Another Subtle Change (#2) to Business Insurance that weakens the cover!

Is insurance there to protect or destroy SMEs when they need the cover the most?

After nearly 41 years of handling insurance claims, what motivates me in all I do is to work towards business and home owners having the right insurance in place so that when ‘it’ does happen to them, they are fully insured.

At the same time, I fully appreciate that an insurer needs to be compensated by way of a fair premium to cover the risk that has been transferred from the Insured to them.

My third motivation is to reduce the number and size of professional indemnity claims against insurance brokers, and, in fact, turn it around so that a client feels that the broker gave them the right advice before any loss and that they (the Insured) have been fairly treated during the claim process.

With the high level of government taxes, the media and politicians demonising the insurance industry and a de-skilling of our profession, I sometimes feel I am fighting a losing battle.

Clearly, those that share my dream have another enemy to fight. This time it is the underwriters who are slowly reducing the cover afforded by their policies.

Last week, I raised the issue that a number of policies now require the Insured to include the GST in the sum insured. Further, that sub-limits also include the GST. See Should the client include GST in their sum insured on Business Insurance?. A couple of weeks before that, I asked, Where has the insurance industries social conscience gone?

This week I want to talk about at the change in some policies as to when the test for co-insurance is to be made.

Long before I joined the industry, the test for under insurance (average or co-insurance) on a property policy was on the commencement date of the policy. In the 1987 Mark IV Advisory Industrial Special Risks (“ISR”) policy, the co-insurance clause which is Proviso (iii) of the Reinstatement and Replacement Memorandum reads as follows:

In the event of damage to any property insured hereunder at any situation caused by any event hereby insured against, the insurer(s) shall be liable for no greater proportion of such damage than the amount that the Insured’s declaration of value of property insured at such situation on the day of the commencement of the Period of Insurance bears to the sum representing eighty-five per cent (85%) of the cost which would have been incurred in reinstatement if the whole of such property had been destroyed on that day, but not exceeding the Limit of Liability expressed in the Schedule; provided that if the sum actually incurred or expended in rebuilding or replacing the damaged property, within the meaning of sub-paragraph (a) of the abovementioned definition of reinstatement, exceeds the amount which would have been payable under this Policy if this memorandum had not been incorporated herein but is less than the cost of reinstatement as above defined, then the sum so actually incurred or expended shall, for all purposes of this memorandum, be deemed to be the cost of reinstatement of the property.”

[emphasis mine]

The reason that the commencement date of the policy was chosen was that it was accepted by socially responsible insurers that the Insured could not reasonably predict changes in the cost of rebuilding or in the cost of replacing stock, machinery, plant or other insured property in the upcoming insurance year. Changes in the economy, legislation, changes in currency values, fashion and a raft of other variables, can and do effect values.

So why then have many insurers started to move the date to test for under insurance from the start or inception date of the policy? (Bearing in mind that in accordance with the ruling in Edwards Dunlop & Co Limited v C.E Heath Underwriting & Insurance (Australia) Pty Limited (1993) 176 CLR 535, that each renewal creates a new contract and a new inception date of the contract of insurance.)

The issue was brought ahead for LMI’s claims team attending to Cyclone Yasi claims earlier this year. The building industry in North Queensland was a bit depressed prior to the cyclone hitting, but then all building trades were in hot demand. Should we test for under insurance 1 minute before the storm hit when building costs were lower or one minute after when the costs had escalated by 30% to 50% due to basic economic principles of supply and demand?

I reviewed the policies that are out in the Australian Market and was surprised to see so many that had moved to testing on the date of the damage. Even insurers that I would never have guessed would move down this route.

At this stage, insurers have not moved on the cluster group policies as far as I can see but on their generic wordings, as they fall due for renewal many are moving them over, and, as far as I can see, not notifying their clients of the difference.

I will not repeat the duty of utmost good faith as espoused by Lord Mansfield said in Carter v Boehm (1766) 3 Burr 1905, but I feel that this change is unfair and undoes the good practice of those, as I say socially responsible underwriters/insurers, that developed the original policies. Our clients deserve more and I believe our industry is better than this. If it is a profitabilty issue, put the price up by the small fraction that is needed but do not take away cover.

I have always strongly believed that policies should contain a co-insurance clause due to the risk of Insureds selecting against the Insured by choosing a sum insured that would cover their estimate of the maximum probable loss. My position has only strengthened as a result of my work arising out of the Christchurch earthquake where I have seen endemic under insurance as Insured after Insured set their estimate of their maximum probable loss on a fire or storm and not a series of massive earthquakes. This has had negative life-changing consequences on so many good people, their families and that of their employees and on the Christchurch and New Zealand economies.

The whole reason that the industry moved from the ISR Mark III to Mark IV was over under-declaration and the primary change was to make the test for under-insurance being the value at risk at the situation at the commencement date of the policy.

The way I see it, this move is going to disadvantage small and medium-sized businesses, who are the backbone of the Australian economy and the primary client base for many Australian insurers. It will not affect those on an ISR policy nor those who use an international broker where co-insurance is often deleted. It is on this point that it will not, at this stage at least, affect those brokers who are part of a cluster group where they stay with their partner insurers and or with a broker who understands and appreciates the significant difference that this change in the wording has. What of the SME client that buys direct? What is the PI exposure to the broker that fails to notify his client of the change in cover?

Our industry has been demonised by the media and government over the flood issue and we have had further legislation thrust upon us. The recommendations went further and asked for the removal of sum insureds on home building policies by 2014. This was an unexpected consequence.

I genuinely fear that when the media and/or regulators become aware of the changes, perhaps during a natural disaster, that there will be a push for the removal of all penalties for under-insurance. The fact that insurers are prepared to do it for some clients, coupled with the poorly communicated change in the time for the test of co-insurance, is just the opening that the regulators will jump on.

I urge all insurers moving down this path to seriously consider what they are doing to their customers and to the brand ‘insurance’.

Remember that there are tools to assist you explain co-insurance to your clients. These are available in LMI RiskCoach with the building cost calculator and the under-insurance calculator. Both of these are available on iPhone and iPad from the Apps store (search for LMI Group), while the Under-insurance Calculator is now avaiable on Android phones via the Market Place. Again, search for LMI Group.

Also remember that LMI PolicyComparison will show you the date for the test for co-insurance and the percentage the loss has to reach before the test is applied. You will see that many insurers are phasing the change in as they update their wordings.

It gives me no pleasure to raise issues such as these. Besides GST and the test date for under insurance, I have a couple more serious concerns that I will give more thought to and do a posting on over the next few weeks.

On the other hand, if I have missed something as to why the change is necessary, please drop me a line via the ‘Comments’ section or write to me at

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