Spot the wording error: fill in the blank

What’s left unsaid can result in a devastating outcome.

It always pays to be clear – particularly in insurance contracts. What might seem obvious to one party may be as clear as mud to the other.

Can you guess the missing word in this vaguely worded clause relating to flood claims? “the sub-limit applies for Property Damage and Time Element [losses] _________”

A US judge certainly couldn’t, in a case that ended up rendering an insurer liable for an entire programme limit of $20 billion.  

(The answer is: combined)

The case

Northrup Grumman Corporation v Factory Mutual Insurance Company [2008] concerned a dispute between the global defence contractor and its insurer over whether it could claim on its property insurance policy after Hurricane Katrina damaged its shipyard in Pascagoula, Mississippi in 2005.

The key issue

Whether the flood damage sub-limit contained in the cover’s primary layer applied to all flood-related claims and if it was also valid for the (much larger) excess layer.

The wording

Northrop Grumman purchased approximately $20 billion all-risks property insurance, which was effectively split into two layers: a first (‘primary’) layer of $500 million of coverage with a second (‘excess’) layer covering the remaining exposure.

There was a sub-limit of $400 million for flood coverage within the primary layer, but the excess layer explicitly excluded flood claims.

An insurance company’s failure to use available language gives rise to the inference that the parties intended ‘not’ to limit coverage.

When Northrop claimed for around $940 million for damage and disruption caused by Katrina’s wind-driven storm surge, its insurer Factory Mutual (FM) denied coverage for a substantial part of the claim, citing the excess policy’s flood exclusion, sparking a lengthy and expensive legal dispute.

The judgement

The judge rejected FM’s contention that the primary policy’s limits of liability provision applied to “any” loss or damage, whether it be direct property damage or consequential time element losses (business interruption) arising from the flooding at Pascagoula.

The judge found there was no language in the flood sub-limit regarding time element losses.  If the insurer wanted to include such a limitation in the policy then that was “not conspicuous, plain or clear”. The judge pointed to certain other peril sub-limits elsewhere in the policy, such as terrorism, where it was clearly stated that the coverage applied for both property damage and time element claims “combined”. Therefore, by not including combined (or similar language) in relation to flood, FM had chosen not to impose this limitation of liability for that peril, the judge found. “An insurance company’s failure to use available language gives rise to the inference that the parties intended ‘not’ to limit coverage,” the judge said.

The courts will generally interpret insurance policies broadly to afford the greatest possible protection to the policyholder.

Since FM had chosen not to include the “combined” qualification for all perils, then it is natural to think there is no sub-limit for time element losses for those perils without that qualification, the judge concluded. Therefore, the $400 million flood sub-limit for flood “only applied” to physical damage losses and not to time element losses, the judge concluded, so Northrop was entitled to claim for them within the programme limit of $20 billion.

The lessons

This case provided an expensive instruction for FM and demonstrates the importance of clear policy language and the attention to detail required to avoid ambiguity and inconsistency within an insurance contract.  The courts will generally interpret insurance policies broadly to afford the greatest possible protection to the policyholder, while exclusions or provisions that limit coverage are generally interpreted narrowly against the insurer.

The policy should have clearly explained how the sub-limits of liability applied to each insured peril, but didn’t, because of sloppy drafting. The London LMA5130 “Application of Sublimits Endorsement” is a good example of a tightly-constructed clause that performs this function well.

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