Weathering the Hard Market: is your CAR Policy Watertight?

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, 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.

Amy Lacey is a Partner at Fenchurch Law