises in the Vicinity (Prevention of Access) claim, it would render the Sub-Limit of Liability for Premises in the Vicinity (Prevention of Access) meaningless. Clearly, the Sub-Limit of Liability for Premises in the Vicinity (Prevention of Access) must be an overarching limit – “the limitation on the Insurer(s) liability” – and amounts payable under the other bases of settlement must fall within both their own Sub-Limits of Liability (if any) and that “limitation”.

There is no rational basis to claim that the Sub-Limits of Liability for Claim Preparation Costs and Additional Increase in Cost of Working should not be subject to the Sub-Limit of Liability for Premises in the Vicinity (Prevention of Access). The purpose of a Sub-Limit of Liability is to limit the insurer’s exposure, and this purpose is defeated if the insurer’s exposure is not $250,000, but potentially $2,250,000. Consider the amounts of the Sub-Limits of Liability: in this example (from a real policy), the Additional Increase in Cost of Working Sub-Limit is four times that of Premises in the Vicinity (Prevention of Access). Again, the purpose of the Sub-Limit of Liability on Premises in the Vicinity (Prevention of Access) is defeated if the Loss of Gross Profits and Pay-Roll components of the claim were limited to $250,000, but the insured could claim up to $1,000,000 for each of Claim Preparation Costs and Additional Increase in Cost of Working.

From the paragraph above, it is clear that “the limitation on the Insurer(s) liability” – as referred to in The Indemnity in “Section 2 – Consequential Loss” can be a Limit of Liability or a Sub-Limit of Liability. Since the same words, i.e. “the limitation on the Insurer(s) liability”, are used in The Indemnity in Section 1, it can be safely concluded that the same applies there.

Another Mk.IV ISR example: Flood

Let’s consider another example where a Policy has the following Sub-Limits of Liability. For Section 1:

  1. Removal of Debris: no sub-limit;
  2. Landscaping: $250,000;
  3. Extra Cost of Reinstatement: $1,000,000;
  4. Additional Extra Cost of Reinstatement: $500,000;
  5. Expediting Costs: $50,000; and
  6. Liability to Make Enquiries: $250,000.

For Section 2:

  1. Claim Preparation Costs: $1,000,000; and
  2. Additional Increase in Cost of Working: $1,000,000.

And for Sections 1 and 2 combined:

  • Flood: $10,000,000.

Now, let’s say Property Insured at the Premises is damaged by Flood, and that the total amount of the damage and resultant business interruption is $20,000,000.

The previous example established that “the limitation on the Insurer(s) liability” can be a Limit of Liability or a Sub-Limit of Liability and, if a Sub-Limit of Liability, such limit is an overarching limit within which other Sub-Limits of Liability operate. Given this, it should be clear that the insurer’s liability is limited to the Sub-Limit of Liability against Flood, i.e. $10,000,000. It would defy logic to claim that the Sub-Limits should apply cumulatively (i.e. “stacking of sub-limits”) and that the insurer’s liability (assuming all other limits could be exhausted) should be $14,050,000, i.e. $10,000,000 plus $250,000 plus $1,000,000 plus $500,000 plus $50,000 plus $250,000 plus $1,000,000 plus $1,000,000. If the limits could stack, perversely, the insured would be disadvantaged by not having a sub-limit for Removal of Debris.

The Mk.V ISR

In the Mk.V ISR, its definition for Limit of Liability includes the following: “If more than one Limit or Sub-Limit of Liability applies, the lesser amount shall be payable”. This was intended to clarify the position in the Mk.IV ISR where “the limitation on the Insurer(s) liability” for a loss could be a Limit of Liability or a Sub-Limit of Liability. Unfortunately, the Mk.V ISR wasn’t clear about when a Limit or Sub-Limit of Liability would “apply” as an over-arching limit. Because if there is not a Sub-Limit of Liability applying as an overarching limit, then the Sub-Limits of Liability in the policy will apply cumulatively (as, for example, in a typical fire claim).

For the Mk.V ISR, the TOPLIM01 endorsement is as follows:

TOPLIM01 Precedence of Sub-Limits

In Definition 1.8, the sentence reading “If more than one Limit or Sub-Limit of Liability applies, the lesser amount shall be payable” is amended to read:

If more than one Limit or Sub-Limit of Liability applies, the greater amount shall be payable.

Respectfully, this endorsement doesn’t make sense. If a policy has a Limit of Liability and, say, a Flood Sub-Limit of Liability, would anyone seriously suggest that the lower Flood Sub-Limit of Liability should be ignored and that the policy’s Limit of Liability should apply to Flood claims? One would hope not, though stranger things have happened.

Addressing the sub-limit problem

Above, I’ve considered a Premises in the Vicinity (Prevention of Access) claim and a Flood claim. So, contingent business interruption and particular perils/circumstances/events can give rise to an overarching Sub-Limit of Liability (i.e. a Sub-Limits of Liability that acts like a Limit of Liability because it is the maximum amount payable).

Although less common, an overarching Sub-Limit of Liability could also arise if a Sub-Limit of Liability applies to a particular item of property. Obviously, however, if damage occurred to both Sub-Limited and not-Sub-Limited property, then the Sub-Limit would only apply to the Sub-Limited property.

To address the operation of Sub-Limits of Liability and Limits of Liability, I drafted a clause that sought to explain how Sub-Limits of Liability should operate, which recognised that:

  1. Sub-Limits of Liability apply independently of each other, subject to exceptions;
  2. those exceptions are when a Sub-Limit of Liability applies to: a peril, event or circumstance; a particular location (i.e. Premises/Situation); contingent business interruption covers; or Property Insured;
  3. if such a Sub-Limit of Liability applies, it is the maximum amount payable by the insurer;
  4. if more than one such Sub-Limit of Liability applies, then the lowest Sub-Limit of Liability is the maximum amount payable (consider Flood enlivening the Premises in the Vicinity (Prevention of Access) memorandum; and
  5. if damage occurs to Property Insured and only part of that Property Insured is subject to a Sub-Limit of Liability, that Sub-Limit of Liability will only apply to that part of the Property Insured.

To demonstrate the operation of the clause, examples were included.

Are so many words needed to solve this problem? Respectfully, the number of words isn’t necessarily a problem. But ambiguity and confusion over the proper operation of Sub-Limits of Liability is a problem. Shouldn’t insurance practitioners be trying to provide clarity?

Post-script: Non-Marine Property Physical Loss or Damage Wording (LMA3182)

After initially drafting this article, I came across the LMA’s Non-Marine Property Physical Loss or Damage Wording (LMA3182). It has sought to address the operation of limits with the following:

LIMIT OF LIABILITY

The Underwriters’ maximum liability in a single Occurrence regardless of the number of Locations or coverages involved will not exceed the Policy limit of liability as specified in the Schedule. However, when a sub-limit of liability for a Location or other specified property or coverage is shown, such sub-limit will be the maximum amount payable for any loss or damage arising from direct physical loss or damage at such Location or involving such other specified property or such coverage. [emphasis added]

Each Sub-limit stated in this Policy applies as part of, and not in addition to, the overall Policy Limit of Liability for an Occurrence insured hereunder. Each Sub-limit is the maximum amount potentially recoverable from all insurance layers and program policies combined for all insured loss, damage, expense, Time Element or other insured interest arising from or relating to that aspect of the Occurrence, including but not limited to type of property, construction, geographic area, zone, location, or peril.

If insured under this Policy, any Sub-limit for Earth Movement, Flood, Windstorm or Named Storm, is the maximum amount potentially recoverable from all insurance layers combined for all insured loss, damage, expense, Time Element or other insured interest arising from or relating to such an Occurrence. [emphasis added] If Flood occurs in conjunction with a Windstorm, Named Storm or Earth Movement, the Flood Sub-limit applies within and erodes the Sub-limit for that Windstorm or Named Storm, or Earth Movement.

Here,

  1. the first paragraph provides that sub-limits of liability for locations and property can be over-arching sub-limits (i.e. “the maximum amount payable…”); and
  2. the third paragraph provides that sub-limits on particular events (Earth Movement, Flood, Windstorm or Named Storm) can be over-arching sub-limits (i.e. “the maximum amount potentially recoverable…”).

I commend the LMA on seeking to provide greater clarity about the operation of sub-limits. The LMA’s approach is different to that which I proposed above and, specifically, it doesn’t:

  1. state a default position that sub-limits of liability apply independently;
  2. address sub-limits of liability for contingent business interruption covers; or
  3. state that the lower over-arching sub-limit will apply.

Some insurance professionals may not consider that these things need to be stated explicitly but, as above, my experience suggests otherwise and clarity is preferable.

Improving the ISR: deleting the Amount of Policy Not Reduced by Loss memorandum, and explaining Event and Aggregate Limits

Posted on by Stephen Tomlinson

Introduction

This article provides two suggestions for improving the Industrial Special Risks (ISR) policy:

  1. deleting the Amount of Policy Not Reduced by Loss memorandum; and
  2. relatedly, explaining “event” and “aggregate” limits.

The Amount of Policy Not Reduced by Loss memorandum

In the Mk.IV ISR policy, the “Amount of Policy Not Reduced by Loss” memorandum appears in the Memoranda Applicable to All Sections:

Amount of Policy not Reduced by Loss
The insurance under each section and/or item of this Policy and the Indemnity Period shall be automatically reinstated in the event of any loss in consideration of the payment by the Insured of a pro-rata additional premium calculated on the amount of the loss settlement at the rate(s) agreed for the Period of Insurance.

Ultimately, this memorandum doesn’t make sense in the ISR policy and should be deleted.

In the ISR policy, the Limit of Liability and Sub-Limits of Liability apply “for any one loss or series of losses arising out of any one event at any one Situation” (i.e. per event and per Situation). Subject to the exceptions (see “Event and Aggregate Limits”, below), the quoted words mean that:

  1. If an event affects multiple locations, the Limit of Liability and Sub-Limits of Liability apply to each location (“Situation”) separately; and
  2. For each event, the full amounts of the Limit of Liability and Sub-Limits of Liability are available. That is, the Limit of Liability and Sub-Limits of Liability are not reduced (or “eroded”) by previous events.

Given this, the “insurance under each section and/or item of this Policy and the Indemnity Period” (as those words are used in the “Amount of Policy not Reduced by Loss” memorandum) does not need to be reinstated by the payment of additional premium, because the insurance was never reduced in the first place.

In this respect, the Limit of Liability and Sub-Limits of Liability in the ISR policy are fundamentally different from the “sums insured” in other Property policies which may be eroded by loss.

Event and Aggregate Limits

So, what about those exceptions? In the ISR policy, Sub-Limits of Liability (and, potentially, Limits of Liability) may apply:

  1. “per event” or “any one event”; and/or
  2. “in the aggregate” or “in the annual aggregate”.

While these terms are reasonably well understood within the insurance industry, their meaning may not be clear to those outside it – and this can create confusion for insureds. At their most basic,

  1. If a limit applies “per event” or “any one event”, then that limit is intended to apply across all insured locations combined. For example, if an insured has multiple locations that are affected by a single Flood event, and there is a Flood limit of $1,000,000 applying “per event”, then the insured would only be able to claim $1,000,000 in respect of that Flood event, regardless of the number of insured locations affected; and
  2. If a limit applies as an “annual aggregate”, then it is intended to apply for all such events occurring during the Period of Insurance. Ambiguity may arise, however, as to whether an aggregate limit applies to a) each location individually or b) all locations combined – this is considered below (see “Clarifying aggregate limits”).

So a limit of liability which applies as an “annual aggregate” could be eroded. But it doesn’t make sense for an annual aggregate limit to be automatically reinstated for a pro-rata additional premium calculated on the loss (to paraphrase the Amount of Policy not Reduced by Loss memorandum) because:

  1. the rationale for an “annual aggregate” limit is to limit the insurer’s exposure;
  2. the amount of the loss settlement may not be known until well after the event which has caused the damage. This is particularly relevant if there is resultant business interruption. If the insured hasn’t made the payment, is the insurance reinstated? The wording memorandum of the memorandum suggests that the answer is “no”; and
  3. if there’s a total loss, what would the reinstated insurance be covering? Why should the insured be required to pay a premium if there is no property to be insured?

Hopefully, the preceding discussion demonstrates that the “Amount of Policy not Reduced by Loss” memorandum serves no purpose in the ISR policy. It should be deleted.

Clarifying aggregate limits

As describe above, ambiguity may arise as to whether an aggregate limit applies to a) each location individually or b) all locations combined. It is therefore prudent for insurance brokers and insurers to define these terms. An example of such a definition is as follows:

Event and Aggregate Limits

Where the term “per event” or “any one event” is stated for any Limit of Liability or Sub-Limit of Liability, the amount of that Limit of Liability or Sub-Limit of Liability represents the Insurer’s maximum liability for any one event in respect of the Period of Insurance for all insured locations combined.

Where the term “annual aggregate” is stated for any Limit of Liability or Sub-Limit of Liability, the amount of that Limit of Liability or Sub-Limit of Liability represents the Insurer’s maximum liability:

a) for any one event; and

b) in the aggregate,

in respect of the Period of Insurance for all insured locations combined.

The second paragraph of this example may seem unnecessarily wordy. However, aggregate limits could apply to events like Flood or to contingent business interruption covers (i.e. covers that do not require damage to property used by the insured at the insured location). Furthermore, the words “in respect of the Period of Insurance” are used because an indemnity period could commence during the Period of Insurance but extend beyond it – this makes the phrase “during the Period of Insurance” problematic. There may be better ways of explaining event and aggregate limits but, for now at least, the above should suffice as an example.

The Indemnity Principle, Replacement Cost Insurance and Reasonable Despatch

Posted on by Stephen Tomlinson

In the context of Property insurance, this article considers:

  1. the indemnity principle;
  2. replacement cost insurance; and
  3. the reasonable despatch requirement.

While the article focusses on the Australian Industrial Special Risk (ISR) policy, it is relevant to Property and Material Damage Business Interruption (MDBI) policies generally.

What is the indemnity principle?

The indemnity principle means that the insured is restored to their position prior to the loss. Where an insurance policy covers real property, the insured can only be restored to their pre-loss by reinstatement (i.e. repair, rebuilding or replacement) of that property.

If the insured was to be indemnified purely on an indemnity basis, the amount of the indemnity would be the cost of reinstatement less an allowance for betterment. Here, betterment is the amount by which the reinstated property (containing new and/or improved materials) is more useful or valuable than the pre-loss property. As Campbell and Stewart explain:

“A deduction for betterment is a necessary corollary of the indemnity principle: the deduction ensures that an insured is not put in a better position, post-indemnity, than he or she was in prior to the loss.”[1]

Replacement cost insurance

Contrary to the indemnity principle, under “replacement cost” insurance:

  1. the insured is indemnified on a “new-for-old” basis;
  2. there is no deduction for betterment; and
  3. the parties effectively “contract out” of the indemnity principle.

The Australian Industrial Special Risk (ISR) insurance policy is an example of “replacement cost” insurance, and many Property insurance policies operate on this basis. For buildings, machinery, plant and other property and contents, the “Reinstatement or Replacement” memorandum in the Mk.IV ISR provides that “[T]he basis upon which the amount payable is to be calculated shall be the cost of reinstatement of the damaged property insured at the time of its reinstatement, subject to the following Provisions…”

Conditions applying to replacement cost insurance

In the Mk.IV ISR’s “Reinstatement or Replacement” memorandum, the following conditions (among others) apply to its replacement cost indemnity:

  1. the reinstated property is not to be better or more extensive that the condition of the original property when it was new. This condition (and condition 4), below) seek to counter the moral hazard that arises in replacement cost insurance;
  2. reinstatement must be commenced and carried out with reasonable despatch. This condition seeks to contain reinstatement costs which could reasonably be expected to increase if reinstatement is not effected promptly. If property were not reinstated promptly, it would increase insurance premiums for insureds generally. Beyond this, reasonable despatch provides contract certainty since, without it, the insured’s responsibilities for effecting reinstatement are unclear (i.e. when is reinstatement to occur?);
  3. co-insurance (also known as average or underinsurance). This condition is vital to ensure that insureds accurately declare reinstatement costs and the premium can be calculated accordingly; and
  4. no payment beyond indemnity value is payable until the cost of reinstatement has been incurred. In the ISR, the however, this condition is tempered by the “Progress Payments” condition.

These conditions are fundamental to replacement cost insurance, and the rest of this article will focus on reasonable despatch.

Reasonable despatch in the Mk.IV ISR

In the Mk.IV ISR, the reasonable despatch requirement in the “Reinstatement or Replacement” memorandum is as follows:

“The work of rebuilding, replacing, repairing or restoring as the case may be (which may be carried out upon any other site(s) and in any manner suitable to the requirements of the Insured, but subject to the liability of the Insurer(s) not being thereby increased), must be commenced and carried out with reasonable dispatch, failing which the Insurer(s) shall not be liable to make any payment greater than the indemnity value of the damaged property at the time of the happening of the damage.”

Reasonable despatch in Australia: CIC Insurance and Brescia

In Australia, the “reasonable despatch” requirement has come under scrutiny as a result of the judgments in CIC Insurance Ltd v Bankstown Football Club (1997) CLR 384 and Brescia Furniture Pty Ltd v QBE Insurance (Australia) Limited & anor [2007] NSWSC 598.

In CIC Insurance Ltd,

  1. six months after the insured lodged its claim, the insurer declined the claim, alleging that it was a fraudulent claim, and cancelled the policy;
  2. the insured’s financial position was such that it could not reinstate and replace property unless it was indemnified under the policy;
  3. a majority of the High Court held that the failure of the insured to commence reinstatement with reasonable despatch meant that the insurer was only liable to pay the indemnity value of the property;
  4. the majority held that reasonable despatch should be measured without consideration of the insurer’s wrongful declinature (at 403).
  5. the majority indicated that the insured’s position would have been better had it accepted the insurer’s repudiation and sought damages for breach of contract. If the insured proved that rebuilding would have occurred had the insurer admitted liability, damages would be calculated on the basis of the cost of reinstatement.

Gaudron J dissented, stating that:

“It is not reasonable, in my view, to require an insured person to commence and carry out rebuilding and repairs in circumstances where the insurer is wrongfully denying liability under a policy of insurance of the kind involved in this case” (at 412).

In Brescia Furniture Pty Ltd v QBE Insurance, the facts were similar, i.e. the insurer declined the claim and the insured could not reinstate and replace property unless it was indemnified under the policy. Hammerschlag J considered that he was bound by the decision in CIC Insurance, such that Brescia was only entitled to indemnity value, and not the cost of reinstatement. Per Hammerschlag J (at 464):

“An outcome in accordance with the reasoning of Gaudron J is in my view a fair and reasonable one but I am bound to follow the majority view. But for that, I would have followed the approach of Gaudron J.”

Campbell and Stewart concur with Gaudron J and Hammerschlag J[2]:

“Where an insurer under a replacement cost policy wrongfully declines a claim, few would disagree that it is unfair of an insurer to argue that its liability under the policy should be limited because of the insured’s non-fulfilment of conditions. This would be to allow the insurer to take advantage of its own wrong.”

Furthermore, other jurisdictions support the views of Gaudron J, Hammerschlag J, and Campbell and Stewart:

  • In an obiter passage in City Realties (Holdings) Ltd v National Insurance Co of New Zealand Ltd (1986) 4 ANZ Insurance Cases 60-695, 74, at 140, the insurer’s wrongful declinature was regarded as relevant to reasonable despatch; and
  • In British Columbia, it has long been held that for so long as the insurer wrongfully declines the claim, it is not reasonable to expect the insured to rebuild. See, for example, see Omega Inn Ltd v Continental Insurance Co (1987) 37 DLR (4th) 573, at 574.

Reasonable despatch and Unfair Contract Terms (UCT) laws

As explained, reasonable despatch is a fundamental condition for replacement cost insurance. However, the decision in CIC Insurance (in 1997) should have been a wake-up call for the insurance industry to ensure that the reasonable despatch requirement operates fairly. And the decision in Brescia Furniture (in 2007) should have been a reminder. Yet it seems that the vast majority of ISR policies were not amended in light of these decisions.

However, Unfair Contract Terms (UCT) laws came into effect in Australia on 5 April 2021, applying to standard form contracts, consumer contracts and small business contracts. As a result, many Property insurance policies (including ISR policies) have been amended to qualify the reasonable despatch requirement so that it would not apply where a delay was due to circumstances beyond the insured’s control – this would appear to include an insurer’s declinature. But not all Property insurance policies have made this transition and, for those that haven’t, reasonable despatch may be an elusive concept. I hope that this article provides some guidance.

[1] Campbell, N., and Stewart B., Prevention of Performance in Replacement Cost Insurance – Preventing a Fictional Response, Otago Law Review (2002) 5 229, at 231.

[2] Campbell, N., and Stewart B., Prevention of Performance in Replacement Cost Insurance – Preventing a Fictional Response, Otago Law Review (2002) 5 229, at 249.