Why this article:
Property (Material Damage) insurance, more traditionally known as Fire Insurance, is a basic insurance cover used by huge number of customers. The promise of true protection under the policy is relied on not only by the customer concerned, but also by their bankers, financiers, employees, suppliers etc. This is because insurance plays an important role in the sustainability of the operations of the economy and therefore the intent and interpretation of the policy has a wider economic angle. During the Tariff regime, under the Tariff Advisory Committee (TAC) the fire policy was considerably expanded to meet various contingencies and renamed as Standard Fire and Special Perils ( in short SFSP) Policy to meet the need for coverage of a wider array of perils. Even after de-tariffing, the standard fire policy wording continues to be in vogue. The basic SFSP policy cover now offers protection against perils such as Fire, Lightning, Explosion/Implosion, Aircraft Damage, Riot, Strike and Malicious Damage, Storm, Cyclone, Typhoon, Tempest, Hurricane, Tornado, Flood and Inundation etc. In addition, the SFSP policy also provides covers for several add-on perils. However, in course of a long stint with the insurance industry, including as a senior officer in two leading PSUs, it has been the author’s view based on experience that some of the standard clauses in the SFSP policy pose serious challenges to the basic concept of indemnity as understood in general. It is seen that the main reason of the same is attributable to some ambiguities in the policy wording created by linguistic over-kill by the draftsmen who formulated the standard clauses. In this article, it is proposed to focus on some major ambiguities and inconsistencies of SFSP policy in respect of prominent commercial risk exposures vis. a vis. the fundamental purpose of insurance, so that the industry may consider a serious and solution-oriented reviewing of the SFSP policy wordings.
Principle of construing insurance contracts:
While interpreting any type of insurance policy, the thumb rule which is to be kept in mind, is the main purpose of insurance, i.e. indemnification against unforeseen losses caused by perils insured. So, in respect of Standard Fire & Special Perils insurance, the object of obtaining such policy, from the perspective of the insured, is to indemnify himself against losses arising from operation of perils covered under the standard policy. The insurer as well, by issuing a policy, holds out to the insured a promise to indemnify, which creates a reasonable and legitimate expectation of protection in the mind of the insured on the basis of his understanding of the scope of coverage. The understanding of the insured should be judged by the parameters of a reasonable understanding of any common man and not of a technical expert of insurance underwriting. To serve this main purpose of insurance contract, any standard and non-negotiable clause in an insurance policy, like the clauses of SFSP policy, which is unilaterally applied by the insurer, must satisfy two criteria: first, it must not pose any ambiguity whatsoever regarding the nature and extent of protection offered, so that the same is totally comprehendible to an insured of natural prudence; and secondly, exclusion clauses or riders in a policy must not defeat the fundamental purpose of contract, i.e. providing indemnity. In marine insurance as well material damage of property insurance against perils like fire, flood or other covered perils, it is the universal practice based on the principle as old as the business of insurance itself, that the scope of indemnification under an insurance contract is determined by the linkage between insured peril and the loss, through a continuous and unbroken chain of causation; which is more commonly known and understood as ‘Proximate Cause’. As such, a standard fire insurance contract, or for that matter, any insurance contract, has to be interpreted always keeping in mind the pivotal objective of indemnity against losses proximately caused by perils insured under the contract. Treating indemnity as the pivotal point of insurance, one can confront some major ambiguities in the SFSP Policy wordings, which are baffling in nature and are susceptible to unfair applications detrimental to a wide spectrum of unsuspecting insureds under SFSP Policy.
The Ambiguities in SFSP Policy:
Keeping in mind that the dominant purpose of insurance is protection against perils covered, two major ambiguities in the SFSP policy which have often vexed the insured and insurer alike are the specific exclusion (a) of the RSMD cover and the General Exclusion No. 10 of the standard fire policy. The specific exclusion (a) to the RSMD cover excludes any loss caused by “total or partial cessation of work or the retardation or interruption or cessation of any process or operations or omissions of any kind.” On the other hand, the General Exclusion No. 10 of SFSP Policy excludes “loss, or damage by spoilage resulting from the retardation or interruption or cessation of any process or operation caused by operation of any of the perils covered.” A reading of both of the aforesaid exclusion clauses shows that barring superfluous structural difference, the specific exclusion (a) to the RSMD cover, is practically same as the General Exclusion No. 10 of SFSP Policy in terms of nature, of their inherent ambiguity, unbridled wideness and circumstances in which they tend to operate. Therefore, both of these exclusion clauses pose same drastic challenges to the fundamental purpose of the fire insurance contract, i.e. indemnity against losses proximately caused by insured perils. The reason for which the focus is on these two above-mentioned exclusions is that these two exclusions, by dint of their inherent ambiguities, have a tremendous potential of defeating the main purpose of insurance for a wide array of customers who obtain SFSP Policy to protect their business interests without being aware or notified of their vulnerability to be deprived of legitimately expected protection under the policy.
The vulnerable sector:
Fire insurance policies are being sold by insurance companies in India to many power-driven manufacturing industries, in which machines and equipments are used under human supervision and control with continuous feeding of fuel or electricity. The best examples of such industries are metallurgical industries and chemical industries constituting a major share of the organized industrial sector of India (Source: http://business.mapsofindia.com), in which regulated heating and cooling in furnaces and boilers are integral to industrial operations. In such industries, operation of most of the insured perils under the SFSP Policy can, more often than not, proximately and inevitably cause major damage to insured plant and machineries through an unbroken and interwoven chain reactions involving power outage followed by retardation of manufacturing operations, without intervention of any other force or peril having originated and working from a new and independent source. This aspect would be clearer by a real-life illustration of a recent incident of loss and repudiation thereof, which came to my notice in course of an informal discussion with an old colleague from the insurance industry. In that case, damage to a furnace of an iron & steel industrial unit maliciously caused by a rioting mob by abruptly and forcibly disconnecting power supply to the furnace by use of violence and threat. The claim for such damage was turned down by an insurance company by resorting to General Exclusion No. 10 of the SFSP policy on the plea that such damage to the blast furnace was caused due to interruption and retardation of operation i.e. regulated heat generation and temperature control in the melting furnace run by electricity. Similarly, if an active furnace or boiler is damaged due to power outage caused by any other insured peril like fire or flood, in such case also, the ambiguous and widely unbridled wordings of the General Exclusion No. 10 would ostensibly allow the insurer to deny liability by resorting to General Exclusion No. 10 on the same plea as resorted to by the insurer in the case which I have described above.
Explaining the ambiguities:
In this article, the ambiguities and arbitrary nature of the wordings of General Exclusion No. 10 shall be discussed and explained since, primarily, the same is made applicable to all insured perils and secondly, the specific exclusion (a) of RSMD cover is same as the General Exclusion No. 10 in sum and substance and in effect and as such, the ambiguities and over-reach of the said specific exclusion (a) to RSMD cover can be well explained by an explanation of the ambiguities of General Exclusion No. 10 and its and inconsistency with the fundamental purpose of the insurance contract. The General Exclusion No. 10 excludes “loss or damage resulting from the retardation or interruption or cessation of any process or operation caused by operation of any of the perils covered”. Such wording has the potential of creating an artificial causation in the form of “retardation or interruption or cessation of any process or operation” solely for the purpose of excluding the loss or damage which is the end result, though such retardation or interruption of an operation is caused solely through an unbroken chain of events in quick succession by operation of an insured peril, without intervention of any force originating and working from a source independent of the operating peril. To explain it by an practical illustration, reference can be drawn to the recent incident pointed out above, of the violent act of rioting mob with malicious intent disconnecting electricity supply to the furnace, which resulted in inevitable, quick and unstoppable damage to a blast furnace by thermal shock; but the said loss was excluded by the insurer under General Exclusion No. 10 by treating the stoppage of power supply to the furnace as the proximate cause of loss, though such power outage was solely caused by operation of an insured peril, and not from any other independent source or eventuality. The ambiguous and unbridled wording of the same exclusion can also be resorted to by an insurer when common insured perils like fire or flood causes power outage which inevitably and unstoppably causes damage to boilers and furnaces, even though such power outage is solely caused by fire or flood. To put it more simply, the General Exclusion No. 10 has the effect of artificially cutting off the insured peril from the starting point of the chain of causation and treating power outage as the proximate cause, which is in the middle of the unbroken chain of events triggered by an insured peril, for the sole purpose of excluding such loss. This amounts to the absurdity of putting the cart before the horse, since the concept causation in insurance, more popularly known as ‘proximate cause’ is not an artificial concept; rather the same has been developed as a complete and universal concept through hundreds of years’ of experience of the industry and shaped by judicial wisdom. The universally accepted and most comprehensive definition of proximate cause is “the active efficient cause that sets in motion a train of events which bring about a result without the intervention of any force started and working actively from a new independent source” (Pawsey & Co v Scottish Union & National Insurance Co). In the celebrated judgment in the Layland Shipping Co. Ltd. Case, the court observed that to treat proximate cause as the cause nearest in time is out of question. As such, when an insurer insures plant & machinery like boilers, melters and furnaces under a SFSP policy, they create a reasonable and legitimate expectation in the mind of an insured that such properties would be covered against losses proximately caused by perils insured under the policy. It should be remembered that in another famous case namely Gray vs Barr, Prudential Assurance Co. Ltd., Lord Denning had observed that proximate cause is to be determined by the common sense and intelligence of the ordinary man. So an exclusion clause like General Exclusion No. 10 of the SFSP Policy, if interpreted in its wide amplitude of literal sense, has the effect of frustrating the main purpose of insuring such plant and machinery and other items, by writing off the insured peril as the natural proximate cause and artificially treating a particular link in the unbroken chain of causation as the proximate cause. Such interpretation of General Exclusion No. 10 is not permissible, as it is universally well-established and judicially approved practice of reading down and narrowly construing an exclusion clause, which may be wide enough to wither away the main purpose of insurance, even if, the language of such exclusion clause is clear. This principle was developed in England in the case of Cornish vs The Accidental Insurance Co way back in 1880s and has been followed universally and consistently by the law courts of various nations including by the Supreme Court of India and other Indian Courts starting from the case of Skandia Insurance Co. Ltd vs Kokilaben Chandravadan. In such circumstances, the only way of sustaining General Exclusion No. 10 of SFSP (Material Damage) Policy is to read down the same to exclude only such losses, which are not results of an unbroken chain of events triggered predominantly by an insured peril, but are caused in a slower process over an interval due to omission or inability of the insured to recommence the operation or to safely upkeep the insured properties after the manufacturing process gets interrupted by an insured peril. In such a case, the retardation or interruption of the manufacturing operation becomes an independent cause of loss originating from the insured’s omission or neglect or inability to safeguard the insured properties. An illustration of such loss is leaving insured properties in a manufacturing unit unutilized and unattended in a vulnerable condition after retardation or interruption of operations caused by perils like and allowing such properties to be spoilt or decayed or deteriorated.
Ambiguity coupled with breach of utmost good faith:
Further, irrespective of the issue of the inconsistency of the wording of General Exclusion No. 10 with the fundamental purpose of the insurance contract, the application of the word ‘spoilage’ in the General Exclusion No. 10 to exclude plant and machinery goes beyond the boundary of ambiguity and amounts to deceptive practice in breach of utmost good faith on the part of the insurer. The expression ‘spoilage’ means the process of damage or decay of goods either in process of its storage or during the process of such goods being manufactured; and neither under common sense or under business sense, the expression ‘spoilage’ can be employed to exclude plant and machinery of a manufacturing unit. It is absolutely inconsequential that TAC decided to exclude plant & machinery by artificially extending the meaning of ‘spoilage’; since such artificially extended meaning of ‘spoilage’ has not been incorporated in the standard policy document. From the standard terms and conditions of SFSP Policy, there is no scope for the insured to understand that the damage to the insured plant and machinery would also be treated as excluded loss by applying such extended and totally uncommon meaning of the word ‘spoilage’. Insurability of loss from spoilage cannot also be accepted as a valid justification since the SFSP policy wordings also does not give any indication of insurability of losses by spoilage. In this respect, the principle of contra proferentem i.e. the principle that in case of any ambiguity in the policy or any word or phrase in the policy having more than one meaning should be interpreted rigorously and adversely against the insurer which has unilaterally chosen such policy wording to express the contract and the meanings favourable to the insured should be adopted. It is to be kept in mind that the logic of indemnity under an insurance contract is simple and straightforward and has to be applied as such. If premium has been collected by an insurer and a bona fide policy is issued in which an array of named perils and properties are duly covered, the policy has to honour losses arising from such named perils in respect of insured properties. If an insurer is not inclined to cover a particular class of property from loss proximately caused by a named peril, then the insurer should decline to insure such class of properties under the policy itself. But when a property is insured in a policy against named perils, the same has to be covered against losses caused proximately by named insured perils. The role of exclusions clauses are limited only to ensure that uninsurable perils and losses are not allowed to enter the indemnity area. Where an exclusion or condition is read to avoid liability to a covered peril, such an exclusion will not stand the test of insurance logic. Therefore, in the larger economic interest and also in the interest of credibility of the insurance sector, it is the need of the day that the stakeholders in the insurance sector review the SFSP Policy wordings and take corrective measures to ensure that the true picture of indemnity be projected from the standard policy wordings itself to the unsuspecting customers in a language of the common man.
(The contributor has worked as Deputy General Manager of National Insurance Co. Ltd. (Tech), General Manager of United India Insurance Co. Ltd (Fire & Engineering), Executive Director of IRDAI and Chair Professor of National Insurance Academy, Pune. He has authored the book: Understanding General Insurance)
Author : P.C. James