UNDERSTANDING THE ISR POLICY A Comprehensive Guide on the cover afforded by the Industrial Special Risks Policy for Insurance Brokers and Advisers, Underwriters and Claims Officers, Loss Adjusters, and Risk Managers

Volume 1: The Mark IV

This volume contains Comprehensive Analysis of Mark IV Advisory & Modified Wordings

Schedule of Available Endorsements with Commentary

Allan Manning

To my wife, Helen For whom nothing is too much trouble…even me!

“Writing a book is an adventure: it begins as an amusement, then it becomes a mistress, then a master, and finally a tyrant.”

Winston Churchill

Other titles by this Author

Understanding the ISR Policy: A Comprehensive Guide - Volume 2: The Mark V Understanding the ISR Policy: A Comprehensive Guide - Volume 3: Aids to Understanding

Business Interruption Insurance & Claims: A Practical Guide Fidelity, Theft & Money Insurance & Claims: A Practical Guide

The Closure of the Bougainville Copper Mine: Anatomy of a Major Claim It Will Never Happen to Me! The Strategic Management of Crises in Business

National Library of Australia Cataloguing-in-Publication entry Manning, Allan. Understanding the ISR Policy : A Comprehensive Guide on the cover afforded by the Industrial Special Risks Policy for insurance brokers and advisers, underwriters and claims officers, loss adjusters, and risk managers. Bibliography. Includes index. ISBN 0 9580948 3 7 (set). 1. Risk (Insurance) - Australia. 2. Risk Management - Australia. I. Title. 368.994 Allan Manning, Author Layout and design by Secretaries on the Move Pty Ltd, Camberwell, Victoria, Australia Printing by Q-Print, Albion, Queensland, Australia Published by Mannings of Melbourne Pty Ltd, Camberwell, Victoria, Australia First published December 2005 Copyright 2005 Mannings of Melbourne Pty Ltd

FOREWORD By Keith Till

Of the many interesting individuals that I have met over my 40-plus years in the insurance industry, Allan Manning stands out as one of the most remarkable. A quiet achiever, Allan also happens to be one of the most qualified practitioners in his field, with a swag of letters to his name including, most recently, a Doctor of Business Administration from Victoria University, following his extensive research into business survival following a major insured loss. But what’s even more impressive is the contribution that he has made to broker education over the past decade, sharing his in-depth knowledge of the nuances of various insurance products via an excellent range of training books and courses. In a small way, I can lay claim to contributing to this Guide’s inception. You see, at my behest, Allan had been conducting a series of workshops over the previous 12 months for brokers in the Zurich network - to help further their knowledge of Business Interruption and ISR insurance. The overwhelming feedback from the hundreds of brokers from across Australia who attended the workshops, held as far afield as Cairns to Perth, was that Allan had helped them gain a more thorough understanding of these products. While Allan had already produced the definitive Australian guide to Business Interruption insurance (‘Business Interruption Insurance & Claims: A Practical Guide’, now in its fourth edition), there was nothing comparable on the market about ISR. So I suggested to Allan that maybe he should put pen to paper again. Nine months on, it’s with great pleasure that I recommend Allan’s ISR guide to you – a practical and comprehensive book based on the insights that he has gained from his many years at the coal face, dealing with ISR claims. True to form, the end result is very thorough, spanning three volumes – essential reading for anyone who wants to gain a comprehensive understanding of the various ISR wordings and endorsements available in the marketplace. ‘Understanding the ISR Policy’ is the kind of book that you’ll refer to time and time again in the day-to-day running of your business – a must-have for every practitioner. Keith Till National Broker Manager Zurich Financial Services Australia Limited North Sydney, 21 September 2005

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified i

CONTENTS

INTRODUCTION 1

PART A 6

Chapter 1 Preamble, Operative & Attestation Clauses....................................... 7

1.1 Preamble 7 Mark IV Advisory and Mark IV Modified........................................ 7

1.2 Operative Clause 8 Mark IV Advisory and Mark IV Modified........................................ 8

1.3 Insurer’s Maximum Liability 9 Mark IV Advisory and Mark IV Modified........................................ 9

1.4 Attestation Clause & Panel of Insurers 10 Mark IV Advisory and Mark IV Modified......................................10

Chapter 2 The Schedule....................................................................................... 11

2.1 The Insured 11 Mark IV Advisory and Mark IV Modified......................................11

2.2 The Business 13 Mark IV Advisory and Mark IV Modified......................................13

2.3 Situation and/or Premises 14 Mark IV Advisory and Mark IV Modified......................................14

2.4 Period of Insurance 15 Mark IV Advisory and Mark IV Modified......................................15

2.5 The Premium 25 Mark IV Advisory and Mark IV Modified......................................25

2.6 Declared Values 25 Mark IV Advisory and Mark IV Modified......................................25

2.7 Limit(s) of Liability 29 Mark IV Advisory and Mark IV Modified......................................29

2.8 Sub-Limit(s) of Liability 32 Mark IV Advisory and Mark IV Modified......................................32

2.9 Deductibles 39 Mark IV Advisory and Mark IV Modified......................................39

2.10 Indemnity Period 42 Mark IV Advisory and Mark IV Modified......................................42

2.11 Pay-Roll Limits 47 Mark IV Advisory and Mark IV Modified......................................47

2.12 Uninsured Working Expense 47 Mark IV Advisory and Mark IV Modified......................................47

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Chapter 3 - Section 1: Material Loss or Damage - The Indemnity......................50

3.0 The Indemnity 50 Mark IV Advisory and Mark IV Modified ..................................... 50

3.1 Trigger for Cover 50 Mark IV Advisory ........................................................................ 50 Mark IV Modified......................................................................... 54

3.2 Additional Benefits 55 Mark IV Advisory and Mark IV Modified ..................................... 55

(a) Architects, Surveyors’ & Similar Fees 55 Mark IV Advisory and Mark IV Modified ........................... 55

(b) Government & Statutory Fees 56 Mark IV Advisory and Mark IV Modified ........................... 56

(c) Fire Extinguishment & Mitigation Costs 57 Mark IV Advisory and Mark IV Modified ........................... 57

(d) Temporary Protection 58 Mark IV Advisory and Mark IV Modified ........................... 58

(e) Replacing Locks & Keys 59 Mark IV Advisory .............................................................. 59 Mark IV Modified .............................................................. 59

(f)(i) Removal of Debris, Dismantling & Temporary Repairs 60 Mark IV Advisory and Mark IV Modified ........................... 60

(f)(ii) Removal of Debris from Premises of Others 67 Mark IV Advisory and Mark IV Modified ........................... 67

(f)(iii) Removal of Debris, Property No Longer Useful 68 Mark IV Advisory .............................................................. 68

(g) Directors’ & Employees’ Clothing & Tools of Trade 69 Mark IV Advisory and Mark IV Modified ........................... 69

3.3 Additional Benefits which are not Subject to Co-insurance 70 Mark IV Advisory and Mark IV Modified ..................................... 70

Chapter 4 Section 1: Material Damage - The Property Insured ........................71

4.0 The Property Insured 71 Mark IV Advisory and Mark IV Modified ..................................... 71

4.1 Definition of What is Insured other than Money 71 Mark IV Advisory ........................................................................ 71 Mark IV Modified......................................................................... 74

4.2 The Extent of Money Cover 74 Mark IV Advisory and Mark IV Modified ..................................... 74

Chapter 5 Section 1: Material Damage - Basis of Settlement...........................76

5.0 Basis of Settlement 76 Mark IV Advisory and Mark IV Modified ..................................... 76

5.1 Designation of Property using Insured’s Records 76 Mark IV Modified Only ................................................................ 76

(a) Buildings, Machinery, Plant etc 77 Mark IV Advisory and Mark IV Modified ........................... 77

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(a)(i) Cover if Insured Elects to Accept Indemnity 77 Mark IV Advisory Only ......................................................77

(b) Raw Materials Supplies and Other Merchandise not Manufactured by the Insured etc 78 Mark IV Advisory Only ......................................................78 Mark IV Modified Only ......................................................80

(c) Material in Process 81 Mark IV Advisory Only ......................................................81 Mark IV Modified Only ......................................................81

(d) Finished Goods 82 Mark IV Advisory Only ......................................................82 Mark IV Modified Only ......................................................82

(e) Rewriting of Records 83 Mark IV Advisory Only ......................................................83 Mark IV Modified Only ......................................................83

(f) Patterns, Models, Moulds, etc 84 Mark IV Advisory Only ......................................................84 Mark IV Modified Only ......................................................84

(g) Glass etc 85 Mark IV Advisory Only ......................................................85 Mark IV Modified Only ......................................................85

(h) Directors’ & Employees’ Clothing & Tools of Trade etc 86 Mark IV Advisory and Mark IV Modified ...........................86

(i) Empty Premises Awaiting Demolition 87 Mark IV Advisory only .......................................................87 Mark IV Modified only .......................................................87

5.2 Cover if Insured Elects to Accept Indemnity 87 Mark IV Modified only .................................................................87

Chapter 6 Section 1: Material Damage – Memoranda to Section 1 ................. 90

6.0 Memoranda to Section 1 90 6.1 Preamble 90

Mark IV Advisory and Mark IV Modified......................................90 6.2 Interests of Other Parties 90

Mark IV Advisory and Mark IV Modified......................................90 6.2.1 Interests of Other Parties – Group Interests ..................90 6.2.2 Interests of Other Parties – Separate Interests..............92 6.2.3 Interests of Other Parties – Concessions Agreement....92

6.3 Branded Goods 93 Mark IV Advisory Only ................................................................93 Mark IV Modified Only.................................................................95

6.4 Declared Values 95 Mark IV Advisory Only ................................................................95 Mark IV Modified Only.................................................................95

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6.5 Reinstatement and Replacement 96 Mark IV Advisory and Mark IV Modified ..................................... 96 6.5.1 Applicable to: ................................................................. 96 6.5.2 Reinstatement and Replacement at the Time

of Replacement.............................................................. 97 (a) Property Lost or Destroyed ................................. 97 (b) Property able to be Repaired .............................. 98 6.5.3 Provisions ...................................................................... 99 (i) Work to be Carried Out with Reasonable

Despatch ............................................................. 99 (ii) In Case of Partial Loss, Liability of Insurer is

not Increased beyond Cost to Replace if Wholly Destroyed .............................................. 105

(iii) Co-insurance Applicable to Reinstatement & Replacement Memorandum .............................. 105

(v) All Other ISR or Fire Policies shall be on a Similar Reinstatement Basis ............................. 119

6.6 Extra Cost of Reinstatement 119 Mark IV Advisory and Modified................................................. 119 6.6.1 Applicable to Buildings, Machinery Plant etc but not…119 6.6.2 Policy Extends to Cover Extra Costs… ....................... 120 6.6.3 Provisions .................................................................... 120

6.7 Floor Space Ratio Index (Plot Ratio) 123 Mark IV Advisory and Modified................................................. 123 6.7.1 Circumstances Where Cover is Available ................... 123 6.7.2 Basis of Settlement...................................................... 124 6.7.3 Timing of Payment....................................................... 124

6.8 Acquired Companies 125 Mark IV Advisory and Modified................................................. 125

6.9 Co-insurance 128 Mark IV Advisory Only .............................................................. 128 Mark IV Modified Only .............................................................. 141

Chapter 7 Section 2: Consequential Loss – The Indemnity............................142

7.0 The Indemnity 142 Mark IV Advisory and Mark IV Modified ................................... 142

7.1 The Trigger for Section 2 Cover 143 Mark IV Advisory Only .............................................................. 143 Mark IV Modified Only .............................................................. 147

7.2 Material Damage Proviso 148 Mark IV Advisory and Mark IV Modified ................................... 148

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Chapter 8 Section 2: Consequential Loss – Basis of Settlement.................. 150

8.0 Basis of Settlement 150 Mark IV Advisory and Mark IV Modified....................................150

8.1 Item No 1. (Gross Profit as a result of a Reduction in Turnover and Increase in Cost of Working) 150 Mark IV Advisory and Mark IV Modified....................................150 8.1.1 Preamble 150

Mark IV Advisory Only..................................................150 Mark IV Modified Only..................................................151

(a) Item No. 1(a): In Respect of Reduction in Turnover 151 Mark IV Advisory and Mark IV Modified.............151

(b) Item No. 1(b): In Respect of Reduction in Turnover 152 Mark IV Advisory and Mark IV Modified.............152

8.1.2 Savings 157 Mark IV Advisory and Mark IV Modified.......................157

8.1.3 Test for Adequacy of Insurance 159 Mark IV Advisory and Mark IV Modified.......................159

8.2 Item No. 2 (Claims Preparation Costs) 163 Mark IV Advisory and Mark IV Modified....................................163

8.3 Item No. 3 (Pay-Roll) 166 Mark IV Advisory and Mark IV Modified....................................166 8.3.1 Preamble 169

Mark IV Advisory and Mark IV Modified.......................169 (a) Item No. 3(a): In respect of Reduction of Turnover 169

Mark IV Advisory and Mark IV Modified.............169 (a)(i) In respect of Reduction of Turnover - Initial Period 170

Mark IV Advisory and Mark IV Modified.............170 (a)(ii) In respect of Reduction of Turnover -

Remainder Period 171 Mark IV Advisory and Mark IV Modified.............171

(a)(iii) In respect of Reduction of Turnover – Option to Consolidate 174 Mark IV Advisory and Mark IV Modified.............174

(b) Item No. 3(b): In respect of Increase in Cost of Working 176 Mark IV Advisory and Mark IV Modified.............176

8.3.2 Pay-Roll Test for Adequacy of Insurance 178 Mark IV Advisory and Mark IV Modified.......................178

8.4 Item No. 4 (Additional Increased Cost of Working) 181 Mark V Advisory and Mark V Modified......................................181

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Chapter 9 Section 2: Consequential Loss – Definitions .................................185

9.0 Definitions 185 Mark IV Advisory and Mark IV Modified ................................... 185

9.1 Rate of Gross Profit 185 Mark IV Advisory and Mark IV Modified ................................... 185

9.2 Turnover 188 Mark IV Advisory and Mark IV Modified ................................... 188

9.3 Indemnity Period 188 Mark IV Advisory and Mark IV Modified ................................... 188

9.4 Pay-Roll 188 Mark IV Advisory Only .............................................................. 188 Mark IV Modified Only .............................................................. 189

9.5 Shortfall in Turnover 190 Mark IV Advisory and Mark IV Modified ................................... 190

9.6 Rate of Gross Profit 190 Mark IV Advisory and Mark IV Modified ................................... 190

9.7 Annual Turnover 191 Mark IV Advisory and Mark IV Modified ................................... 191

9.8 Standard Turnover 191 Mark IV Advisory and Mark IV Modified ................................... 191

9.9 Rate of Pay-Roll 191 Mark IV Advisory and Mark IV Modified ................................... 191

9.10 The Adjustments Clause 192 Mark IV Advisory and Mark IV Modified ................................... 192

Chapter 10 Section 2: Consequential Loss – Memoranda to Section 2 ..........195

10.0 Memoranda to Section 2 195 Mark IV Advisory and Mark IV Modified ................................... 195

10.1 Preamble 195 Mark IV Advisory and Mark IV Modified ................................... 195

10.2 Turnover Elsewhere After Damage 195 Mark IV Advisory and Mark IV Modified ................................... 195

10.3 Departmental Clause 198 Mark IV Advisory and Mark IV Modified ................................... 198

10.4 New Business 199 Mark IV Advisory and Mark IV Modified ................................... 199

10.5 Accumulated Stocks 201 Mark IV Advisory and Mark IV Modified ................................... 201

10.6 Books of Account 203 Mark IV Advisory and Mark IV Modified ................................... 203 10.6.1 Auditors Certification 203

Mark IV Advisory and Mark IV Modified ...................... 203 10.6.2 Words and Expressions 203

Mark IV Advisory and Mark IV Modified ...................... 203 10.7 Public Utilities Extension 204

Mark IV Advisory and Mark IV Modified ................................... 204

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10.8 Turnover/Output Alternative 206 Mark IV Advisory Only .........................................................206 Mark IV Modified Only..........................................................207

10.9 Computer 208 Mark IV Advisory and Mark IV Modified...............................208

10.10 Salvage Sale 208 Mark IV Advisory Only .........................................................208 Mark IV Modified Only..........................................................211

10.11 Premises in the Vicinity (Prevention of Access) 212 Mark IV Advisory and Mark IV Modified...............................212

10.11.1 Property in the Vicinity Mark IV Advisory and Mark IV Modified...............................212

10.11.2 Premises forming Part of a Complex Mark IV Advisory and Mark IV Modified...............................213

10.12 Registered Vehicles and/or Trailers 214 Mark IV Advisory and Mark IV Modified...............................214

Chapter 11 Exclusions to All Sections – Property Exclusions ..................... 215

11.0 Property Exclusions 215 Mark IV Advisory and Mark IV Modified .................................215

11.1 Property (Except Money) whilst in Transit 215 Mark IV Advisory and Mark IV Modified .................................215

11.2 Money 217 Mark IV Advisory and Mark IV Modified .................................217

(a) Whilst Carried by Professional or Common Carriers 218 Mark IV Advisory and Mark IV Modified.......................218

(b) Stolen from an Unlocked and Unattended Vehicle 219 Mark IV Advisory and Mark IV Modified.......................219

(c) From a Safe or Strongroom using a Key or Combination left at the Situation 220 Mark IV Advisory and Mark IV Modified.......................220

(d) Not Discovered within 5 Working Days 221 Mark IV Advisory and Mark IV Modified.......................221

(e) Due to Kidnapping, Bomb Threat, Hoax, Extortion 222 Mark IV Advisory and Mark IV Modified.......................222

11.3 Jewellery, Furs, Bullion, Precious Metals or Stones 222 Mark IV Advisory and Mark IV Modified .................................222

11.4 (a) Locomotives, Rolling Stock and Watercraft 223 Mark IV Advisory and Mark IV Modified.......................223

(b) Aircraft or their Accessories 224 Mark IV Advisory and Mark IV Modified.......................224

11.5 Registered Vehicles or Trailers 224 Mark IV Advisory and Mark IV Modified .................................224

11.6 Livestock Animals, Birds or Fish 225 Mark IV Advisory and Mark IV Modified .................................225

11.7 Standing Timber, Growing Crops and Pastures 225 Mark IV Advisory and Mark IV Modified .................................225

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11.8 Land 226 Mark IV Advisory Only ........................................................... 226 Mark IV Modified Only (Title: Land, Unmined or Unrecovered Oil, Gas and Mineral Deposits) ............................... 227

11.9 Bridges, Canals, Roadways, Tunnels, Railway Tracks, Dams and Reservoirs 228 Mark IV Advisory Only ........................................................... 228 Mark IV Modified Only (Title: (a) Bridges, Canals, Roadways, Tunnels, Dams and Reservoirs) ................................ 228 Mark IV Modified Only (Title: (b) Railway Tracks).................... 229

11.10 Dock, Wharves and Piers not forming Part of any Building 229 Mark IV Advisory and Mark IV Modified................................. 229

11.11 Mining Property Located Beneath the Surface of the Ground 230 Mark IV Advisory and Mark IV Modified................................. 230

11.12 Property during the Course of, and as a Result of, its Processing 230 Mark IV Advisory and Mark IV Modified................................. 230

11.13 (a) Gates, Fences, Retaining Walls, Textile Awnings and Blinds (by Wind, Rainwater or Hail) 231 Mark IV Advisory and Mark IV Modified ...................... 231

(b) Property in the Open Air (by Wind, Rainwater, or Hail) 234 Mark IV Advisory and Mark IV Modified ...................... 234

11.14 (a) Property Undergoing Construction 237 Mark IV Advisory Only ................................................. 237 Mark IV Modified Only ................................................. 237

(b) Empty Premises Undergoing Demolition 238 Mark IV Advisory Only ................................................. 238 Mark IV Modified Only (Title: Empty Premises

upon which Demolition has Commenced) ......................... 239 11.15 Oil and Gas Drilling and/or Production Rigs whilst Offshore 239

Mark IV Advisory and Mark IV Modified................................. 239 11.16 Machinery 240

Mark IV Advisory and Mark IV Modified................................. 240 11.17 Boilers 240

Mark IV Advisory and Mark IV Modified................................. 240

Chapter 12 Exclusions to all Sections – Perils Exclusions............................242

12.0 Perils Exclusions 242 Mark IV Advisory and Mark IV Modified................................. 242

12.1 (a) War, Invasion, Hostilities etc 244 Mark IV Advisory and Mark IV Modified ...................... 244

(b) Confiscation, Nationalisation or Requisition 245 Mark IV Advisory and Mark IV Modified ...................... 245

12.2 Nuclear Material 246 Mark IV Advisory and Mark IV Modified................................. 246

12.3 (a) Flood 247 Mark IV Advisory and Mark IV Modified ...................... 247

(b) Sea, Tidal Wave or High Water 249 Mark IV Advisory and Mark IV Modified ...................... 249

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(c) Proviso to Exclusion 12.3 249 Mark IV and Mark IV Modified......................................249

12.4 (a) Moths, Termites, Vermin, Rust, Oxidation, etc 250 Mark IV Advisory and Mark IV Modified.......................250

(b) Wear and Tear 254 Mark IV Advisory and Mark IV Modified.......................254

(c) Error in Design, Plan, Specification or Failure of Design 254 Mark IV Advisory and Mark IV Modified.......................254

(d) Normal Settling, Seepage, Shrinkage 256 Mark IV Advisory and Mark IV Modified.......................256

(e) Faulty Materials or Faulty Workmanship 256 Mark IV Advisory and Mark IV Modified.......................256

(f) Write Back of Subsequent Damage Listed in Perils Exclusion 4 258 Mark IV Advisory and Mark IV Modified.......................258

12.5 (a) Incorrect Siting of Building 264 Mark IV Advisory and Mark IV Modified.......................264

(b) Demolition Ordered by Government 265 Mark IV Advisory and Mark IV Modified.......................265

12.6 (a) Theft of Property in the Open Air 265 Mark IV Advisory and Mark IV Modified.......................265

(b) Unexplained Inventory Shortage 267 Mark IV Advisory and Mark IV Modified.......................267

(c) Spontaneous Combustion 268 Mark IV Advisory and Mark IV Modified.......................268

12.7 (a)(i) Fraudulent & Dishonest Acts 269 Mark IV Advisory and Mark IV Modified.......................269

(a)(ii) Access to Computer System 271 Mark IV Advisory and Mark IV Modified.......................271

(a)(iii) Circumstances where Exclusion 7(a) does not Apply 275 Mark IV Advisory Only..................................................275 Mark IV Modified Only..................................................275

(b) Cessation of Work Due to Labour Dispute 276 Mark IV Advisory and Mark IV Modified.......................276

(c) Erosion Subsidence, Earth Movement or Collapse 276 Mark IV Advisory and Mark IV Modified.......................276

(d) Kidnapping, Bomb threat, Contamination, Hoax or Extortion 283 Mark IV Advisory and Mark IV Modified.......................283

(e) Write Back of Subsequent Loss Due to Perils Listed in Exclusion 7 284 Mark IV Advisory and Mark IV Modified.......................284

12.8 Legal Liability 284 Mark IV Advisory and Mark IV Modified .................................284

12.9 Consequential Loss Except as Provided by Section 2 285 Mark IV Advisory and Mark IV Modified .................................285

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Chapter 13 Memoranda Applicable to all Sections .........................................287

13.0 Memoranda Applicable 287 Mark IV Advisory and Mark IV Modified................................. 287

13.1 Preamble 287 Mark IV Advisory and Mark IV Modified................................. 287

13.2 Automatic Reinstatement of Insurance 287 Mark IV Advisory and Mark IV Modified................................. 287

13.3 Application of Earthquake Deductible 289 Mark IV Advisory and Mark IV Modified................................. 289

13.4 Subrogation Waiver 290 Mark IV Advisory and Mark IV Modified................................. 290

13.5 Adjustment of Premium 291 Mark IV Advisory and Mark IV Modified................................. 291

(a) Premium if Provisional 291 Mark IV Advisory and Mark IV Modified ...................... 291

(b) Declaration Required at Expiry of Period of Insurance 294 Mark IV Advisory and Mark IV Modified ...................... 294

(b)(i) Declaration Required at Expiry of Period of Insurance 294 Mark IV Advisory and Mark IV Modified ...................... 294

(b)(ii) Gross Profit and Pay-Roll to be Declared using Most Nearly Concurrent Accounts 294 Mark IV Advisory and Mark IV Modified ...................... 294

(c) Provisional Premium Adjustments 297 Mark IV Advisory and Mark IV Modified ...................... 297

(d) Allowances to be made for Abnormal Fluctuations 297 Mark IV Advisory and Mark IV Modified ...................... 297

(e) No Adjustments Allowed Due to Claims 297 Mark IV Advisory and Mark IV Modified ...................... 297

Chapter 14 Conditions Applicable to All Sections..........................................301

14.0 Conditions – Applicable to All Sections 301 Mark IV Advisory and Mark IV Modified................................. 301

14.1 Misrepresentation and Non-Disclosure 301 Mark IV Advisory and Mark IV Modified................................. 301

14.2 Alteration 313 Mark IV Advisory and Mark IV Modified................................. 313

14.3 Sprinkler Installations 315 Mark IV Advisory and Mark IV Modified................................. 315

14.4 Other Insurance 317 Mark IV Advisory and Mark IV Modified................................. 317

14.5 Cancellation 318 Mark IV Advisory and Mark IV Modified................................. 318

14.6 Notification of Claims 322 Mark IV Advisory Only ........................................................... 322 Mark IV Modified Only............................................................ 323

14.7 Fraud 324 Mark IV Advisory and Mark IV Modified................................. 324

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14.8 Reinstatement 327 Mark IV Advisory and Mark IV Modified .................................327

14.9 Insurer(s) Rights 327 Mark IV Advisory and Mark IV Modified .................................327

14.10 Subrogation 329 Mark IV Advisory Only............................................................329 Mark IV Modified Only ............................................................343

14.11 Precautions to Prevent Loss 343 Mark IV Advisory and Mark IV Modified .................................343

14.12 Insured’s Action After the Theft or Damage 346 Mark IV Advisory Only............................................................346 Mark IV Modified Only ............................................................346

14.13 Termination of Cover Under Section 2 346 Mark IV Advisory and Mark IV Modified .................................346

14.14 Observance of Terms and Conditions 348 Mark IV Advisory and Mark IV Modified .................................348

14.15 Progress Payments 349 Mark IV Advisory and Mark IV Modified .................................349

14.16 Headings 351 Mark IV Advisory and Mark IV Modified .................................351

Chapter 15 Additional Exclusions that may attach to the Policy.................. 353

15.1 Terrorism ................................................................................353 15.1.1 Example No. 1 (Based on what is commonly

referred to as the Munich Re Terrorism Exclusion) ........................................................359

15.1.2 Example No. 2 (A variation of the Lloyds Market Association Terrorism Exclusion NMA2920) ...360

15.1.3 Example No. 3 (Lloyds Market Association Terrorism Exclusion NMA2920).......................361

15.1.4 Example No. 4 (Lloyds Market Association War and Terrorism Exclusion Endorsement NMA2918)........................................................362

15.1.5 Example No. 5 (Source a QBE Mercantile Mutual Policy) ..................................................363

15.1.6 Example No. 6 (Source a CGU Policy Wording) ..........................................................363

15.1.7 Final Comment on Terrorism...........................364 15.2 Electronic Date Recognition Exclusion...................................364 15.3 Failure to Receive, Send, Access or Use Electronic

Data for any time or at all .......................................................365 15.4 Mould and/or Toxic Exclusions...............................................365

15.4.1 Background to Mould and Toxic Exclusions....365 15.4.2 Example of a Mould Exclusion ........................370 15.4.3 Example of a Toxic Exclusion..........................370

15.5 Deception, False Pretence, Wilful False Promise or Trickery...................................................................................371

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Chapter 16 Policy Splitting ................................................................................372

16.1 Introduction ............................................................................ 372 16.2 The Underlying Principle........................................................ 372 16.3 Policy Splitting in Practice...................................................... 372 16.4 Example of Endorsement Limiting Cover to Fire and

Specified Perils ...................................................................... 373 16.5 Example of Difference in Conditions Endorsement used

with a Split Program............................................................... 373

PART B 374

Chapter 1 Endorsements....................................................................................375

INDEX 554

Tabl

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TABLES

Table 1. Calculation of Gross Profit (to Sub-Clause 8.1.1(a)) ..........................................152

Table 2. Calculation of Gross Profit including Increase in Cost of Working (to Sub-Clause 8.1.1(b)) ..........................................................................................157

Table 3. Calculation of Gross Profit less Savings (to Sub-Clause 8.1.2) .........................158

Table 4. Example Discount Rates for an Indemnity Period less than 12 Months ............161

Table 5. Formula for the calculation of the Average in Accordance with Sub-Clause 10.1.4......................................................................................................162

Table 6. Calculation of Item 1 - Actual Loss of Gross Profit due to Reduction in Turnover and Increase in Cost of Working (to Sub-Clause 8.1).........................162

Table 7. Calculation of Item No. 1 (Actual Loss of Gross Profit Due to Reduction in Turnover and Increase in Cost of Working) and Item No. 2 (Claims Preparation Costs) .............................................................................165

Table 8. Calculation Item No. 1 Gross Profit which includes 100% of Pay-Roll...............167

Table 9. Calculation Item No. 1 Gross Profit with Pay-Roll insured separately under Item No. 3 .................................................................................................168

Table 10. Calculation of Loss of Pay-Roll “Initial Period” (to Sub-Clause 8.3.1(a)(i) ............................................................................................................171

Table 11. Calculation of Loss of Pay-Roll ‘Initial Period’ & ‘Remainder Period’ less Savings (to Sub-Clause 8.3.1(a)(ii))............................................................173

Table 12. Calculation of Loss of Pay-Roll ‘Option to Consolidate’ (in accordance with Sub-Clause 8.3.1(a)(iii)) ..............................................................................175

Table 13. Comparison of Results – No Consolidation v Consolidation..............................176

Table 14. Calculation of Item No. 1 (Actual Loss of Gross Profit due to Reduction in Turnover and Increase in Cost of Working), Item No. 2 (Claims Preparation Costs) and Item No. 3 (Pay-Roll) to Sub-Clause 8.3.2 (Increase in Cost of Working) ....................................................................177

Table 15. Formula for the Calculation of the Average for Pay-Roll in accordance with Sub-Clause 8.3.2.........................................................................................179

Table 16. Calculation of Item No. 1 (Actual Loss of Gross Profit Due to Reduction in Turnover and Increase in Cost of Working), Item No. 2 (Claims Preparation Costs) and Item No. 3 (Pay-Roll and Increase in Cost of Working) .................................................................................................180

Figu

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FIGURES

Figure 1. Declaration for Premium v Claims (Basis of Settlement) Purposes..................... 27

Figure 2. Recommended Endorsement: Basis of Settlement Provisions - Insurance of Variable Charges for a Percentage or Fixed Sum .......................... 49

Figure 3. Replacement with Dissimilar Property Endorsement (RRDISS4)...................... 104

Figure 4. Co-insurance Memorandum (ONEAVXB4)........................................................ 114

Figure 5. Co-insurance Memorandum (ONEAVXB4)........................................................ 136

Figure 6. Declaration for Premium v Claims (Basis of Settlement) Purposes - Revisited............................................................................................................. 160

Figure 7. Variable Expenses to Total Revenue................................................................. 186

Figure 8. Recommended Endorsement Basis of Settlement Provisions Insurance of Variable Charges for a Percentage or Fixed Sum ........................ 187

Figure 9. Fidelity Endorsement (FIDELAS4) ..................................................................... 272

Figure 10. Declaration for Premium v Claims (Basis of Settlement) Purposes................... 295

Figure 11. Supplementary Explanatory Memorandum - Premium Adjustments & Average/Under-Insurance .................................................................................. 299

PHOTOGRAPHS

Photograph 1. A typical fire damaged building .................................................................. 61

Photograph 2. Cyclone damage to amenities block at Emma Gorge Eco Tourism Resort, 16 March 2005 .............................................................. 227

Photograph 3. Cyclone damage to amenities block at Emma Gorge Eco Tourism Resort, 16 March 2005. ............................................................. 281

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 1

INTRODUCTION

“This [ISR] policy is made up of a jumble of ill-assorted documents expressed in that distinctive style which insurance companies have made their own.”

Mason, J. (1974)1

The Industrial Special Risks (“ISR”) policy has now been a feature of the Australian general insurance market for over two generations. While much has been written about the policy, its benefits and limitations, the vast majority of this material is now 15 or more years old and, in many cases, is no longer in print2. This, coupled with the fact that the policy is so widely used, makes it one of the policies (along with business interruption, fidelity, and professional indemnity) that so many wish to learn more about. Following the enormous response to Business Interruption Insurance & Claims: A Practical Guide3. and Fidelity, Theft & Money Insurance & Claims4, I was asked by several industry organisations to turn my attention to developing a similar guide to the ISR policy. You are now holding the result. I did come to this project with some small experience, for while I was not involved in the drafting of the Australian policies, I did sit on the industry-wide drafting committee that developed an update of the ISR policy for Papua New Guinea in the late 1980s. It is fair to say that the ISR policy is a bit like a camel: a racehorse designed by a committee. The policy has many fine points, but it does carry with it some baggage from the old fire and perils policies, particularly in the area of the exclusions. In some cases, this been taken further, and it appears to me that it occurs when an underwriter has paid a claim they did not consider they should have paid. On the other hand, some brokers (particularly on larger risks) want to increase the cover. As a result of these last two phenomena, manuscript wordings have been developed by some underwriters and brokers for particular risks or industries, or for general use by the organisation. Understandably, it is not possible to go into all these specially developed wordings. However, it is hoped that by looking in a little detail at the four main wordings in general use, as well as the main endorsements available, the reader will be able to interpret any ISR policy they may encounter. The policies examined in this text are:

• ISR Mark IV Advisory

• ISR Mark IV Modified

1 Guardian Assurance Company v Underwood Constructions Pty Ltd (1974) ALJR 307 at 308 (High Court of

Australia) where Mason, J, as he was then, was describing an early ISR wording. 2 The ISR Book(s) are excellent publications for both the Mark IV and Mark V policies, and were produced by David

Goodlad, who sat on the drafting committee. The texts are still available, and are highly recommended for brokers, advisers, underwriters, claims staff and general insurance practitioners. They can be obtained from the publisher, Risk Technologies Pty Ltd, PO Box 46, The Patch, Victoria 3792, Australia (facsimile: +61 3 9752 0168).

3 Manning A., 2005, Business Interruption Insurance and Claims: A Practical Guide, 4th Edition, Mannings of Melbourne, Camberwell.

4 Manning A., 2005, Fidelity, Theft & Money Insurance & Claims, 2nd Edition, Mannings of Melbourne, Camberwell.

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Insurance intermediaries should always keep in mind that whichever policy they choose to recommend to their client, they need to ensure that the cover arranged meets their client’s needs in respect of risk transfer. This means that the intermediary must understand the basic cover(s) and the additional protection that is available through endorsement. This Guide has been designed, along with an electronic version available through www.LMIGroup.com/PolicyCoach to assist their understanding and to allow the tailoring of the base wording (Mark IV or Mark V) to meet the clients needs. As you can imagine, I am often asked which policy is “better”. The short answer is that neither policy should be marketed in its base form. The complete answer is that the base wording of the Mark IV provides greater cover for the Insured in many areas, but the drafting and construction of the Mark V wording is superior. Therefore, as a base to work from, to tailor a policy for a specific client’s needs, the Mark V as it was originally designed and with suitable endorsements, is superior. Like my earlier texts, this Guide has been designed to be of use to all those in the industry, no matter what level of training and experience. To illustrate important points, examples from actual cases are used, although the name of the Insured has been changed. Therefore, the names of companies, insurers and individuals used in the illustrations are completely fictitious, and any resemblance to a company, insurer or individual, past, present or in the future, is completely fortuitous and unintentional. Having said this, the Guide has not been designed to be a far-reaching and meticulous tome that covers every single possible legal and insurance issue that could possibly arise from a claim under the policy. I do not think I would live long enough to achieve this! The reality is that judicial interpretation of ISR policies is not that frequent. This does not mean that it is necessarily easy to read or understand. While Section 2 of the policy is addressed in this Guide, the mechanics of the cover is explained in more detail in ‘Business Interruption Insurance & Claims: A Practical Guide’, where the Mark IV Advisory5 is used as the basis of the analysis. The reader may wish to refer to this book if further understanding is sought. For example, that Guide provides practical case studies on how to calculate a declared value or a claim, and includes several chapters on the insurance of wages (pay-roll), including a detailed dual wages example. To assist you in using this Guide, the format of the Volumes is such that we first examine the Mark IV wordings (Advisory and Modified) in Volume 1, and then the two Mark V wordings in Volume 2, looking at each clause and sub-clause of the policy. Where one version of the policy differs from another, e.g. the Modified wording differs from the Advisory wording, then each wording is reproduced and an explanation on their similarities and differences is provided. In the formative stages of preparing this Guide, I had in mind to compare all four policies in the same part of the Guide. The difference in layout between the Mark IV and Mark V wordings made this completely impractical, hence the two-part approach. The Mark V wordings have clause numbers, and these are quoted for ease of reference - they certainly do make it easier to navigate around the policy. Regrettably, the Mark IV wordings do not have such a convenient numbering system, but I have used my own headings and numbering system in an effort to make it easier for you, the reader. As mentioned above, examples are given where appropriate. It is believed that this is the first time such a comparison of the policies has been given in this way. In my referencing of the various paragraphs and sub-clauses of ISR wordings, I have used the term “Clause” to refer to each titled section of the policy such as ‘The Indemnity’ in the Mark IV wording, with each sub-clause or paragraph within the Clause referred to as a “Sub-Clause” for ease of understanding.

5 Available from the publisher, Mannings of Melbourne, PO Box 2116, Camberwell 3124, Australia

(telephone: +61 3 9835 9999 or email: publisher@mom.com.au).

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 3 I was caught in a bit of a quandary when actually writing the text, as I realised that while some would read it from cover to cover, it would be used more often by readers (including those that had previously read it from cover to cover) as a reference when they have a question on a particular section of the policy. As many sections are linked or are duplicated in the four policy wordings, I had to decide whether to refer the reader to other sections of the Guide or to repeat relevant sections and commentary. I personally find it frustrating having to go backwards and forwards from one section to another while researching an issue in any Guide or, worse still, having to search a whole library to gain an understanding. Therefore, unless a point I had previously raised and wished to raise again was physically quite close to where I was currently writing, I tended to reproduce the earlier section. While this approach makes it easier for the researcher, the duplication can be frustrating for those who read the Guide in its entirety. I apologise for this in advance, and trust that by reading a point more than once, the reader will find this to be an advantage, with the point being reinforced, as you should remember the point. I hope you find, like me, that not having to jump all around the Guide outweighs the repetition. I would also warn the reader that while some sections may appear to be the same, one may include additional material pertinent to that clause or sub-clause. Just as there was no easy way to draft the book, there is no easy way to read it fully, other than word for word. As I was preparing this Guide, I continually thought about the best way to present the endorsements. It is difficult, in the two-dimensional format of a typed page, to deliver them in a way that is meaningful. Clearly, the best way is through a decision tree, but this is simply not practical in a book. I had the same problem when I was preparing comparisons of policy wordings for use by the insurance industry. The solution there was www.PolicyComparison.com. The obvious answer was a similar concept, allowing the tailoring of an ISR policy with the appropriate endorsements for a particular risk. Therefore, using this Guide as the foundation, a complete expert system to assist in the preparation of the ISR policy has been developed and is available through www.LMIGroup.com/PolicyCoach. For those who prefer the traditional hardcopy version, a list with explanatory notes of the more common requirements can be found at Part B of both Volumes 1 and 2, being the endorsements for the Mark IV and the Mark V, respectively. While this Guide is predominantly a text on the ISR policy, I thought it would be useful to include a section on the rules used in the interpretation of a contract of insurance or a statute. I had manuscript wordings in mind in particular when I decided to include this section, which can be found in Volume 3 at Part A. Similarly, I felt a separate detailed look at the doctrine of proximate cause would be beneficial to a reader, who may be determining if a loss falls within the scope of the policy. A paper on this subject can be found at Part B of Volume 3. At Part C of Volume 3, the reader will find a schedule of the near 200 differences between the four versions of the ISR wordings analysed in this Guide. During the writing of the text, I referred to dictionaries for definitions from time to time. As Lord Coleridge said in R v Peters (1886)6:

“I am quite aware that dictionaries are not to be taken as authoritative exponents of the meaning of words used in the Acts of Parliament, but it is a well-known rule of courts of law that words should be taken to be used in their ordinary sense and we are therefore sent for instruction to these books.”

The definitions I have used are taken from The Macquarie Dictionary7 unless specifically stated. A full list of all the definitions used can be found at Part D of Volume 3. 6 R v Peters (1886) 16 Cox CC 36; (1886) 16 QBD 636. 7 The Macquarie Dictionary, Revised 3rd Edition, edited by Delbridge A., Bernard JRL., Blair D., Peters P., and

Yallop C., 2001, The Macquarie Library Pty Ltd, Sydney, p.11.

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I have also referred to many Court cases that were relevant to the area of the policy that I was discussing. In addition, cases were used when I was looking at the rules of contract interpretation and for the section on proximate cause. While I am not a lawyer and I do not have the research facilities of a large firm on which to draw, I have attempted to provide some initial thoughts on each section. However, such references within this Guide should not be relied on in lieu of a detailed analysis by a legal advisor specialising in insurance law. I wish to express my sincere appreciation to Ms Celandine Letcher for her assistance in double-checking these cases and, in some cases, locating the full citation on decisions, particularly those that I only remembered by some obscure name from my student days. I know this took Celandine many hours of careful research, but her efforts greatly add to the value of this Guide. The cases to which I have referred are all listed in Volume 3 at Part E. Similarly, the statutes referred to are listed in Part F. Sir Isaac Newton wrote in a letter to Robert Hooke on 15 February 1675: “If I have seen further it is by standing on the shoulders of giants”. I am no Newton, but I know exactly what he meant by this line. During the course of preparing this Guide, I have referred to many excellent books, papers, articles and judgements. While I have provided reference to these throughout the book, a full bibliography is provided at Part H of Volume 3. A Guide of this type is dependent on a very detailed index. In respect to the Mark IV wording, this can be found at the very end of this Volume. Similar indexes can be found at the end of Volume 2 covering the Mark V wording, and at the end of Volume 3. To maintain ease of use, the indexes provided at the end of each Volume, reference that Volume only. I personally hope that many things come out of the development of this Guide and the expert system that flowed from it. One is that it assists insurance advisers in tailoring the correct cover for their clients. A second, but no less important one, is to ensure that claims are considered correctly under the ISR Policy. Towards the end of producing this Guide, I was appointed to review a claim that I determined was excluded by no less than three exclusions under the Mark IV policy. Yet a loss adjuster recommended liability be accepted and the two co-insurers took that advice. The amount involved on both Sections 1 and 2 was substantial. This is not a rare occurrence and, in just as many cases, genuine claims are denied or at the very least payment is delayed, which can cause great hardship to an Insured when they need financial help most. I would be extremely pleased to receive feedback regarding the relevance, ease of understanding and usefulness of the material contained herein, and any suggestions for improvement. You can contact me via email at: allan.manning@LMIGroup.com. It is through such feedback that this Guide will continue to grow with each new edition. A work of this size - over ½ million words - does not just happen. I had great support from a number of people. Sincere thanks goes to many of my colleagues at the LMI Group, who have offered valuable comment based on their years of experience. They have also provided ongoing encouragement and other practical help. Those involved include: Terry Onto, Angus Stewart, Bruce Avenell, Les Thorpe, Mike Quinlan, Thomas Korab, Gordon Lum, Helen Manning, Ian Fry, Phil Burn, Peter MacLeod, and Steven Manning. Valuable assistance was also provided by Victoria University and the Graduate School in particular, as well as Janet Lambrou and Josh Pederick. For this help, I am most grateful. Special thanks also goes to David Goodlad, Max Salveson, Adam Matteson, Robert Riddoch, Jim Hatz, Rob Willsher and Dale Coombes, all industry experts of whom I have the highest regard, and who offered comment or debate on many points. Any views that I express in this book are not necessarily shared by all of those listed.

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 5

Limitations & Disclaimers This text has been prepared as a guide only and is not intended to be anexhaustive or definitive review of the policies of insurance or law referred to herein. Whilst great care has beentaken in the preparation of the Guide, it should not be used or relied upon as a substitute for professional legalor business advice, nor as a basis for formulating any commercial or legal decision. Special care needs to betaken when reading the Guide as no two policies of insurance or factual circumstances are alike, and thespecific policy wording needs to be carefully read and understood in full, having regard to all the circumstances. Throughout this Guide the names of fictitious insurers, companies and individuals have been used by way ofexample to illustrate a particular point or points. Any resemblance to any company, insurer or individual, past,present or future is completely fortuitous, coincidental and unintentional unless expressly stated to the contrary. The summaries and references to judicial decisions used in this Guide do not reflect the view or opinion of theauthor or publisher as to the correctness or otherwise of any such judicial decision or pronouncement of law. The Guide is sold and distributed on the terms and understanding that the author and publisher are notresponsible for the results or outcomes or any actions taken on the basis of reliance on the material in theGuide, nor for any error in or omission from the Guide, and the author and publisher expressly disclaim all andany liability and responsibility to any person including a purchaser or reader of the Guide in respect of anythingand the consequences thereof of whatsoever kind done or omitted to be done by any such person in relianceupon the contents in full or in part of the Guide. The above limitations and disclaimers extend not only to the text in this guide, but also to any relatedinformation provided in writing or verbally (for example, responses to queries regarding the information in theguide). If any provision of this section headed “Limitations & Disclaimers” is void, avoided, illegal orunenforceable, the provision is to be read down (and applied as read down) to the extent necessary to preventit from being void, avoided, illegal or unenforceable. However, if that cannot be done, the provision is to besevered and the rest of this section is to be given full effect with any necessary modifications resulting from theseverance of the provision.

Finally, I wish to thank Wendy Hunter of Secretaries on the Move for her assistance in the design and presentation of the text. Allan Manning Melbourne, 27 November 2005 © Mannings of Melbourne 2005 All Rights Reserved No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, scanning, recording, or any other information storage system, without permission in writing from the publisher. Requests for permission to reproduce content should be directed to publisher@mom.com.au or a letter of intent should be faxed to the Permissions Department on +61 3 9885 6996. © Commonwealth of Australia 2005 All legislation is reproduced by permission but does not purport to be the official or authorised version. It is subject to Commonwealth of Australia copyright. The Copyright Act (1968) permits certain reproduction and publication of Commonwealth Legislation. In particular, Section 182A of the Act enables a complete copy to be made by or on behalf of a particular person. For reproduction or publication beyond that permitted by the Act, permission should be sought in writing from the Australian Government Printing Service. Requests for assistance should be addressed to: Commonwealth Copyright Administration, Attorney General’s Department, Robert Garran Offices, National Circuit, Barton, ACT 2600 or posted at http://www.ag.gov.au/cca. Printed in Australia

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Page Understanding the ISR Policy 128 Volume 1: Mark IV Advisory & Mark IV Modified

6.9 Co-insurance

MARK IV ADVISORY ONLY

“CO-INSURANCE Unless otherwise stated herein to the contrary, this Policy is subject to the following Co-insurance memorandum: In the event of damage to property insured hereunder at any situation caused by any event hereby insured against, the Insured(s) shall be liable for no greater proportion of such damage than the amount of the Insured's declaration of value of such property on the day of the commencement of the Period of Insurance bears to the sum representing eighty-five per cent (85%) of the actual value of property insured at such situation on the day of commencement of the Period of Insurance but not exceeding the Limit of Liability expressed in the Schedule. Provided that this clause shall not apply if the amount of the damage does not exceed 5% of the amount of the Insured's declaration aforementioned. It is expressly understood and agreed that the provisions of this Co-insurance Memorandum shall not apply in respect of that part of any claim which is made under the provisions of the Reinstatement and Replacement Memorandum.”

Regrettably, the Mark IV wording has two Co-insurance clauses. This one, as a Memorandum to Section 1, and the second, as Proviso (iii) to the Reinstatement and Replacement Memorandum - refer Sub-Clause 6.5.3(iii). The fact that two have been included has caused the occasional problem when it comes to determining the Insured’s entitlement under the policy. To add to this woe, the Mark IV Advisory wording did not use a consistent wording between the two Co-insurance Clauses. In the first of the two Co-insurance Clauses, that is, the proviso to the Reinstatement and Replacement Memorandum, the test for Co-insurance is: “the value of property at such situation on the day of the commencement of the Period of Insurance”. In the Advisory wording, at the second Co-insurance Clause now being considered in the second paragraph, the test is: “the value of such property on the day of the commencement of the risk”. This later test was considered by some practitioners to mean all the property of the Insured, that is, across all locations, whereas the draftsperson(s) did in fact mean it to only refer to the Property Insured at the Situation of the Loss. The issue was addressed in the Mark IV Modified wording and, as this wording is now the one in use, this particular problem has been resolved. This change, however, does not correct the more deep-seated problem of there being two Co-insurance Clauses. In a recent letter to me, David Goodlad205 really ‘hit the nail on head’ when he stated that there was no need to have two Co-insurance Clauses in the Policy. I agree. All this confusion could have been avoided if the draftsperson(s) had simply included one Co-insurance Clause, referring to the Basis of Settlement Clause as the basis of arriving at the value at risk and the gross claim, and allowing the Insured to claim indemnity if they wished, with a corresponding change to the value at risk using the same methodology so that you are comparing ‘apples with apples’, that is, that the same basis of arriving at the value was used to calculate both the value at risk and the gross loss.

205 Goodlad D. B., 2005, unpublished letter to Dr Allan Manning dated 8 March 2005, p.2.

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 129 I have addressed the conflict between the two different Co-insurance Clauses earlier in the Chapter at Sub-Clause 6.5.3. For those who have just read this section, there is no need to revisit the subject again. For those who have used the index and come straight to this section, or are using the electronic version of this Guide, put the kettle on, make yourself a coffee and consider the following: With Insurers prepared to extend the cover from Indemnity to Reinstatement and Replacement Conditions, they wished to ensure that they were not selected against, and wanted to make certain that they received the correct Premium for the risk. This meant that the Insured had to declare the full value of the Insured Property in accordance with the Basis of Settlement Clause. This requirement is stated on the Policy Schedule under the heading Declared Values (refer Sub-Clause 2.6). As such, under the Reinstatement and Replacement Memorandum, the draftsperson(s) included a Co-insurance (sometimes known as Average) Clause. The Reinstatement and Replacement Memorandum can be utilised, or not, by the Insured. Further, if certain of the Provisos are not met, then the Policy reverts to one of Indemnity. As such, a second and all encompassing Co-insurance Clause was also included as the final Memorandum to Section 1. This sub-clause states, in the final paragraph, that:

“It is expressly understood and agreed that the provisions of this Co-insurance Memorandum shall not apply in respect of that part of any claim which is made under the provisions of the Reinstatement and Replacement Memorandum.”

This made sense for, if the claim had been considered under the Reinstatement and Replacement Memorandum, then the test for Co-insurance had already been completed. A conflict does arise in the wording, however, which the original draftsperson(s) appear not to have appreciated. I can understand how it came about and will explain this shortly, but will address the problem itself first. To do so, we need to go back to the first sentence of the Reinstatement and Replacement Memorandum (refer Sub-Clause 6.5.1), which states:

“REINSTATEMENT OR REPLACEMENT (Applicable to buildings, machinery, plant and all other property and contents; other than those specified in items (b) to (i) under Basis of Settlement).”

This clause reminds us that, as was stated in the Basis of Settlement Clause, the Reinstatement and Replacement Memorandum does not apply to all property. To refresh the reader’s mind, I again summarise below, using my own sub-clause numbering system and headings, those Items listed as (b) to (i) under the Basis of Settlement, and which therefore are not subject to the benefit of this Reinstatement and Replacement Memorandum:

• 5.1(b) Raw Materials Supplies and Other Merchandise not Manufactured by the Insured • 5.1(c) Material in Process • 5.1(d) Finished Goods • 5.1(e) Rewriting of Records • 5.1(f) Pattern, Moulds, etc • 5.1(g) Glass etc • 5.1(h) Directors and Employees’ Clothing and Tools of Trade etc • 5.1(i) Empty Premises Awaiting Demolition

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The Policy states that property falling within the definition of those items listed on the preceding page are subject to their own particular method for arriving at the Basis of Settlement. Each is defined in Chapter 5. For all other property, which includes buildings, machinery and plant, office equipment and the like, the Insured is entitled to the benefit of the Reinstatement and Replacement Memorandum. Proviso (iii) of the first Co-insurance Clause, which forms part of the Reinstatement and Replacement Memorandum states: “Property insured under this memorandum is separately subject to the following Co-insurance clause” – refer Sub-Clause 6.5.3(iii). This strictly means that the Basis of Settlement items (b) to (i) - refer list on previous page - are not covered by this test for Co-insurance, and need to be tested separately using the second Co-insurance Memorandum (see Sub-Clause 6.9). The conflict arises in the second paragraph of Proviso (iii), ie. the Co-insurance Sub-Clause, of the Reinstatement Sub-Memorandum - refer Sub-Clause 6.5.3(iii). The wording states:

“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 Insurance206 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.”

This sub-clause refers to “value of property insured at the situation”. On the Policy Schedule, as it was designed by the Policy draftsperson(s), the Schedule under Declared Values (refer Sub-Clause 2.6) states:

“DECLARED VALUES: (In accordance with the Basis of Settlement) Section 1 All Property Insured $ Section 2 All Gross Profit $

Insured Pay-Roll $ Other (Specify) $”

There is no requirement here to split the Declared Value by Classification, that is (using my numbering and descriptions) between:

• 5.1(a) Buildings, Machinery, Plant etc as defined under the Basis of Settlement category (a); and

• 5.1(b) Raw Materials Supplies and Other Merchandise not Manufactured by the Insured • 5.1(c) Material in Process • 5.1(d) Finished Goods • 5.1(e) Rewriting of Records • 5.1(f) Patterns, Models, Moulds, etc • 5.1(g) Glass etc • 5.1(h) Directors’ and Employees’ Clothing and Tools of Trade etc • 5.1(i) Empty Premises Awaiting Demolition

206 Emphasis mine.

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 131 Insurers, brokers and insurance advisers over the years have tended to split the Declared Values on Section 1 - Material Damage in two ways. Firstly by Situation, and this is to comply with the second paragraph of Proviso (iii), ie. the Co-insurance Sub-Clause, of the Reinstatement Sub-Memorandum - refer Sub-Clause 6.5.3(iii). The wording states:

“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 situation207 on the day of the commencement of the Period of Insurance....”

As explained at the start of this section, this same requirement for the test for Co-insurance to be at the “situation where the damage occurred” appears in the second Co-insurance Memorandum (paragraph 2) of the Mark IV Modified policy. The conflict between the test being for “value of property at such situation”, with the requirement that this test for Co-insurance is not to apply to the Reinstatement and Replacement Memorandum (refer Sub-Clause 6.9, paragraph 5), is also present. I reproduce, for the reader’s convenience, the entire second Co-insurance Clause found as the final Memorandum to Section 1 in the Mark IV Modified wording:

“CO-INSURANCE Unless otherwise stated herein to the contrary, this Policy is subject to the following Co-insurance memorandum: In the event of damage to property insured hereunder at any situation caused by any event hereby insured against, the Insured(s) shall be liable for no greater proportion of such damage than the amount of the Insured's declaration of value of such property, at the situation where the damage occurred208, on the day of the commencement of the Period of Insurance bears to the sum representing eighty-five per cent (85%) of the actual value of property insured at such situation on the day of commencement of the Period of Insurance but not exceeding the Limit of Liability expressed in the Schedule. Provided that this clause shall not apply if the amount of the damage does not exceed 5% of the amount of the Insured's declaration aforementioned. It is expressly understood and agreed that the provisions of this Co-insurance Memorandum shall not apply in respect of that part of any claim which is made under the provisions of the Reinstatement and Replacement Memorandum.”

The second split is often provided between buildings, contents other than stock, and stock, or something similar. I have seen many variations of this, with stock and other contents sometimes being grouped together, or machinery and plant being one category and other contents being another. While I have seen a myriad of splits in the Declared Assets, I have never seen one in sufficient detail as to split the assets as per the classifications listed in the Basis of Settlement Clause. The reason that this second split came about was, as I understand it, from two causes. The first was that underwriters requested a breakdown of the Material Damage assets between (i) buildings, (ii) contents other than stock, and (iii) stock, to assist them in arriving at a rough Probable Maximum Loss (“PML”). For example, on a brick building, they may set the PML at 80%, on Contents other than Stock at 90%, and on stock 100%209.

207 Emphasis mine. 208 Emphasis mine. 209 These percentages are for explanatory purposes only, with individual companies and/or underwriters having their

own methodology and percentage.

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The second reason was that brokers and advisers felt that by splitting the Material Damage assets up, it got the Insured to focus on the different types of assets that the business owned or utilised, and a more accurate overall Declared Value for Section 1 was reached. For the sake of completeness, I wish to make the comment that under the heading The Indemnity (refer Clause 3), the Policy states in the final sub-clause (Sub-Clause 3.3) that:

“Provided that the insurance under Clauses (b) to (g) inclusive shall not be subject to any Co-insurance clause or memorandum contained in this Policy.”

This the reader will recall means that certain of the Additional Benefits afforded by the Policy need not be included in the Declared Values. Using my headings and numberings, they are:

• 3.2(b): Government and Statutory Fees • 3.2(c): Fire Extinguishment and Mitigation of Costs • 3.2(d): Temporary Protection • 3.2(e): Replacing Locks and Keys • 3.2(f): Removal of Debris • 3.2(g): Directors’ and Employees’ Clothing and Tools of Trade

Only one of these Additional Benefits is addressed in the Basis of Settlement Clause, and that is: Directors’ and Employees’ Clothing and Tools of Trade. This therefore leaves, under one interpretation of the Policy, buildings, machinery, plant etc (as defined under the Basis of Settlement category (a) – refer Sub-Clause 5.1(a) - to be considered under the Co-insurance Clause forming part of the Reinstatement and Replacement Memorandum, with the remaining categories (b) to (i) of the Basis of Settlement, to be tested for Co-insurance using a second Co-insurance Memorandum. These categories are:

• 5.1(b): Raw Materials Supplies and Other Merchandise not Manufactured by the Insured • 5.1(c): Material in Process • 5.1(d): Finished Goods • 5.1(e): Rewriting of Records • 5.1(f): Patterns, Models, Moulds • 5.1(g): Glass etc • 5.1(i): Empty Premises Awaiting Demolition

To do the test correctly on this reading of the Policy, categories (b) to (i) of the Basis of Settlement (refer Sub-Clause 5.1) all need to be declared on the Schedule (at Sub-Clause 2.6), separately from building, machinery, plant etc and all the other tangible, physical, real and personal property of the Insured not listed above. However, in practice, to my knowledge, this is never done. I would suggest that it would be far too complex to do in any event. For example, how could the value of glass easily be separated from buildings, and plant and machinery? What happens in practice is patterns, models, moulds and the like are invariably declared as part of Contents other than Stock, as are the Insured’s records. Premises awaiting demolition are not a common asset under an ISR policy, and should correctly be declared separately. Stock is more often than not declared separately, but is sometimes grouped together with Other Contents. Neither I, nor any insurance adviser or underwriter I have discussed this issue with, have ever seen an ISR Policy Schedule provide a Declaration of Assets showing Raw Materials Supplies and Other Merchandise not Manufactured by the Insured, Material in Process, Finished Goods. It is grouped, as stated above, as Stock or as Contents.

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 133 Two questions therefore arise. The first is why has the industry practice adopted by insurers, brokers, other insurance advisers, risk managers etc, been not to provide or require this split? The second question is, should one or two tests for Co-insurance be made in cases where stock is declared separately? I answer each in turn. The reason that the industry has not gone to the trouble of breaking down the Declaration of Section 1 into the various categories is that when the Mark IV Advisory policy was launched, it was explained in seminars and papers that the test would be on all “such property insured at the situation where the damage occurred”. One such paper was presented by Mr Terry Hooper of Royal Insurance Australia. An extract of that paper is reproduced on the following page.

“The Material damage under-insurance clause is tested comparing the true value (usually ‘replacement’ basis) of the assets, at the situation (where the damage occurred) with its declared value. The test values (both true and declared) are as at the commencement of the insurance period not at the date of loss. It is necessary for the declared value to be at least 85% of true value otherwise the claim is reduced proportionately to the under insurance below 85%. The advantage to the Broker of this Day 1 Insurance is that they do not have to speculate on future asset increases. Furthermore 85% is more generous than earlier policies.”

Hooper (1990), p.1210

Mr Goodlad offers similar advice in his instructional guide, A Working Guide for Insurance Executives and Risk Managers (Mark IV)211. He certainly does not advise readers to split the Declared Values as technically is required. As a then loss adjuster working in a practice where specialised in large and complex losses from the introduction of the Mark IV Advisory wording in 1987 through to 1999, it was industry practice, not only for the firm that I worked for, but our principals as well, that only one test for Co-insurance was to be made. To gain a full understanding of the history of this issue, I contacted Mr David Goodlad, seeking his advice, and he kindly provided a reply. I reproduce relevant extracts below.

“As you know, I was a member of NIBA’s negotiating committee when the Insurance Council of Australia drafted and promulgated the 1990 (“Mark V”) version of the ISR base wording. I was also a member of the (1987) “Mark IV” committee during the latter stages of its drafting process. I was not involved in drafting the (1983) “Mark III” wording, which is no longer in use. You may recall that the under-insurance test in Mark III was applied to all property insured, although the loss was usually limited to a single situation. However loss adjusters found that test extremely difficult to apply in practice. Therefore the test under today’s base wordings (Mark IV and Mark V) is limited to the situation where the damage occurs.

210 Hooper T., 1990, “Adjustment of Premium/Average Debate”, unpublished paper delivered at training seminars on

the ISR policy, p.1. 211 Goodlad D., 1989, A Working Guide for Insurance Executives and Risk Managers (Mark IV), Craftsman

Publishing Pty Ltd, Burwood.

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Page Understanding the ISR Policy 134 Volume 1: Mark IV Advisory & Mark IV Modified

In the material damage section of Mark IV, the Reinstatement or Reinstatement Memorandum provides a test at clause (iii) but there is also a (second) “Co-insurance” memorandum, that is stated not to apply to any claim made under the Reinstatement and Replacement Memorandum. This second clause refers to “the actual value” of property, whereas the first clause refers to the cost of reinstatement. It was never intended that the second clause should apply specifically or solely to stock and this inference can be gathered from the wording. The term “actual value” was intended to mean indemnity value having regard to the age, condition and remaining useful life of the property, as distinct from the replacement cost (new for old) of destroyed property insured under the Reinstatement or Replacement Memorandum. “In the material damage section of Mark V, there is a single under-insurance clause (7.2.2) which refers to the value of property, calculated in accordance with the basis of settlement clause. The Mark V base wording was drafted with more care and attention to detail than its predecessors and it was recognised that two separate under-insurance clauses weren’t really necessary because the various bases of settlement for different categories of insured property were expressed elsewhere in the material damage section. The overriding consideration in both base wordings is that the under-insurance test – an 85% “day one” test – is to be applied to all property insured at the situation where the damage has occurred, without regard to the separate declared values for different categories of insured property at that situation on the first day of the Period of Insurance.”

Goodlad, 2005, pp.1-2212

As part of my research, I discussed the issue with many respected personnel in the industry who, unlike me, had been either underwriters, agents or brokers during the introduction of the Mark IV wording. The explanation given to me supports the position that the second Co-insurance Memorandum was a ‘belt and braces’ approach in case an Insured for some reason elected not to utilise, or was prevented from utilising, the benefits of the Reinstatement and Replacement Memorandum. At that time, the issue of stock was not considered an issue that may or would affect the Policy, as the Policy was designed so that stock was to be insured on a stock declaration basis. Therefore, in theory neither Co-insurance Clause would ever apply to stock. The industry found that stock declarations were not suitable for a number of reasons and they lapsed from use in the vast majority of cases. Without stock being subject to declarations on which the correct premium was paid, it became necessary to test the adequacy of Declared Value at the commencement of the Period of Insurance at the Situation where the damage occurred. The practice was to simply add the stock into the one Co-insurance calculation along with the building, machinery, plant and all other contents213. As Goodlad stated above, the issue was corrected in the Mark V policy, but was never corrected in the Mark IV policy. However, most practitioners have continued to apply only one test for Co-insurance. This partly explains the second question, which was: should one or two tests for Co-insurance be made in cases where stock is declared separately? This issue has only arisen in the industry in the past few years, with some loss adjusters and/or claims personnel seeking to impose two separate tests for Adequacy of Insurance/Co-insurance. It appears to have been originated by people who do not have a good understanding of the history of the Mark IV policy. Technically, as we have discussed, they have a point as, given the way the two Co-insurance Clauses are worded, two tests are required.

212 Goodlad D.B., 2005, unpublished letter to Dr Allan Manning dated 8 March 2005, pp.1-2. 213 I especially wish to thank Mr Max Salveson for being the first to explain this history to me. The advice has been

repeated to me by many who lived through the introduction of the Mark IV Policy.

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 135 Having said this, the fact that two tests for Co-insurance are contained in the one Policy came about through the draftsperson(s) wishing to make certain that an Insured did not avoid the test at all. It was certainly never designed to require a second Co-insurance calculation for stock. The Mark V wording has only one Co-insurance Clause, in line with the intention of the Mark IV. The Mark V wording was expected to replace the Mark IV wording but, for a number of reasons, this has not occurred. In hindsight, this issue should have been addressed in the Mark IV Modified wording, but my research suggests that the problem had not manifested itself at the time of drafting, only coming to light in the past few years through a handful of loss adjusters. Further, it must be remembered that stock is not the only classification of asset that is caught by this issue. The fact that the insurance industry, as a general practice does not require, seek or even suggest separate declarations for all the assets not covered by the Reinstatement and Replacement Memorandum, demonstrates that industry practice continues to be that only one Co-insurance Clause should be applied. The effect of the separate tests is that the Insured can be penalised. By doing one test, if an Insured were say over-insured on stock and under-insured on building, but overall had declared the correct total value at risk at the Situation, then they are not penalised as the over-insurance on one asset category is offset by the under-insurance on another. Insurers do not charge a separate/different Premium rate for stock from what they charge on buildings or machinery and plant. Therefore, I strongly believe that, if an Insured has the overall Declared Value correct, it would be inequitable to penalise them because they made an error in the split between these types of assets. I would also make the observation that with stock, where the Insured elects to replace it, they are entitled to “the replacement cost at the time and the place of replacement” subject to some conditions. This is virtually the same cover afforded buildings and many other contents. Yes, raw materials, work in process and finished goods have different issues in the case of obsolescence, which are addressed in the respective Basis of Settlement Sub-Clauses, but none necessitates a separate Co-insurance calculation. As part of my research, I have carried out a straw poll of loss adjusters around Australia, on how they apply the test for Co-insurance. Most only apply one test, but there are some who have started to apply two. There appears to be neither rhyme nor reason to who does and does not; even adjusters within the same office take different approaches. From an Insured’s perspective, it is a form of Russian Roulette as to whether the adjuster that is appointed to their claim, applies one test or two. What I can say is that where I am acting as a loss adjuster or claims preparer, I only apply the one test. In all of the claims that my firm has been involved in where the loss adjuster has attempted to conduct more than just the one test for Co-insurance, I have written an opinion to the Insurer and, on learning the history/industry practice for over 15 years and considering the question of equity, every Insurer has accepted that only one should be applied. While I genuinely believe that only one test for Co-insurance should be applied, it is naturally best to avoid the issue. Even where the claim is adjusted with only one test for Co-insurance, there is delay while the problem is addressed and that certainly does not assist the end user of the insurance product, the Insured. For this reason, PolicyCoach214 has developed an Endorsement that states that in the event of a claim under a Mark IV wording, there will be only one test for Co-insurance in accordance with the vast majority of industry practice.

214 http://www.LMIGroup.com/PolicyCoach.

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Page Understanding the ISR Policy 136 Volume 1: Mark IV Advisory & Mark IV Modified

The suggested endorsement ONEAVXB4215 is set out over the page, but must be used in conjunction with endorsement number INDCKX4, tited ‘Election to Claim Indemnity Value’. Please note that should Endorsement (RRDISS4) titled ‘Replacement with Dissimilar Property’ have been used, then the deletion of Provision (iii) of the Reinstatement and Replacement Memorandum should not occur.

Figure 5

Co-insurance Memorandum (ONEAVXB4) The Co-insurance Clause applies only where there has been under-insurance at the commencement of the Period of Insurance. This is sometimes referred to as ‘Day 1’ as in the first day of the insurance cover as opposed to the date of the loss. I would remind the reader that the loss is calculated in accordance with the Basis of Settlement Clause (see Clause 5). It is only the valuation of the Section 1 Property Insured that is based on ‘Day 1’ values.

215 This Endorsement was drafted by Mr David Goodlad following our discussion on the issue, and I wish to record

my sincere appreciation for his allowing me to reproduce it here.

Co-insurance Memorandum (ONEAVXB4) Provision (iii) of the Reinstatement or Replacement Memorandum is deleted, together with the Co-insuranceMemorandum and the Declared Values Memorandum. The following additional Memorandum shall apply to Section 1: Average/Under-insurance The Insured is required to insure for full value calculated in accordance with the appropriate Basis of Settlement Clauses,as at the commencement of the Period of Insurance and, in relation to any Property Insured acquired after thecommencement of the Period of Insurance, as at the time of acquisition of that property. In the event of a claim, the moneys otherwise payable under Section 1 of this Policy shall be the proportion that theInsured’s declaration at the time of the commencement of the Period of Insurance of the value of all Property Insured atthe Situation to which the Damaged item or items belong bears to 85% of the value of all such property as at the time ofthe commencement of the Period of Insurance calculated in accordance with the appropriate Basis of Settlement Clauses. This Memorandum shall not apply if the amount of the Damage does not exceed 5% of the amount of the Insured’sdeclaration of value for that Situation. For the purpose of the application of this Memorandum, the Insured’s Declared Values at any Situation shall not includeany allowance for Extra Cost of Reinstatement or for the costs and expenses referred to in the Additional Cover providedin Clauses (b) to (g). 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 ofvalue of property insured at such situation on the day of the commencement of the Period of Insurance bears to the sumrepresenting eighty-five per cent (85%) of the cost which would have been incurred in reinstatement if the whole of suchproperty had been destroyed on that day, but not exceeding the Limit of Liability expressed in the Schedule; provided thatif 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 payableunder this Policy if this memorandum had not been incorporated herein, but is less than the cost of reinstatement asabove defined, then the sum so actually incurred or expended shall for all purposes of this memorandum, be deemed tobe the cost of reinstatement of the property.”

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 137 As with the Mark V policy, the intention of the clause is to confine the application of the Co-insurance Clause to the relevant Situation, being the Situation “to which the Damaged item or items belong”. As discussed, this intention was again not achieved in the second Co-insurance Clause. In any event, in the case of property that sustains Damage at the Situation where it is normally kept, this poses no difficulty. In the case of property that is in transit, it will be the Situation at which the property is normally housed. This means that separate Declared Values are required for separate Situations. Prior to the Mark IV wording, the Co-insurance calculation was to be carried out across all locations. As a loss adjuster at the time, I can assure you that for many large clients, the cost of calculating the value at risk would have cost more than the value of the claim. Therefore, in many cases, the test was not carried out. It is for this reason that it was changed in the Mark IV wording to the relevant Situation only. It is stated in the Memorandum titled Declared Values (refer Sub-Clause 6.4) that the “value” which needs to be declared and which is examined to determine whether this Co-insurance Clause applies, is the value calculated in accordance with the Basis of Settlement Clause set out in the Policy (see Sub-Clause 4). The Basis of Settlement Clause (Sub-Clause 4) provides that “on buildings, machinery, plant and all other property and contents other than those specified below”, the Basis of Settlement has to be the “cost of reinstatement and replacement or repair in accordance with the provisions of the Reinstatement and Replacement and Extra Costs of Reinstatement Memoranda”. Please note that while the requirement for the valuation to be in accordance with the Basis of Settlement Basis of Settlement Clause is set out here in Sub-Clause 6.4, any penalties for under-insurance are set out in Sub-Clause 7.2.2, which allows for a tolerance of 15% (85% co-insurance). This means that if the Insured is within 85% of the value at risk, then Co-insurance will not apply. Even where it does, the Insured is only penalised on 85% of the shortfall between the Day 1 value at risk, in accordance with Clause 4 - Basis of Settlement, and the Declared Values provided at the commencement of the Period of Insurance. This is greater than that allowed in the Mark III version, which was only 10%. In some cases where there is significant under-insurance on a Reinstatement and Replacement basis, the Insured may in fact be economically better off by electing to obtain an Indemnity settlement and forgo their entitlement under the Reinstatement and Replacement Memorandum which, as we are just discussing, incorporates this Co-insurance Sub-Clause. Yes, there is still a separate Co-insurance Memorandum (Sub-Clause 6.9), but when the Basis of Settlement and the loss are calculated on an Indemnity basis, the net figure may be higher. The following example demonstrates the case in point. The Insured’s right to elect to claim indemnity is confirmed in the final paragraph of the Basis of Settlement Clause (see Sub-Clause 5.2). In this example, the total replacement value of the Insured Property is $20 million. Much of what has not been damaged has a low indemnity value. It is the newer, high value property that has been destroyed. Therefore, adjustments for age, wear and tear, to arrive at a fair and reasonable Indemnity Value would be much more severe on the value at risk than on the loss amount. The Insured is grossly under-insured and therefore a calculation has been carried out to look at the amount paid on an Indemnity basis and under the Reinstatement and Replacement Memorandum, to see which achieves the highest settlement payout for the Insured.

Details: Limit of Liability $11,000,000

Declared Value $10,000,000

Value at Risk - Replacement Value $20,000,000

Value at Risk - Indemnity Value $12,000,000

Loss - Replacement Value $10,000,000

Loss - Indemnity Value $8,000,000

Deductible Nil

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Page Understanding the ISR Policy 138 Volume 1: Mark IV Advisory & Mark IV Modified

Settlement Calculation on Replacement Value (Sub-clause 6.5)

Formula: Declared Value x Loss

85% of Value at Risk $10,000,000 $10,000,000 0.85 x $20,000,000

= 58.82% $10,000,000

= Amount Claimable (Replacement) $5,882,353

Settlement Calculation based on Indemnity Value (Insured elects not to utilise the benefits of the Reinstatement and Replacement Memorandum)

Formula: Declared Value x Loss

85% of Value at Risk $10,000,000 $8,000,000 0.85 x $12,000,000

= 98.04% $8,000,000

= Amount Claimable (Indemnity) $7,843,137 As can be seen, subject to the Limit of Liability being adequate, the Insured is significantly better off taking an Indemnity Settlement over one based on Reinstatement and Replacement. It should also be remembered that the Insured is still entitled to claim Extra Costs of Reinstatement subject to five provisos, even if they elect not to claim under the Reinstatement and Replacement Memorandum (refer Sub-Clause 5.2). If the reader wishes to review the various methods that are used to arrive at the Indemnity Value, please go to Chapter 5, Sub-Clause 5.2. The second-last paragraph of this second Co-insurance clause is in line with both the first Co-insurance clause and the Mark V Policy and excludes any penalties for under-insurance to claims that are to be valued at less than 5% of the Insured’s Declaration of Value for that Situation. The reason for this is that the cost of determining the value at risk at the commencement of the Period of Insurance for claims under 5%, would be greater than any benefit Insurers would gain by the application of the Co-insurance penalty. Notwithstanding this, a small claim should be used by an Insured as a reminder to test the adequacy of insurance at the location, using the Basis of Settlement as defined by the Policy (refer Clause 5) and, if the Declared Values on the Policy are too low, then increase them to the full value.

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 139 Goodlad (1990)216 also reminds us that it was never the intention of the Mark IV ISR policy to penalise the Insured for claims arising out of theft or money where the loss exceeded 5% of the Declared Value at the Situation at the commencement of the Period of Insurance, where that Declared Value was not adequate. Established market practice is to insure both theft and money on a ‘first loss’ basis. This was again addressed in the Mark V policy but has never been rectified in the Mark IV, although it appears that the issue no longer arises due to an industry understanding. The final point I wish to discuss under what already is a complicated subject, is the fact that it is felt by many Insureds and insurance brokers, that the inclusion of a Co-insurance Clause as well as an Adjustment of Premium Sub-Clause (refer Sub-Clause 13.5) is unfair in that the combined effect of both clauses is to enable an Insurer to apply Average on a claim on the basis that there has not been full insurance, and yet seek to have the Premium adjusted in line with the full value of the Property Insured. These critics claim that having both provisions in the one Policy is a breach of the duty of the utmost good faith, and that reliance on both conditions concurrently would also amount to a breach of that duty. Marks and Morgan (1993)217 disagree and state that this “argument is unfounded”. They argue that the effect of the Co-insurance Clause is to require the Insured to insure for the full value calculated in accordance with the Basis of Settlement Sub-Clause. That of course means, as we saw in Chapter 5, that if reinstatement is on a ‘new for old’ basis, which is provided for by the Policy, then the Declared Value must be fixed on the same basis. The penalty for not declaring the value at risk adequately in line with the Basis of Settlement Sub-clauses is for a proportionate reduction in the amount payable in the event of a claim. On the other hand, the Adjustment of Premium Sub-Clause (refer Sub-Clause 13.5), requires that at the end of the Period of Insurance there be an adjustment of the Premium to reflect the full value of the Insured Property calculated, once again, in accordance with the Basis of Settlement Sub-Clause. (In the case of Section 2 – Consequential Loss of Profits Insurance, this needs to be read in conjunction with Sub-Clause 13.5(b)(ii) for the Adjustment of Premium and Sub-clause 8.1.3 for Co-insurance). Their argument is that those moneys are not, however, payable until after the end of the Period of Insurance, so that the Insurer has effectively been deprived of some part of the Premium throughout the Period of Insurance. The Adjustment of Premium Clause also accommodates circumstances where there has been a variation in the value of the Property Insured during the Period of Insurance, a matter which is not addressed by the Co-insurance Clause and is confined to requiring full value insurance at the commencement of the Period of Insurance only (in the case of Section 1). In this way, it is suggested that no breach of the duty of the utmost good faith is involved as an Insurer relies upon both clauses. One matter that these commentators have omitted to mention is the case where the Insured has over-insured, particularly on Section 2 – Consequential Loss. As was explained in Chapter 2, Sub-Clause 2.6 titled Declared Values, the amount that needs to be declared to avoid Average under Section 2 – Consequential Loss is higher than the amount upon which the premium is ultimately based. Therefore, the policy in fact requires an Insured to over-insure Section 2 from a Premium calculation point of view, particularly where the business turnover/insurable gross profit is growing. This means that the declaration at the commencement of the Period of Insurance will be higher than the declaration at the end of the Period of Insurance. As such, under the terms of the Premium Adjustments Sub-Clauses, the Insured obtains a return Premium based on 100% of the rate for Section 2 – Consequential Loss.

216 Goodlad D., 1993, The ISR Book: A Working Guide for Insurance Executives and Risk Managers, Mark V Edition,

Craftsman Publishing Pty Ltd, Burwood, p.xiv. 217 Marks F.and Morgan T., 1991, Guide to the 1990 ISR Advisory Policy Wording, Dunhill Madden Butler & Robins

GAB, Sydney, p38.

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Page Understanding the ISR Policy 140 Volume 1: Mark IV Advisory & Mark IV Modified

In fact, if you consider the combination of the two clauses in this way, you can see that there is no reason why an Insured should ever be under-insured on Section 2. The Insured should estimate generously their declaration of Gross Profit and Wages to avoid any chance of Average, in the full knowledge that at the end of the period, they will be entitled to a full refund of any over-insurance due to the Adjustment of Premium clause. The issue appears to be simply a lack of understanding on the part of those who criticise the wording and find themselves or their client without adequate cover after a loss has occurred. They then seek to make a declaration after the loss, often for the first time in the history of the policy, which may have been running for many years. This, to me, is a far greater breach of the duty of good faith than the inclusion of both the Co-insurance Clause here - at Sub-Clauses 6.9 or 8.13; 8.3.1(a)(ii) - and Adjustment of Premium Sub-clauses - 13.5(b)(i) and 13.5(b)(ii) - in the ISR policy. While I support the views of Marks and Morgan (1993)218, I am aware of more than one case where, after a loss has occurred, the Insured has made a declaration increasing the Declared Values and paying the Premium on the increased declaration, and then sought to have Average/Under-insurance waived. In several of these cases, it was the first declaration ever made by the Insured at the end of a Period of Insurance. In all cases, the Insurers have not been prepared to test the policy and, despite initial resistance, have settled the claims prior to trial. On the other hand, if an Insured were to make accurate declarations year on year at both the start and end of each Period of Insurance and had paid premiums accordingly, and yet when a loss occurred, they found that they were unintentionally under-insured, I am certain that most Insurers would be far less stringent on the application of the Average provisions. I do not condone this practice and, as I have repeatedly stated throughout this Guide, those responsible for the insurance program must take great care to ensure that the Declared Values are adequate in accordance with the relevant Basis of Settlement Clause prior to any loss occurring. It should be borne in mind that while many Insureds obtain valuations on their physical assets, it has only been in recent times that specialist accountants with a good grounding in insurance, have started offering a service to determine an adequate Declared Value on Section 2 - Consequential Loss. With so many accountants, both internal and external, not appreciating the difference between accounting gross profit and insurable gross profit, this is a valuable service, which I encourage the use of.

218 Marks F. and Morgan T. , 1991, Guide to the 1990 ISR Advisory Policy Wording, Dunhill Madden Butler &

Robins GAB, Sydney, p38.

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Understanding the ISR Policy Page Volume 1: Mark IV Advisory & Mark IV Modified 141

MARK IV MODIFIED ONLY

“CO-INSURANCE Unless otherwise stated herein to the contrary, this Policy is subject to the following Co-insurance memorandum: In the event of damage to 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 of the Insured's declaration of value of such property, at the situation where the damage occurred, on the day of the commencement of the Period of Insurance bears to the sum representing eighty-five per cent (85%) of the actual value of property insured at such situation on the day of commencement of the Period of Insurance but not exceeding the Limit of Liability expressed in the Schedule. Provided that this clause shall not apply if the amount of the damage does not exceed 5% of the amount of the Insured's declaration aforementioned. It is expressly understood and agreed that the provisions of this Co-insurance Memorandum shall not apply in respect of that part of any claim which is made under the provisions of the Reinstatement and Replacement Memorandum.”

The wording changed with the addition of the following clause in the second paragraph: “at the situation where the damage occurred”. This brought this second Co-insurance Clause in line with the first which, as has been stated above, forms part of the Reinstatement and Replacement Memorandum (Sub-Clause 6.5). The purpose of the change was to reflect the intention of the draftsperson(s) of the Mark IV policy to move the test of Declared Assets to the true value at risk from all locations, as was the case in the Mark III wording, to the Situation where the damage occurred. This made the test much more convenient and cost-effective, particularly with very large risks, say of a multi-national with a great many locations across Australia.

THE AUTHOR Professional Qualifications Doctor of Business Administration Bachelor of Commerce Master of Business Administration Fellow Certified Practising Accountant Fellow Aust & NZ Institute of Insurance & Finance Fellow Chartered Insurance Institute (UK) Fellow Chartered Loss Adjuster Fellow Chartered Institute of Loss Adjusters (UK) Chartered Insurance Practitioner (UK) FUEDI European Loss Adjusting Expert

Professional Experience

After 11 years experience with General Accident Insurance, Allan joined Robins MBS Loss Adjusters in 1981. In 1987, he transferred to Papua New Guinea, as Managing Director. During this time, Allan handled one of Australia's largest claims, which surrounded the closure of the Bougainville Copper mine. Allan returned to Australia in 1990 as State Manager, Western Australia and, in 1991, was appointed Regional Manager for the Southern Region, as well as head of GAB Robins’ large claims team. Dr Manning founded the LMI Group in 1999, a firm dedicated to providing a high level of customer service and technical expertise in both pre- and post-loss insurance services. These include loss management, risk assessment and technical advice to the general insurance and business communities. He developed Policycomparison.com, an online comparator of general insurance products, now widely used in Australia and New Zealand. His most recent brainchild is PolicyCoach, a web-based expert system to aid in the preparation of ISR and Marine Cargo policies, including industry-specific endorsements. Naturally, this system also provides comprehensive online training. For 35 years, Allan has managed large and complex losses, involving major property, business interruption including advanced consequential loss, fidelity, construction and liability throughout Australia, Asia Pacific, Europe and North America. Assignments have been completed for multi-national and government organisations, as well as small and medium businesses. He particularly enjoys the challenge of assisting companies to return to normal trading after a major crisis. His interest in the survival of a business following an insured loss prompted him to complete a Doctoral thesis, involving 6 years of extensive research. Over the past 6 years, Allan has been engaged to review the insurance programs and the level of sum insureds for businesses, including multi-nationals, to ensure adequate declared values, indemnity periods and cover. Allan has lectured at RMIT on Claims Management, and has delivered over 200 papers at seminars on Business Interruption, Property Insurance and other insurance-related topics. Dr Manning is the author of five books on insurance subjects.

Allan Manning DBA, B.Com, MBA, FCPA, ANZIIF (Fellow), FCII, FCILA

RRP (3-volume set) Australia $550.00 (inc GST) New Zealand $550.00 Published by Mannings of Melbourne, Camberwell, Australia