Weathering The Hard Market: Is Your CAR Policy Watertight? – Insurance

The increasing prevalence of water damage losses on construction
projects, combined with hard market conditions, has led to a rise
in disputes over insurance policy response for these types of
events. Claims in consequence of cascading water from burst pipes
or adverse weather conditions often give rise to disagreements over
the occurrence and timing of ‘damage’, in order to
trigger coverage under contract works policies, and a number of
standard exclusion clauses may impact upon the level of
protection.

Insuring Clauses

The legal test for damage requires proof of physical change to
insured property, adversely affecting its value or usefulness.
Authorities demonstrate a distinction between policies requiring
‘damage’ – which includes transient or reversible
changes if time and money has been spent dealing with the problem
(Ranicar v Frigmobile; The Orjula) – as opposed to
policies with a ‘physical damage’ trigger, which may
not respond in the absence of a permanent alteration in condition
(Transfield Constructions v GIO).

The need for coverage in respect of temporary changes is
particularly important in water damage scenarios, where the insured
property could dry out relatively quickly. Insurers might suggest
that no lasting damage remains, even if the policyholder has been
put to considerable expense and inconvenience through a water
ingress event, especially where guarantees relating to electrical
elements of contract works may be invalidated.

It is sufficient for physical change to have occurred at a
microscopic level, detectable only through careful examination
using advanced inspection techniques, such as accumulation of dust
on carpets (Hunter v Canary Wharf) or increased
brittleness and liability to early degradation of a pastel painting
following exposure to high temperatures (Quorum v
Schramm).  Accumulations of water can result in physical
changes to insured property in the form of rot or fungal spores,
especially in close proximity to timber elements, although expert
assistance may be required to identify the presence of this type of
damage.

Exclusions from Cover

Contract works policies typically exclude cover for damage
resulting from changes in the water table level, and may refer to
fungus or rot alongside other naturally occurring processes as part
of a gradual deterioration exclusion.

Another key aspect of the policy wording determining the scope
of protection for water damage events are relevant defects
exclusion clauses.  Contract works insurance usually contains
a standard defects exclusion based on the DE or LEG suite of
options, offering different levels of coverage for cost of repair
associated with defective design, workmanship or materials.
 Failed connections in water systems may involve a combination
of design or workmanship problems, and the proximate cause of loss
will often need to be identified to determine policy response.

DE5 or LEG3 usually provide the broadest coverage for losses in
consequence of defects, to include costs incurred to gain access to
property damaged as a result of defects, and excluding only the
cost of improvements. Some policies provide an option as to
application of DE5 or DE3 / LEG3 or LEG2, at the
policyholder’s option at the claims stage, allowing
flexibility to determine which alternative produces the most
favourable outcome with knowledge of the particular circumstances
arising.

Some standard exclusion clauses (such as DE4) provide cover for
damage to ‘other property’ caused by defects, but not
the defective ‘part’ itself, which often leads to
disputes over divisibility of insured property between defective
and non-defective parts. In general terms, the courts will look to
the commercial reality of whether a particular aspect of the
development would be viewed by contracting parties as a separate
package or phase of works (Seele Austria).

The aggregation wording in the policy may also impact upon
coverage for complex aspects of contract works, such as structures
formed from separate sections or modular elements, with the
possibility of insurers arguing that multiple ‘losses’
have occurred for purposes of the limits of indemnity and
deductible.

Policy Conditions

Careful consideration should be given to policy conditions
requiring particular steps to be taken in relation to risk
mitigation and claims handling.

In order to establish breach of a ‘reasonable
precautions’ condition, the insurer must prove recklessness
i.e. the insured subjectively appreciated the risk but didn’t
care or ignored it; mere negligence will not suffice (Sofi v
Prudential).  This is distinguishable from policy
requirements imposing positive continuing obligations on insureds
to take specific actions, such as unoccupied buildings conditions.
The recklessness threshold will not apply where there is
“a highly defined and circumscribed set of particular
safeguards which have to be put in place” (Aspen
Insurance v Sangster).

Insurers are increasingly focused on water damage risk
management procedures as part of the underwriting process, and may
include specific provisions in the policy requiring compliance with
e.g. CIREG best practice guidelines.  The inclusion of
‘conditions precedent’ should be resisted, given the
draconian remedy of avoidance available for any breach of such
clauses, with use of appropriate ‘best endeavours’ type
language especially if works on site involve third party
sub-contractors, so that compliance with the condition is not
entirely within the policyholder’s control.

Conclusion

Advice should be sought from specialist brokers on potential
improvements to the scope of insurance for contract works, with
particular reference to the trigger for coverage, exclusion clauses
and policy conditions. When a loss does occur it is important to
investigate and document the condition of insured property without
delay following a water damage incident, with expert input if
required, to minimise the prospect of insurance disputes.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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