Limits of Liability v Sub-Limits of Liability v Schedule of Declared Values
I was recently appointed by the Chief Financial Officer of a company to cast a fresh pair of eyes over their insurance program. As I was going through the Industrial Special Risks (“ISR”) schedule I noticed a number of issues that needed to be remedied. Without wishing to embarrass anyone, I will discuss a few of these over the next few posts, particularly those that I see crop up quite often.
The first point I noticed was that the Schedule included a definition of “Buildings”, and another for “Machinery & Plant” etc. As I explained in 2 recent posts this is not necessary and if anything undoes some of the benefit of the ISR policy.
Rather than repeat myself, I attach a link to the two articles which not written for the particular concern, explain the reason why a definition is not required. If you are still not sure please let me know and I will go over this in more detail.
The next and more important issue is that under the heading Limits of Liability, the Schedule listed what in effect was the Declared Values for the building at each location, the stock values, machinery and plant etc. This is simply not correct.
An ISR Policy is not a Business Pack Policy with sums insured or limits for each category of asset. There are several types of amounts to be shown on the Schedule. Limits of Liability, Sub-Limits of Liability and Declared Values. They should not be confused.
The Schedule of Declared Values is what the premium is primarily based upon and which the test for co-insurance will be made against. It was never designed to be a Limit or Sub-Limit of Liability.
On the first page of the ISR just after the Operative Clause (the clause that sets out on what conditions the policy will respond. The actual words read:
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.”
The very next clause of the Policy sets out the extent to which the Insurer will meet claims. This reads”
Provided that the total liability of the Insurer(s) at any one Situation shall not exceed the appropriate Limit or Sub-Limit(s) of Liability as stated in the Schedule or such amount(s) as may be substituted therefore by endorsement or memorandum hereon or attached hereto and that each Insurer specified below shall only be liable to contribute to any loss covered by this Policy that proportion of the loss as is specified beside its name.” [emphasis mine].
No where in this clause does it refer to Declared Values only to the Limits and Sub-Limits of Liability.
For reasons that I have stress in my ISR Master Class, the Limit of Liability should always be higher than the value of Declared Assets at the largest location. There are two main reasons for this.
After any property or business interruption claim, once the claim has been calculated in accordance with the relevant basis of settlement the claim is subject to three tests.
First a test for under insurance. Under a standard Mark IV or Mark V ISR property claims are tested with 85% co-insurance. whereas business interruption is tested with 100% average or co-insurance.
The second test is against any Sub-Limits. A good example is flood. If the loss after the application of co-insurance is greater than the Sub-Limit then the claim payment is limited to that Sub-Limit.
The third test is the Limit of Liability. Here the total liability of the Insurer is capped to the Limit of Liability. Additional benefits provided by the policy such as Removal of Debris or Extra Cost of Reinstatement are not paid in addition to the Limit of Liability but out of it.
On the subject of additional benefits, not all items claimed are subject to average and removal of debris, extra cost of reinstatement, and employees clothing and tools of trade are but a few. This is one of the two main reasons that the Limit of Liability should always be higher than the total of the Declared Value at the ‘target’ or largest location.
The second major reason the limit should be higher than the Declared Value is that there may be some escalation of costs between the start date of the policy, the time period against which the adequacy of the Declared Values will be tested by the Co-Insurance test and the date of the final repair. With a loss perhaps occurring 364 days after the start date of the policy and you then add a reasonable period to reinstate the asset it may be several years later. Having a separate an higher Limit of Liability is a great benefit introduced by the drafters of the ISR wording. These underwriters and brokers clearly had protection for the Insured top of mind.
Having the Declared Values listed as Limits of Liability under the ISR does away with one of the major benefits of this great policy, the Australian ISR.
I am often torn between explaining an issue in sufficient detail to make it clear but at the same time, I am mindful that readers do not like long articles. If you would like to learn more please read chapter 2 of my book, Understanding the ISR Policy volume 1 – the Mark IV.
As with any policy, the schedule needs to confirm with the structure of the policy wording and certainly not unintentionally limit what is standard coverage. To do so makes for a very uncomfortable time in the witness box.
In my next post I will discuss the difference between Accidental Damage, Specified Damage and Unspecified Damage.