Alarming Trends – Part 2: Reinstatement and Replacement Conditions vs Indemnity Conditions

Previously, we have addressed the topic of indemnity periods and I expressed my concern on the number of questions I have had come through from Insurance Brokers and Underwriters where the indemnity period for a client was being reduced in this time of increasing rates.

Another issue which has resurfaced as a result of these rate increases is the move to reduce the cover from reinstatement replacement conditions, to indemnity conditions.

Up until the late 1960’s and early 1970’s, the vast majority of insurance policies were settled on indemnity conditions. One of the great innovations and improvements in insurance was to move to reinstatement and replacement conditions, also known as ‘new for old’. This proved, and continues to prove, to be an enormous benefit to an Insured who in the event of a partial or total loss, does not have to find the funds to make up the difference between the, let’s call it market value for the sake of convenience, than the actual cost of replacement.

Subsequently, the insurance industry went one step further by introducing extra costs of reinstatement, which meant not only did we bring the asset back to a condition as new, but also brought it up to date where required to meet any statutory or regulatory requirements.

Not only is there a significant financial benefit to the Insured in the event of a loss, there is also a significant saving in time for there is no need to have the haggle to agree indemnity value which in most cases is based on the replacement value, less an allowance for its age and condition (again, I stress that this is not universally across).

I find that in my discussions with Insureds that wish to consider this option, that they are thinking of a total loss situation and they are factoring in what I call the “it will never happen to me” syndrome. Most losses are partial, and the most common type of loss, say to a building, is not a fire but rather storm damage.

So, let’s say that an insured owns a commercial property and there is a hail storm and the roof requires replacement. If the Insured is reluctant to pay the premium on insurance, how will they feel when they have to meet the cost differential between the cost of a brand new roof, particular if it requires upgrading to meet requirements, and the depreciated replacement value based on the age and condition of the old roof.

If the building is only a few years old and there is going to be no depreciation anywhere, there is no benefit in insuring for indemnity conditions for the value between the replacement value and the depreciated replacement value will be negligible in any event. It is only when the building is older that there is any benefit in premium, but then the question is, at what cost to protection?

Another scenario that crops up is that an Insured, particularly in the manufacturing sector, makes the claim that if there was a total loss and they lost 46 production machines, they would move their operation to China and therefore there is no benefit in having reinstatement and replacement conditions. I again point out that most losses are partial. What happens if fire or water damage makes only 1 or 2 machines irreparable? Would the Insured move their operation overseas having only lost a small portion of the equipment in Australia? Invariably, the answer is no.

In my discussions with insureds where we have a meaningful discussion about the additional risk that is being accepted by the insured by moving from reinstatement and replacement to indemnity conditions that in the vast majority of cases when the Insured considers all the facts, they elect to remain with reinstatement and replacement conditions.

I can not recall a single claim that I have handled in my 45 year career where the Insured has been insured for indemnity conditions and where it is proved to be a good outcome for the business or the principal stakeholders.


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Alarming Trends – Part 1: Indemnity Periods

Over the past month or so, I have been inundated with questions regarding moving from reinstatement and replacement conditions to indemnity, in reducing Sums Insured and reducing indemnity periods. Over the next couple of days, I will address each of these and I will start today with Indemnity Periods.

Back when I first wrote my blue book on Business Interruption insurance in 2001, I was often confronted with indemnity periods of 3 or 6 months and my aim with the book and training sessions, was to move to 12 months being the minimum. Since that time, it has become more and more apparent that 12 months is not sufficient even for many risks, particularly property owners and manufacturing risks. When I say property, this includes infrastructure such as airports and tourism resorts.

If you add to this the complexity of a natural disaster, where the resources of the insurance industry, along with builders, engineers, right down to town building and planning departments, this only exasperates an already crucial problem.

As such, over the last 5 – 10 years, I have really been pushing for indemnity periods, particularly on larger risks which are insured under an ISR, to have a minimum of 24 months or at least 18 month indemnity periods. Speaking to underwriters and brokers, it has been pleasing to see that this advice has been accepted by many insureds.

What is alarming me, is that with the rate increases which are filtering through of late, many clients and/or brokers are reducing the indemnity periods back to 12 months. Yes, there is a premium saving, however, at what risk?

Going beneath 12 months, I believe, is complete folly for the rating of business interruption insurance is not simply a pro rate based on the length of time set for the indemnity period.

Statistically, my research shows that about 75% of business interruption losses have a period of disruption of 3 months or less. As such, if a client was to insure for a 3 month indemnity period, no insurer in their right mind would charge 1/4 of the premium that 12 months cover would cost, for they are going to pick up 75% of the claims, and even with claims which extend beyond the 3 months, they are likely to pick up the biggest burden during that first 3 month period.

Typically, the difference in premium for a 6 month indemnity period and 12 month is less than 10% of the fire rate applied to the full 12 months Insurable Gross Profit figure.

When considering the indemnity period, I have set out under the heading “How long should I insure for?” in the BIExplained section of the LMI Business Interruption Calculator all the things that should be considered when setting an indemnity period. You will note, the cost of insurance is not one of the criteria.

Speaking to underwriters about the situation, one of the reasons they have had to increase the premium rate, is that they are not getting the growth in premiums that they require. This is because we are not increasing Sums Insured as we should each year. If we are going to reduce cover, this is only going to create more problems moving forward as insurers are forced to increase rates again to make up for the lost revenue of people reducing their coverage. I know in the property insurance for LMI Group, there is two things about the program, the first is that we tend to over insure for we see first hand what happens to businesses when they under insure and we would rather pay a little extra premium rather than risk not being fully indemnified in the event of a loss. Secondly, we review our insurances every year, this being the case, we have found our rate has been retained.

Next post, I will go into a bit of detail about the risk of moving from reinstatement and replacement to indemnity conditions.

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California wild fires

In what is the end of the Northern Hemisphere’s summer it is terrible to see the impact in areas of California, including the Napa Valley, as well as East of Los Angeles Metropolitan area, being affected by bush fires.

The full details of the catastrophe are still coming in, but the early reports indicate that over 1000 structures have burned with 1000’s more under threat. Reports so far put the death toll at 13.

The cause of this fires is that it has been the especially dry conditions, similar to what we have experienced for much of our winter here in Australia, a long with strong winds. Australia is heading for another hot summer, and it is a reminder to any of us who live in bush fire areas to carry out a risk management audit of their property and review their evacuation procedures.

PHOTO: Wildfires whipped by powerful winds have swept through northern California. (AP: Jeff Gritchen/The Orange County Register)

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Another fire in one of the world’s tallest buildings

Images from social media

I posted an article back in March 2015 on a fire in a residential tower block in Dubai.

Back then, as a precursor to the terrible Grenfell Tower fire, the combustible cladding was blamed for the rapid fire spread.

Firefighters have just brought yet another fire at this tower, ironically called, the Torch, under control.  To read one of the many news articles go here.

This building is the 65th tallest in the world.

With the police in the United Kingdom predicting a charge of corporate manslaughter against council representatives and the building managers following the Grenfell Tower fire, I hope that we see an immediate end to not only the combustible cladding but all non-conforming building materials.

In the meantime, there has to be some brand damage for those who have invested in these huge tower blocks when it comes to occupancy and resale. Particularly if there is a need to replace the cladding or any other non conforming building products.

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Finally something a government has done that actually makes sense!

It was really great to read that the Victorian Government has removed stamp duty from insurance on farm policies. Well done!

This on top of the removal of Fire Services Levy is a great initiative and makes the vital protection provided by insurance affordable by a segment of our economy who can least afford not to have it.

Now if only other governments would show as much leadership and good sense. Three come immediately to mind that should follow suit.

Home and business owners in North Queensland are struggling due to the high cost of insurance yet, after Cyclone Yasi and the Brisbane Foods in 2011 the Queensland State Government increased stamp duty on insurance from 9% to 10% (a full 1% increase at a time when a government with even 1 eye open should have seen the importance of business and home owners to be fully insured.

Thorough research by Federal Government Departments has shown that the pricing of insurance in North Queensland is fairly priced on the risk being transferred to insurers. Thank goodness those advocating for a Mutual did not succeed as Tropical Cyclone Debbie would have probably wiped out the fund, everyone’s investment and left many people uninsured.

Let’s save all the money on enquiries and address the elephant in the room. If the Queensland Government followed the lead of Victoria and removed Stamp Duty followed by the Federal Government reducing the Terrorism Levy for those in North Queensland the cost of insurance would fall by more than 10%!

The decision by the New Zealand Government to drastically increase the cost of insurance due to changes to the Fire Service Levy defy understanding for they, like the Queensland Government, should understand the value to their economy of everyone being well insured.

The third Government in the trio is the Tasmanian government, who currently holds the record of taxing their business owners the most through insurance. This of course is a disincentive to development.

Like people around the world, I have become greatly disillusioned with the lack of statesmanship in our politicians where it is power at all cost with more than just a little bit of ego gone mad to boot. It is in this frame of mind that I see some hope and refuse to believe my inner doubt that the decision was made to buy votes and not protect the State’s economy. The reality is what ever the reason, I am extremely pleased. Well done Victoria.

I witness far too often the heartbreak and financial stress that home and business owners face when they are not fully insured and so I urge Victorian’s benefiting from this change to take this valuable opportunity to review your insurance and make sure you are fully protected to make the most of your Government’s wise change of policy.

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LMI Mining attending claims due to Cyclone Debbie

There has been a good deal of news regarding the effect of Cyclone Debbie on the supply of coal to the world. We at LMI have been keeping a close eye on this and assisting many mining clients to calculate their business interruption losses as a result of the damage.

What many readers do not know, is that LMI have a specialist mining division that specialises in mining claims, risk assessment, policy and endorsement drafting and review.

Headed by Murray Rowley, with 50 years experience in mining losses, and backed by a team of on staff qualified mining engineers and accountants, the team are handling several losses arising from the closure of the rail lines in Queensland due to damage that occurred during Cyclone Debbie.

I myself, am proud to be part of this team, having handled mining losses since the mid 1980’s including some of the world’s largest claims. My MBA Thesis was on the Closure of the Bougainville Mine. My experience, however, is far outweighed by Murray’s.

Mining, perhaps more than any 0ther industry, requires a great deal of knowledge and experience. There is often a great deal of money at stake and it is certainly not an area for the generalist or amateur. While Murray and his team are based in Queensland, he and his team have and continue to handle losses all around the world due to their extensive expertise in this industry.

LMI Mining is just one of the specialist divisions we have at LMI that provide expertise for specific industries such as tourism, packaging, manufacturing, energy risks, motor trade, crop, retail, and property management.

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Blog Question: How best to insure business interruption for a packing house and the owner farmers

Here is quite an interesting question regarding a packing house and the farmers who own and use the facility.

Hello Allan,

Would you mind having a look at a case for me?  Are we doing this correctly?

We have a company which runs a fruit & vegetable packing shed insured on a Cluster, XYZ, [Group and insurer name withheld] Business Package for property and business interruption.

The’X’number of  directors of this company, also run their own farms (different entities) who send their produce to the above company to be packed and sent to market for sale.

The company receives the income from the sale of the produce, and then charge the farmers a fee to cover their costs, and the balance is paid to the farmer.

How do the farmers (also directors of the company) cover their loss if the packing shed was unable to trade due to an insured event and they are unable to send their produce to market?

Do the farmers have to have their own individual business interruption cover separately, or can the company insure their loss under their policy?

Hope I have explained this correctly.

Look forward to your thoughts.


Mark [surname and email provided]

As is often the case there is more ways than one to achieve the result. As so often happens as I set down in writing the options one appears better than the rest and that is what happened here.


Hi Mark

There are a couple of ways of doing this.

The first would be have each farmer take out their own policy but with a specified supplier being noted, that is the packing shed, with the sub-limit being set based on the value of the proportion of their sales that go through that facility.

You could then also arrange Additional Increase in Cost of Working cover for them so that the farmers could use this to use a different packing house if one was available.

Another way would be to have a contract in place between the farmers and the packing company that in effect guarantees the farmers their proportion of the sales that they normally would achieve.

You would then need to insure this under the Contractual Fines and Penalties section. The issue here is that if the farmer were to find another packing house they would make a super profit. This goes against the spirit of indemnity under an insurance policy. That is to put the Insured back in the same position they would have enjoyed but for the loss.

Another version is to name all the entities on the one policy, declare the total gross profit that they all earn as one declared value. (I would probably record this separately  on your own file so that you can demonstrate to any adjuster or forensic accountant that they are included).

Thinking about this as I type my reply, I think this last option is the best way forward. This way their stock of fruit is also covered whilst at the packing house. This is often overlooked.

To be belt and braces if you ever move this to an ISR, I would also include the following Interdependency Endorsement under an ISR. The code if you need it, is IDEPAXB4


Loss as insured by Section 2 of the policy resulting from interruption of or interference with the Business in consequence of Damage to property not insured by Section 1 of the policy and situated at any other premises in Australia owned and/or occupied and/or used by the Insured for the purpose of the Business or any other business shall be deemed to be loss resulting from Damage to property used by the Insured at the Premises.

As I say it is belt and braces and unless I am missing something, it is not required under a business pack as the farmer would have an insurable interest in their stock at the packaging house.

What could happen though is that there is a fire or storm damage at the premises before the season starts, say during the set up stage, and there is no stock for one or several of the farmers at the packing house. This is when the adequacy of the sub-limit for customers and suppliers premises is so very important.

One of the other issues to consider is the prevention of access issue if the farmers cannot get their produce through to the packing shed or from the shed to market. This is where you need to check the coverage for prevention of access (typically excludes roads and bridges) or coverage for roads and rail lines that the stock of the insured passes over.

I hope this gives you some food for thought.



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Dubai launches Dolphin water jetpack system for firefighting from the air

Reports from an article published by the ABC show how Dubai is taking firefighting to new heights, quite literally, with their introduction of a water jet pack system called ‘Dolphin’. You can view a video of the Dolphin in action on the ABC website (link above).

Alongside the Dolphin is the Martin Jetpack being looked at as an option to reach those tricky areas safely as it can be both unmanned and controlled remotely, or manned on the system.

As the heat from a fire goes up, I am not quite sure about this one but it is clearly worth a look for areas where it is extremely difficult to get to.


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2 Articles caught my eye today

There were two articles that I looked at today with mixed feelings.

The first suggested that 50% of claimants were ‘dodgy’ and inflated their claim. Having handled claims for over 45 years, yes there are some people that do exaggerate claims but 50%. I really do not think so.

It is my experience that people go in conservatively so that the claim goes through quickly and with as little fuss as possible. This goes for men, women, professional or blue collar.

The trouble is with so many insurers now is that everyone is dodgy until proven innocent which could in fact be exasberating the whole issue.

On the otherside of the coin, 25% of the people surveyed when I did my doctoral thesis, stated that they believed that insurers and their loss adjusters slowed down the claim payment so that they could offer a lower settlement.

In an industry that is supposed to be based on Utmost Good Faith all of this is really quite distressing.

The second aritcle confirmed my worst fear and that is that more and more small business owners are going direct.

Insurance is so complex despite the commodiasation of insurance products but this constant focus on price over protection is going to really hurt brokers and the industry as a whole, not to mention Insureds, communities and our ecnonomy.

All of us in the insurance industry need to provide genuine advice to the customer on risk management and proper insurance protection.

I feel like a bit of broken record on this one but perhaps suveys showing the move away from brokers may prompt more to focus on the advice model.

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Blog question – Embargos

Over the past 24 hours, I have had a number of questions regarding Embargo’s on insurance policies.

My son, Steven, recently posted a YouTube video explaining Embargos and I would refer those interested to this. Which can be viewed here:

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