Blog Question on Time Excess

bigstock-Business-Interruption-Sign-39078256Hi Allan,

Trust your well.

I believe you’re the best person that may be able to assist – with the following:

Time Excess – 48 hours

Blanket for section two including gross profit

Is this possible?  If yes, can you explain to me how this would work.

I have been Head Broker for Lloyd’s of London via [name provided], (back in the good old 80’s) and worked at [an international broker] here in Australia for more then fifteen years, and never have come across the above.

Any assistance would be appreciated Allan.

Kind Regards

Cathy [surname and email provided]

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Before answering I asked if it was a claim scenario so that I could best explain how it would apply or if it was something being suggested by an underwriter for a new account. It turned out to be something being suggested by a colleague for a business in the education sector.

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I replied: I dislike time deductibles with a passion and would strongly support your questioning it. I think they were invented by a loss adjuster who wanted to increase his fee income as that is the only person who wins out of these.

I can understand an underwriter not wishing to pick up claims for short term disruptions of say a day or 2 but if the claim is longer than that, the time and effort trying to work out the excess amount can be significant.

I am not sure if you have access to my blue covered book on Business Interruption Insurance and Claims. In that I have a whole chapter showing just some of the problems associated with Time Deductibles.

If you do not have a copy I will get a copy of the chapter to you.

I would prefer it is a monetary deductible and or a time franchise. A time franchise which many business pack policies (particularly those drafted by LMI) have takes out claims of a short duration up to the length of the nominated time period, but then meets the full claim if the disruption, say a power outage extends beyond the time franchise period.

I see time deductibles in the mining sector and in some extensions such as public utilities but not across a whole Interruption program in non mining occupations.

As an aside, I would add that I have discussed the issue of time excesses with Murray Rowley who has been specialising in mining claims adjustment /claims preparation, handling some of the world’s largest losses for over 35 years, he now heads LMI Mining, and he is even more against time excesses than me. His strong view is that monetary deductibles are the only way to go.

I would be directing your colleague away from a time excess towards a much less complicated monetary deductible which the underwriter, insured, broker and loss adjuster all know what it is in advance of any claim.

I hope this helps.

Regards

Allan

Cathy kindly replied:

Thank you Allan.

Yes I have a copy of your ‘Business Interruption Insurance & Claims’  always sitting on my desk.

I did read the chapter on time excesses and deductibles prior to sending through my question to your good self.

Thank you once again Allan, for your assistance, very much appreciated.

Cathy

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Business-Interruption_03For those that do not have the blue bible on interruption insurance (Business Interruption Insurance and Claims) I reproduce the chapter on some of the issues on time deductibles below.

Chapter 18 – Time Excesses/Time Deductibles

18.1   Introduction

Time excesses were previously rarely seen, except for particularly large risks, especially in the mining industry. The large number of business interruption claims that arose from the gas crisis in Victoria, Australia in September 1998 highlighted the inherent problems associated with time deductibles. Many of the issues have again been seen following the Western Australian gas crisis 10 years later, in June 2008.

The purpose of this chapter is to highlight some of the many problems that can arise with the interpretation of a time deductible. A second, equally important, purpose is to offer suggestions for alternative forms of deductible that may assist each party to the insurance contract in understanding their respective position in the event of a loss.

18.2   Case Study 1: 3-Business Day Time Deductible

The first case example is in respect of a large manufacturer that has a Section 2 Deductible of “3 business days”.

The loss of 7 days’ production caused by the gas outage was made up by the Insured by working weekends and public holidays between the date when the gas supplies resumed and the end of the Indemnity Period. The loss was confined to the Increase in Costs of Working associated with making up the lost production.

The position that should be adopted with such a disruption being considered under a policy with a time deductible is that regardless of when the costs are incurred, they should be matched to the benefit that the increased costs have generated. For example, if within the first 3 days the Insured had incurred significant costs, say several million dollars, to convert their production facilities to run on LPG rather than natural gas, but the benefit of this expenditure was not realised until after the first 3 days and was therefore to the entire benefit of the insurer, then the insurer should, in equity, meet the entire cost of the Increase in Costs of Working. This is logical even though it was incurred during the first 3 days.

Conversely, any costs associated with making up lost production suffered during the first 3 days, for instance by way of overtime etc, should be at the expense of the Insured; the first 3 days being the period of time deductible.

This is in line with not only the generally accepted accounting principle of matching revenue with expenses, but also with the spirit of the underlying principle of indemnity which, as we have discussed elsewhere in the text, is to “put the Insured back, as near as money will allow, to the same position that they would have enjoyed but for the loss” [1].

In this case, an accountant acting for the Insured as a claims preparer, argued that there were no lost sales during the first 3 days and, as such, there was no loss suffered by the Insured. They went further to argue that as the Insured ‘stood down’ employees during this period, there were savings made. However, as these were made during the 3-day deductible, these costs should not be taken into consideration in adjustment of the claim. If this was to be accepted (and it was not), it would have converted the deductible into a positive benefit to the Insured. This is because the insurer was being asked to meet all the additional costs to make up the lost production, but was not being granted any benefit of the savings made during the period.

This is a nonsense argument that goes against the underlying principle of business interruption insurance, as set out at the start of Chapter 2. What this case study does, however, is highlight the problems that can arise in adjustment of a claim involving a time deductible. The lesson to be learnt from this case is that the policy must clearly state how the deductible is to be applied.

18.3  Case Study 2: 24 Hours after Cessation of Supply

This case study involves another large manufacturer. In this case, the wordings for the time deductible contained within the Public Utility clause provided that cover does not commence until “24 hours after cessation of supply”.

To avoid major damage to the insured plant at a large production facility, the gas supplier allowed the Insured to implement a staged shutdown of the gas supply over the site, which took 11 hours. In other words, it took 11 hours from when gas supply was cut to the first machine, until it was cut to the last machine. Does this mean that the Insured in fact suffers a 35-hour time deductible? That is, 24 hours from the cessation of supply, plus the 11 hours of disruption they suffered during the phased shutdown. The wording of the deductible did not match the intention of either the insurer or the Insured.

In this case, using the Departmental Clause, it was possible to identify the loss by machine, and the claim was settled by applying the 24-hour time deductible on a machine-by-machine basis. A much more difficult adjustment and negotiation would have been required to achieve the agreed intention of the time deductible had the method of claim calculation used not been possible.

18.4  Case Study 3: The Policy will not Cover Losses within the First 24 Hours

The third case involves a wording that states the policy will not cover losses within the first 24 hours. In many cases of smaller commercial and industrial premises, the Insured was not advised to shut down their gas until after 5.00pm on Friday, 25 September 1998.

If they had no planned production within the next 24 hours, they suffered no losses and, as such, the time deductible did not apply. Had the shutdown occurred at the same time on Sunday, Monday, Tuesday, Wednesday or Thursday, then the same time deductible would have applied, but this time with a financial penalty being borne by the insured business.

On the other hand, taking restaurants for an example, Friday and Saturday evenings are often their busiest nights. They, therefore, were penalised by pure chance due to the fact that the disruption caused by the Longford Gas Explosion occurred on a Friday. For them, if it had occurred on a Sunday or Monday, the reduction in the claim due to the application of the deductible would have been much less.

Rather than know their respective positions when a loss occurs, it could be said that the insurers and operators of businesses that do not operate 7 days per week are both playing Russian Roulette with a revolver holding 5 bullets in a 7-chamber gun. That is, 5 working days in a 7-day week.

18.5    What is the Answer?

I would suggest there are several answers to the problems of time deductibles, and would like to explore three with you.

The first is to replace the excess/deductible with a franchise. If the insured business is disrupted due to an event for a period less than the franchise of say 1, 2 or 3 days, then the loss will be at the full expense of the Insured. If it extends beyond the period of the franchise, then the entire amount would be met by the insurer. This would mean that the Insured would carry the risk for minor periods of disruption, but beyond that they would have the comfort of having full insurance subject to adequacy of insurance etc.

The second solution is to apply a monetary deductible, which both the Insured and insurer know and understand in advance. I would suspect that this would be easier for the underwriter to underwrite and the Insured would be in a much clearer position as to the effect of the deductible in the event of a claim. It would also reduce the stress and claims handling costs following a loss.

The third alternative is simply a combination of the first two. The monetary deductible would apply after the franchise period had lapsed.

18.6   Summary of Chapter

Space limitations have only allowed three case studies to be provided. Underwriters, claims staff and Insureds who lodged a claim following the gas crisis or any business interruption claim with a time deductible can provide similar examples of complications arising from their experiences of the interpretation of time deductibles.

At the very least, time deductibles need to be reviewed to incorporate clear details in the policy as to how they should operate. Alternatively, they should be replaced with a franchise, a set monetary deductible, or a combination of both. Food for thought to improve what, in the main, is a very good product.

[1]     Castellain v Preston (1883) 11 QBD 380.

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