thereby restricting the overall ‘global’ figure to a strict indemnity.
1.3.3What are the consequences?
Policyholders may be seen to be claiming a double indemnity for costs incurred, contrary to the principle of indemnity.
If the insured mitigates its losses by using its own labour (often at considerable saving to insurers), it might recover the costs incurred from its material damage insurers. If the labour costs paid are then deducted from the BI claim in order to avoid this so called ‘double indemnity’, the policyholder may feel that it is penalised unjustifiably.
There is no facility for making any adjustments (to reflect the duplicated amounts) within either the material damage or the BI policy. Such adjustments are generally applied to the BI settlement, but these do not fall within any of the clearly-defined elements of the standard UK BI policy wording. Consequently, they are often treated incorrectly as ‘savings’ even though they do not fall within the definition of costs/expenses saved in consequence of the incident, giving rise to the claim.
Notwithstanding this, where one or other element of the cover (MD/BI) is underinsured and average conditions are incorporated, policyholders may be entitled to ‘cherry pick’ the sections of the policy against which the costs that are covered under both sections are allocated.
1.3.4Potential solutions
There are several possible solutions to this issue.
If it is the intention to avoid any double indemnity, a provision could be made in either the material damage or BI policy to make an appropriate deduction. Current practice would seem to be that any adjustment be made under the BI policy, but this could act to the detriment of the insured if the material damage settlement had already been limited by the application of average.
It is possible to amend the wording of the BI policy to enable such costs that have already been paid (after application of average) within the material damage policy or section to be taken into account in the BI settlement. This could be achieved by, for example, including the following clause:
Due account will be taken of any payment already made in respect of insured costs under a related Property Damage policy or section of this policy.
Alternatively, it may be insurers’ intention to pay both the BI and material damage claims on the basis that the insured has paid the full premium for both covers.
The US approach is to exclude BI losses relating to finished stock, which reduces the significance of the overlap in relation to stock but does not address the circumstance where the insured’s own labour undertakes material damage repairs to buildings, plant, etc.
1.4 Material Damage Proviso
1.4.1Current position
The material damage proviso is fused with the operative clause in some policies, and set out separately in others. Regardless, it is invariably not identified in policy wordings as ‘the material damage proviso’ (MDP) – this term is used within the industry to refer to a form of words seen in most policies.
A typical material damage proviso might read:
[The Operative clause will trigger] provided that at the time of the happening of the damage there shall be in force an insurance covering the interest of the insured in the property at the premises against such damage and that payment shall have been made or liability admitted therefore under such insurance.
The main purpose of the material damage proviso stated in Riley4 has been to ensure that sufficient funds are available to facilitate reinstatement, which in turn will mitigate the BI loss. A subsidiary objective is to obviate the need for the business interruption adjuster to duplicate the work of the material damage adjuster in investigating cause and considering the application of any clauses precedent to liability.
1.4.2What is the problem?
It seems to be widely accepted that when it comes to the availability of sufficient funds to effect reinstatement, the material damage proviso fails. There is no requirement for the property insurance to be adequate, or for that matter that it be on a reinstatement basis. The proviso is either satisfied or it is not; an all-or-nothing position is established, irrespective of the underlying commercial sufficiency of the cover.
The need to anticipate separate material damage and business interruption investigations into causation is anachronistic, particularly in respect of commercial combined policies.
The material damage proviso was conceived when the various covers were purchased as separate policies. Not only have commercial combined covers become the norm, but also the breadth and availability of BI extensions have increased. The extent to which the traditional material damage proviso wording can be applied to these extensions varies between wordings.
This issue was tested in the courts in the case of Glengate-KG Properties Ltd v Norwich Union Fire Insurance Society Ltd and Others.5 Glengate bought an old department store building on Oxford Street to redevelop. It took out two policies with Norwich Union, one for material damage and one for business interruption. It had a temporary site office in the building, which was used by the construction professionals, including the architects. There was a fire that destroyed the site office, and, with it, a large number of drawings on which the the architects were working. Importantly, the drawings were very clearly the architects’ property. They retained the copyright and ownership and the drawings were in their possession. Once completed, Glengate was to have a license to use the drawings.
The architects had not insured the drawings. There was an extension in the material damage policy that included temporary offices and plans, but only if these were the, ‘property of the insured or for which they are responsible’. Norwich Union argued that the material damage proviso in the business interruption policy was not satisfied because there was no cover in force for the drawings. The two majority judgments rejected this argument. These drew a distinction between the type of interest covered by the business interruption policy and the insurable interest necessary to insure property under a material damage policy. It was held that the former was broader and focused on the fact that the business interruption cover clause only required the property to be used by the insured for the purposes of the business at the premises. It did not spell out a need to have a proprietary interest (e.g., ownership). In contrast, they found that the material damage cover required an insurable interest in a more narrow sense, namely a proprietary or contractual interest in the property.
By this reasoning, the Court of Appeal found that there was sufficient insurable interest to allow the claim under the business interruption section but no insurable interest for the purposes of the material damage section, meaning that there was no breach of the material damage proviso. The broader interest required by BI did not need to be insured by Glengate and the claim was paid.
1.4.3What are the consequences?
The material damage proviso is ineffective in terms of the main objective stated in Riley.6 In the event of significant underinsurance giving rise to delay in the reinstatement process, insurers have to employ other arguments to avoid their liability being increased by virtue of a potentially extended indemnity period.
If the current wordings can produce unfairness to insurers, there can also be disproportionate difficulty for the policyholder. In Glengate, there was a suggestion that any failure to satisfy the material damage proviso might invalidate all of the BI cover, which may have produced an unfair resolution in the mind
