Engineering insurance and reinsuranceAn introduction

Engineering insurance and reinsuranceAn introduction

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Contents

1. Foreword 5

2. Engineering insurance – historical reflections 7

3. Engineering classes of business – a summary 9

4. When does engineering insurance begin? 11

5. Non-renewable (one-off) covers 135.1 Contractors’ All Risks insurance 145.2 Erection All Risks insurance 165.3 Contract Works All Risks insurance 185.4 Extensions of cover and special clauses 195.5 Advance Loss of Profits insurance 23

6. Renewable covers 266.1 Contractors’ Plant and Equipment insurance 276.2 Boiler and Pressure Vessel Explosion insurance 286.3 Machinery Breakdown insurance 296.4 Loss of Profits following Machinery Breakdown insurance 306.5 Deterioration of Stock insurance 326.6 Computer All Risks insurance 336.7 Low Voltage and Electronic Equipment All Risks insurance 34

7. Reinsurance 367.1 Forms and types of reinsurance 367.2 Engineering reinsurance 377.3 Engineering treaty wordings – terms and conditions 397.4 Recent developments in reinsurance 42

8. Engineering and Swiss Re 45

9. Visual perspectives 46

1. Foreword

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A well-known dictionary definesengineering as “the activities or functionof an engineer” and “the application ofscience and mathematics by which theproperties of matter and the sources ofenergy in nature are made useful topeople in structures, machines, products,systems, and processes”. Both of thesedefinitions have a strong relationship tothe words “engineering insurance”, whichthe insurance industry uses as a collectiveterm to describe various types of policiesfor the protection of construction works,as well as the erection and operation ofmachinery.

There are several specialised publicationswhich deal with the individual lines ofengineering insurance, but few whichgive an overview of this complex andextremely interesting branch. Thisbulletin attempts to provide a basicintroduction to engineering insuranceand reinsurance. It is intended forcompanies and underwriters who as yethave no profound experience in thisfascinating field.

2. Engineering insurance – historical reflections

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From 1920 to 1930, some German andBritish companies introduced a contrac-tors’ policy providing insurance cover forbuildings and civil works during thecourse of construction. Based on thispolicy, Contractors’ and Erection AllRisks policies were developed. However,neither of these types of policies reachedany great importance until after WorldWar II when postwar reconstruction anddevelopment brought these covers to theirpresent standing.

With the advance of technology, otherengineering policies such as ComputerAll Risks, Low Voltage and ElectronicEquipment All Risks, and Deteriorationof Stock following Machinery Breakdownwere developed, along with businessincome protection covers such as AdvanceLoss of Profits, written in conjunctionwith Contractors’ All Risks and ErectionAll Risks policies.

Today, new engineering insurance pro-ducts are being sought. New insuranceneeds are arising in respect of risks suchas prototype machinery, contractualliabilities and guarantees, and certain po-litical risks (expropriation, confiscation,change of law etc) which have so far beenconsidered uninsurable. These needs havebeen largely brought about by the after-math of new project finance methods, andthe transfer of these risk elements is oftenimposed by project financiers. In orderto meet this demand, new insurance solu-tions – for example in the fields of non-vitiation, liquidated damages, availabilityand performance guarantees – have beenand are being developed. At Swiss Re, webelieve that engineering insurance willcontinue to evolve. The engineering in-surance industry will undoubtedly have toremain flexible and adapt itself to newinsurance needs as a result of the hugetechnological advances which the worldis facing.

The origins of engineering insurance areto be found in the inspection of steamboilers. In the nineteenth century, inGreat Britain during the industrial revo-lution, the frequent occurrence of explo-sions involving serious property damageand loss of life made it necessary to takesteps to guard against such dangers. In1854, prominent gentlemen interested inthe use of steam decided to form the Man-chester Steam Users’Association. Memberswere entitled to use the services of boilerinspectors who were employed by theassociation. This organization not onlygave advice on how to prevent explosionsbut also undertook to guide its membersin the most advantageous and economi-cal method of using the plant. Thisprinciple is still maintained today. Plantowners can call upon the engineer-surveyor for advice and suggestions onplant operation and maintenance.

Though the Manchester Steam Users’Association rendered valuable services, itwas not an insurance company. In 1858,however, in response to an evident need,certain members founded the first engi-neering insurance company, the SteamBoiler Assurance Company. This com-pany started with the insurance of boi-lers, and its lead was soon followed bythe formation of similar companies. Atfirst only boilers were insured, but coverswere gradually extended to pressure ves-sels of various kinds. Engine Insurance(known today as Machinery Breakdowninsurance) began in 1872, and both boil-er explosion and engine covers rapidlyspread to other industrialised countries.

By the beginning of the twentieth century, the first insurance policies forloss of profits following machinerybreakdown were being issued. At thesame time, erection insurance (coveringthe on-site erection and assembly of machines) appeared. The policy was on a“named perils” basis and did not coverfire, but it offered reasonable protectionfor small and medium-sized erectionprojects.

3. Engineering classes of business – a summary

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The classes of business under the collec-tive heading “engineering insurance” canbe categorised as either property orbusiness income protection policies; andas either non-renewable or annuallyrenewable covers:

In principle, there are business incomeprotection covers which dovetail withpractically all engineering propertycovers. However, in this publication onlythe most common types are dealt with,bearing in mind that engineering insur-ance is essentially a material damagecover.

Some of the policies are of the broad, all risks type (property insurance againstphysical damage by all risks of lossexcept those specifically excluded), whichoffer protection against human andtechnical errors and the perils of nature.Certain combinations of cover are alsopossible: for example cover for contrac-tors’ plant and equipment may be endorsed to CAR, EAR and CWARpolicies, or boiler and pressure vesselexplosion to an MB policy.

Annually renewable engineering propertyand business income protection coversare also encountered under Industrial AllRisks (IAR) policies – a multiline packagepolicy which can include fire, marine,liability and engineering. It is usuallybought by large industrial or commercialenterprises to protect all of their installa-tions, whether at home or abroad. Policyforms are either standard or tailor-madealthough one form customarily domi-nates in each country. The main problemlies in interpreting the cover: all possiblerisks – even unknown ones – are insuredunless explicitly excluded. Loss adjust-ment can also cause headaches, especiallyin the field of business income protec-tion. Therefore, if written, it is impera-tive to ensure that the cover concept istransparent, that the IAR policy does notundermine the conditions usually appli-cable to the respective mono-line covers,that risk assessment is carried out sepa-rately for each type of mono-line, thatthe premium is commensurate with therisk, and that no technically unjustifieddiscount is given.

Property covers Abbreviation

Contractors’ All Risks CAR 1

(synonyms: Builders Risks, Course of Construction)Erection All Risks EAR 1

Contract Works All Risks CWAR 1

Contractors’ Plant & Equipment CPE 2

Machinery Breakdown (synonym: Boiler and Machinery) MB 2

Boiler & Pressure Vessel Explosion BPVE 2

Computer All Risks COMP 2

Low Voltage & Electronic Equipment All Risks LVEE 2

Business income protection covers

Advance Loss of Profits in conjunction with CAR, EAR, CWAR ALOP 1

Loss of Profits following MB MLOP 2

Deterioration of Stock following MB DOS 2

1 = Non-renewable (or one-off) covers 2 = Annually renewable covers

Po

ssib

le c

ov

ers

From feasibility study to operation

Off-site activities On-site activities

Feasibility study Transport Construction OperationDesign ErectionManufacturing Commissioning/testing

Fire & Extended Coverage Marine Contractors’ All Risks (CAR) Fire & Extended CoverageProfessional Indemnity Storage Erection All Risks (EAR) Fire Loss of Profits

Contract Works All Risks (CWAR) LiabilityAdvance Loss of Profits (ALOP) Contractors’ Plant Contractors’ Plant and Equipment (CPE)and Equipment (CPE) Boiler and Pressure

Vessel Explosion (BPVE)Machinery Breakdown (MB)Loss of Profits following MB (MLOP)Deterioration of Stockfollowing MB (DOS)Computer All Risks (COMP)Low Voltage and ElectronicEquipment All Risks (LVEE)

Engineering insurance involvement Engineering covers

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4. When does engineering insurance begin?

Most projects usually start with afeasibility study. The CAR, EAR orCWAR policy (sometimes inconjunction with an ALOP cover)incepts at the beginning of theconstruction or erection phase and endsupon completion of the project. Then,depending on the type of risk, one or

Ph

ase

more of the annually renewable types ofengineering policies provide cover duringthe operational phase. The exception to this flow is the annually renewable CPE policy which, depending on what isactually insured, may be in force duringeither the construction/erection phase orthe operational phase, or both.

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5. Non-renewable (one-off) covers

Non-renewable policies are concludedfor projects under construction and/orerection. The sums insured for such pro-jects can easily reach millions of dollars,resulting in a real need for insurancecover for principals and contractorsalike. In some markets, it is compulsoryto insure construction and erectionprojects. Most financial institutions willnot provide financing unless the projectis protected by a suitable policy.

The period of insurance for all non-re-newable covers – that is, the construction/erection phase of a project – commencesimmediately after the unloading of pro-perty to be insured on the site, or withthe onset of the insured contract work. Itends for any part of the contract workswhen handed over to the principal, orwhen taken into use, or on the datespecified in the policy wording, which-ever occurs first. Therefore, the actualperiod of insurance is determined by theconstruction/erection time schedule.

All non-renewable policies have certaingeneral conditions and general exclu-sions. Some of the main points are asfollows:

General conditions

• The insured shall take all reasonableprecautions to prevent loss, damage orliability and to comply with soundengineering practise, statutory require-ments and manufacturers’ recommen-dations designed to ensure the safeworking of plant and equipment.Furthermore, the insured must alsomaintain in efficient condition allcontract works, plant, machinery andequipment insured by the policy.

• The insured is obliged to immediatelyinform the insurers of any materialchange of risk (changes in the sums in-sured, construction/erection time sche-dule, design criteria etc). This isextremely important because such ma-terial changes in the risk itself can af-fect the insurer’s exposure, and thus itmay have an effect on the terms andconditions previously agreed for therisk.

• In the event of any occurrence whichmight give rise to a claim under thepolicy, the insured must immediatelyadvise the insurers and supply allparticulars and proofs of claim as maybe required.

General exclusions

• Liquidated damages or penalties fordelay or detention, or in connectionwith guarantees of performance andefficiency; loss of market.

• Wilful act or omission or grossnegligence of any director, manager orresponsible site official.

• Nuclear risks: losses arising fromionising radiation or contamination byradioactivity from any nuclear fuel orfrom any nuclear waste from thecombustion of nuclear fuel, as well aslosses caused by or contributed to orarising from nuclear weapons material.

• Political risks such as war, civil war,civil commotion, etc.

The common features of projects insuredunder non-renewable policies arenormally limited to similarities inconstruction/erection and/or the type ofrisk. However, this is not sufficient toestablish premium rates. The topog-raphy, geology, hydrology and naturalperils exposure of each particular risk,fire protection measures, and severalother technical factors, all have a con-siderable influence on hazards duringconstruction/erection, and thus on thepremium rate. Therefore, except forsimple, homogeneous risks such as one-storey or two-storey residential houses, itis not possible to establish ratingmanuals with fixed tariffs. More com-plicated risks must be assessed indivi-dually. Rating guides based on expe-rience and statistical analysis help theunderwriter to assess risks, but the finalpremium rate must be determinedindividually using information providedby the insured. To ensure that infor-mation is supplied in complete anduseful form, the insurer provides detailedquestionnaires to be filled out, and mayrequest plans and drawings.

5.1 Contractors’ All Risks insurance (CAR)

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Contractors’ All Risks (CAR) insurancepolicies cover all types of building andcivil engineering construction and offerprotection against the hazards whichmay threaten works under construction.Most construction projects includecertain elements of machinery erection(eg installation of air conditioning andlifts in buildings). If such erection worksare of an ancillary nature (not overroughly 10 – 20% of the total projectvalue) they can be insured under theCAR policy, thereby making it un-necessary to issue an additional EAR, or a CWAR (Contract Works All Risks)policy.

Cover

The policy provides cover on an all risksbasis for physical loss or damage to theinsured property, providing such loss ordamage is of an unforeseen andaccidental nature, and is not otherwiseexcluded from the scope of the policy.

Insured parties

In most cases, the project as a whole isinsured. Therefore, the insured parties(principal or employer, contractors andsub-contractors) are considered as oneentity (the “joint insured”).

Main hazards

The main hazards covered are: fire andexplosion, theft, burglary, collapse, earth-quake, seaquake, landslides, storm andflood. Certain perils (especially forces ofnature) obviously vary from location tolocation, and the likelihood of loss ordamage is also influenced by the actualtype and method of construction.

Particular exclusions

In addition to the general exclusions,CAR policies also exclude normalmaking good, normal upkeep, conse-quential loss of any kind or loss of use,damage to plans, losses only discoveredduring the course of an inventory, wearand tear, corrosion, erosion, deteriora-tion due to lack of use, and normalatmospheric conditions. The basic policywording also excludes damage caused by defects in design, plans or specifi-cations, as well as direct damage causedby defective material or badworkmanship.

Sum insured

The sum insured is the anticipated value(usually referred to as the “total contractvalue”) of the completed works includingmaterials, salaries, transport, customduties and taxes, plus the value of anymaterial or labour supplied by the prin-cipal. During the course of construction,the insured is obliged to advise theinsurers immediately of any change inthe sums insured. Upon completion ofthe project, the final total investment isdeclared, making it possible to adjust theprovisional premium that was initiallycharged on the basis of the anticipatedtotal contract value.

Loss settlement

Loss settlement is made on the basis ofvalid bills, documentary evidence andjustification, as the case may require.The cost of any provisional repairs willonly be borne by the insurer if suchrepairs constitute part of the final repairsand do not increase the total repair costs.The cost of any alterations, additionsand/or improvements which may beundertaken as a result of any loss or dam-age are not indemnifiable.

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In repairable damage cases, the basis forloss settlement is the cost of the repairsnecessary to restore the property to itscondition immediately before thecovered occurrence, less salvage. Totallosses are settled at the actual value ofthe property immediately before the loss occurred, less salvage – but neverexceeding the sum insured stipulated inthe policy, of course.

Claims are subject to a monetary excess,or deductible, borne by the insured.Most policies stipulate different excessesaccording to defined groups of perils, egmajor perils (loss due to forces of natureor collapse); consequences of defectivematerial/workmanship; and all othertypes of claims. The reasons for excessesare twofold: firstly to eliminate smallclaims, where administration costs oftencan exceed the claimed amount itself;and secondly, to ensure that the insuredwill comply with his obligation to avoidclaims by taking all reasonable precau-tions to prevent loss or damage.

Third party liability

Contractors and subcontractors shouldhave annually renewable general liabilitypolicies to protect their constructionactivities against claims made by thirdparties. However, in some countries it iscommon for CAR policies to include arestrictive third party liability section.This section protects the insured againstthird party claims for any bodily injuryor property damage caused by construc-tion activities. The intention behind aCAR policy’s third party liability sectionis not to replace Contractors’ GeneralLiability policies. The section shouldoperate as a subsidiary cover only, andthere are a number of importantexclusions:

• Expenditure incurred in repairing orreplacing any work or propertycovered or coverable under thematerial damage section of the policy.

• Liability arising out of loss or damageto any property or land or buildingcaused by vibration, or by the removalor weakening of support, or injury toany person or property occasioned byor resulting from any such damage.(Under certain circumstances andagainst payment of additional pre-mium, this exclusion may be waived –and limited cover offered – by way ofan endorsement to the policy.)

• Also excluded is liability arising out of:a) bodily injury to, or illness of, the

employees or workmen of thecontractor(s), or the principal, orany other firm connected with thecontract work;

b) loss or damage to propertybelonging to, or held in the care,custody or control of, the con-tractor(s), or the principal, or anyother firm connected with thecontract works, or of any employeeor workman of one of the aforesaid;

c) any accident caused by vehicleslicensed for general road use, or bywaterborne vessels or aircraft;

d) any contract or agreement, unlesssuch liability would have attachedin the absence of such contract oragreement;

e) technical or professional advicegiven by the insured or by anyperson acting on behalf of theinsured.

5.2 Erection All Risks insurance (EAR)

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Erection All Risks (EAR) policies coverthe erection of individual machines orcomplete plants – ranging from completepower stations to lifts and air condition-ing equipment. The policy wording issimilar to CAR. Many erection projectscall for a certain amount of ancillaryconstruction work (eg foundations forthe machines to be erected, or a buildingto house them). If the value of suchconstruction work does not exceedapproximately 10–20% of the totalproject value, it can be covered underthe EAR policy together with themachinery.

Cover

EAR policies provide protection on anall risks basis, including cover for thetesting and commissioning of the erectedmachines – providing that they are notconsidered prototypes. Similar to CAR,EAR covers physical loss or damage of anunforeseen and accidental nature, whichis not otherwise excluded from the policy. In contrast to CAR, however,EAR policies also cover faults in erection(ie bad workmanship occurring at theerection site itself ).

Insured parties

The insured parties are as in CAR, withthe addition that the machinery manu-facturer may be included as an insuredparty if he performs a function on theerection site. However, cover is limitedto accidents originating from on-siteactivities. The off-site design work andactual manufacturing of the machines atthe manufacturer’s premises are notcovered.

Main hazards

The variety of hazards threatening erec-tion works vary according to the type ofworks and location. If machinery erec-tion takes place in buildings – and manyprojects do – the exposure to forces ofnature (except flood and earthquake) isusually less pronounced than in CAR.One main hazard is fire or explosion,especially during the final erection phasewhen values at risk accumulate, orduring testing when raw materials and/orfeedstock are introduced. Equally seriousis machinery breakdown during the test-ing and commissioning period. Thepossibility of substantial mechanicaldamage occurring during this phaseshould not be underestimated.

Exclusions

The exclusions are basically the same asunder CAR policies.

Sum insured

As in CAR, the initial sum insured is theanticipated value of the completedworks. If necessary, it must be adjustedduring the course of erection. The finaltotal investment is declared upon com-pletion of the project. This permits finaladjustment of the provisional premium,which is charged initially on the basis ofthe anticipated total contract value.

Loss settlement and third party

liability

The comments made for CAR are alsovalid for EAR.

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Definitions

Cold-testing (functional testing)The checking of parts and elements ofinsured property by mechanical, electri-cal, hydrostatic, or other forms of testingunder “no load” conditions. Correctrotation of electrical motors is to bechecked before coupling them tomachines. Cold testing excludes theoperation of furnaces or the applicationof any direct or indirect heat, the use offeedstock or other material for process-ing. In electrical power stations, coldtesting excludes connection to a grid orother load circuit of electrical generating,transforming, converting or rectifyingequipment.

Hot-testing (operational andcommissioning tests)*The checking of parts, elements and/orproduction lines of insured propertyunder full or partial load and normal orsimulated operational conditions includ-ing the use of feedstock or other materialfor normal processing or other media forload simulation. In electrical powerstations, hot-testing means checkingafter connection to a grid or anotherload circuit of electrical generating,transforming, converting or rectifyingequipment.

Commissioning*The taking into operation or the puttingunder load of insured property or anypart thereof with feedstock or othermaterials for processing; or in electricalpower stations, the connection to a gridor other load circuit of electricalgenerating, transforming, converting orrectifying equipment.

Commissioning test, acceptance test*Operation of insured property underproduction conditions for the purpose ofattaining performance (quantity, quality)specification requirements.

* For insurance purposes, these threedefinitions are collectively known asthe “Testing Period”.

5.3 Contract Works All Risks insurance (CWAR)

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In some projects the sums insured forthe construction part of a project andthe erection part can be roughly equal:an example would be a hydroelectricpower plant including the constructionof a dam, river diversion and power-house buildings, and the erection ofturbine generators with coolers, excitersand all auxiliary equipment. Thisnormally entails issuing two separatepolicies – one for the construction worksand one for the erection of the machin-ery. However, there is another possibility:In order to close any possible gaps incover and to reduce administration,Swiss Re have developed a ContractWorks All Risks policy which is a combi-nation of the Contractors’ All Risks andErection All Risks policies. The insur-ance protection offered is as describedunder Contractors’ All Risks and Erec-tion All Risks policies (Chapters 5.1 and5.2).

5.4 Extensions of cover and special clauses

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There are numerous extensions of coverand special clauses which can be appliedto CAR, EAR and CWAR policies.Application mainly depends upon thetype of work to be done and the projectlocation. The extensions of cover andspecial clauses are endorsed to the basicpolicy wording by way of speciallyworded endorsements. Only the mostimportant and frequently used of theseare described here.

Extensions of cover

MaintenanceThe works contract (that is, the contractbetween the principal and the contractorwhich details the work to be carried out)often specifies a maintenance period(also referred to as the defects liabilityperiod) which begins at the time theworks are provisionally handed over tothe principal (ie when construction/erection work is completed), and endswhen the works are finally handed over.Contractors often require insurancecover for these maintenance obligations,which usually last from 6 to 24 months.It is possible to give such cover byadding an endorsement to the construc-tion or erection policy. There are twomain types of maintenance cover: (a)“visits maintenance”, which coversdamage which the contractor causesdirectly, when he is on-site with thepurpose of complying with his mainte-nance obligations; and (b) “extendedmaintenance”, which provides the samecover as visits maintenance, plus coverfor damage caused by the contractorduring the construction/erection periodbut first discovered during the mainte-nance period. Both of these endorse-ments exclude loss or damage resultingfrom normal, regular duties associatedwith the proper upkeep and operation ofthe insured property (including normalplant management duties and instructionor training of the operating staff ), nomatter what the contractor’s contractualobligations may be in this regard.

Furthermore, as it is usual for the prin-cipal or owner to conclude a cover forfire and extended perils upon completionof the project, maintenance endorse-ments will normally not be called uponto pay for fire and natural perils lossesduring the maintenance period.

Debris removalAlthough debris removal may be foundas an extension of cover, it is usuallyincluded in the basic policy wording.This cover is for the costs incurred bythe insured for the clearing, removaland/or disposal of debris (eg bricks andrubble after the collapse of a building)following an event which is insuredunder the policy. The removal of other(extraneous) debris is also covered,providing such removal is madenecessary by an indemnifiable loss (forexample, the removal of silt followingflooding). The limit of indemnity isexpressed as a monetary limit per event;depending on the type of risk andlocation, it usually ranges between 1%and 10% of the total contract value.

50/50 clauseGoods in transit to the construction/erection site – especially if they areimported – are usually covered under amarine policy. Upon arrival at the site,such goods must be inspected forpossible damage during transit. However,if the goods are to be left in theirpacking until later, the packing isinspected visually, and if any externalsign of damage is found, the goods mustbe unpacked and inspected immediately.Claims for any damage revealed by suchan incoming inspection can be lodgedunder the marine policy. However, ifdamage is discovered when the goods areunpacked at a later date, and it is notpossible to establish whether the damagewas caused before or after their arrival,settlement is made 50/50 under marineand construction or erection policies.

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Existing propertyQuite often, existing property is alreadylocated on the construction or erectionsites, or in the immediate vicinity. Ifsuch property belongs to the insured –the principal and/or the contractor(s) –or is in their care, custody or control, itobviously cannot be considered thirdparty property. However, it is possible toinsure such property against loss ordamage directly due to the construction,erection or testing of works coveredunder the material damage section of theconstruction or erection policy. Loss ordamage is not covered if it is caused byforces of nature, or is due to any causenot related to the contract works. Allconsequential losses are also excludedfrom cover. The limit of liability isusually expressed as an aggregate limitfor the period of insurance.

Contractors’ Plant and EquipmentMost contractors conclude a separatepolicy for the plant and equipment theyuse in the construction or erection of aproject. A separate policy is preferablebecause the cover is not limited to oneparticular site, as is the case with aconstruction or erection policy. However,sometimes the principal or contractorwill prefer to include their plant andequipment under the construction orerection policy – especially if specialplant is needed to do the job. Suchinclusion is possible by way of a policyendorsement which must include a list –periodically updated – of the itemscovered. The period of insurance com-mences with the arrival of the plant on site and ends after notification to theinsurer upon its withdrawal.

Expediting costsFollowing an indemnifiable claim underthe construction or erection policy, thecontractor may have to order overtime,night shifts or work on public holidays;or it might be necessary to have goodsdelivered by express freight to keep thework on schedule and avoid payment of

late completion penalties. These costscan be covered by way of a policyendorsement. The sum insured is eitherexpressed as a limit of indemnity perevent or a percentage of the repair costof any damage. The cover may beextended to include the cost of deliv-ering goods by air freight.

Manufacturer’s Risk (defects in design,material and workmanship)There are a number of clauses whichprovide various degrees of cover fordefects in the design, material andworkmanship of a project. In most casesonly the consequences of such defects arecovered which means that the faulty partitself is excluded. For example, if duringtesting one of the blades attached to therotor of a turbine generator set flies off,only damage to the rotor and/or theturbine casing is covered. The clausesreplace the corresponding exclusions inthe basic policy wording. An example ofa clause providing cover for consequen-ces of defective design material andworkmanship is as follows:

“This policy excludes loss of or damageto and the costs necessary to replacerepair or rectify:a) Insured property which are in a

defective condition due to a defect indesign plan specification materials orworkmanship of such insured propertyor any part thereof.

b) Insured property lost or damaged toenable the replacement repair orrectification of insured propertyexcluded by a) above.

However paragraph a) above shall notapply to other insured property whichare free of the defective condition but aredamaged as a consequence thereof ”.

Cross liabilityThis extension of cover attaches to thethird party liability section of a CWAR,CAR or EAR policy. The widely usedterm “cross liability” often leads toconfusion about what is actually covered:

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“separate insured liability” would probab-ly be a more accurate expression. Thepurpose of the endorsement is to specifythat any person or body who is named asthe insured in the policy schedule shallbe considered as a separate and distinctentity. This means that the words “theinsured” shall be considered as applyingto each such person or body, just as if aseparate third party liability policy hadbeen issued to each of them in his namealone. However, in no event shall anyinsured be considered as a third party.Thus, if one named insured breaches thepolicy conditions, this will result in voi-dance of the policy for him; however,third party liability cover will still remainin force for the other named insuredswho have not breached the conditions ofthe policy.

Vibration, Removal or Weakening ofSupportThis is also an extension of coverattaching to the Third Party Liabilitysection of CWAR, CAR or EAR policies.It extends liability to include the total orpartial collapse or imminent danger ofcollapse to third party buildings andstructures caused by vibration or by theremoval or weakening of support, subjectto certain conditions which include:• The preparation of a report at the

expense of the insured on thecondition of any endangered buildingor structure in the vicinity of theworks under construction or erection.The report must indicate any existingdefects and be submitted to theinsurers.

• The condition of any endangeredbuilding or structure must be sound orthe necessary loss prevention measuresmust have been taken at the insured’sexpense prior to the commencement ofthe works which could endanger thethird party property.

The endorsement does not cover damageto buildings or structures under demoli-tion or declared by the relevant publicauthority to be dangerous; superficial

damage (eg cracks not impairing stabili-ty); damage which occurred prior to thecommencement of the insured’s opera-tions or caused by an event not relatedto the insured works; claims directly orindirectly caused by loss or damage tounderground services (pipes, cables etc.),roads, pavements and other slab-on-ground structures; or swimming pools.

Special clauses

Existing underground cablesExisting underground facilities (electriccables, telephone cables, water and gaspipes, sewers etc) are often present atconstruction/erection sites, and some-times they have to be relocated beforeconstruction/erection commences.However, no matter whether they haveto be relocated or not, it is obviously theinsured’s duty to find out whether suchunderground facilities run through thesite or in its vicinity, in order to avoiddamage. The purpose of this specialclause is to ensure that the insured takesall possible steps to locate suchunderground facilities. Therefore, repaircosts following accidental damage tounderground facilities are only indem-nifiable if the insured has: (a) requestedand obtained the exact position of allcables/pipes from the public authoritiesor owners of such underground facilities;and (b) traced their existence and indi-cated their location on the site. Conse-quential loss is not covered.

Used machineryThe erection of used (second-hand)machinery presents a special risk becauseit is no longer under the manufacturer’sguarantee in most cases. Quite often it isnot possible to determine whether themachinery is in first-class condition.Therefore, losses due to previousoperation and testing/commissioningshould be excluded from policy coverage.In addition to these points, the UsedMachinery policy endorsement alsoexcludes damage caused by dismantling,except in cases where dismantling hasbeen insured under the same policy as

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the re-erection. However, even then, itshould be noted that there is no coverwhilst the dismantled machinery is beingrefurbished or whilst it is in transit fromone site to another. Marine insuranceshould be arranged to cover the latterperil.

Fire prevention measuresDuring construction and erection, theinsured property is usually not so wellprotected against fire losses as comparedwith a completed and operational risk.The purpose of the Fire PreventionMeasures endorsement is to ensure thatcertain basic measures are indeed takenin order to prevent fires. Such basicmeasures include the immediate removalof waste material, empty boxes, wastewood, paper etc from buildings andconstruction/erection works; or therelocation of any such material, untilpermanent removal, to the site’s “safe”side (with respect to the direction ofprevailing winds); the readiness of afirefighting crew and firefightingequipment before any machinery,equipment or interior furnishing isstored or installed in the bare structureof buildings or machine rooms; thepresence of a watchman equipped withfire extinguishing equipment; and adirect communication line to the firealarm centre whenever hot work is done(such as welding, flame cutting, the useof open fire for the application of hotcoatings etc).

Construction of pipelines, conduits andmainsTrenches are excavated prior to theinstallation of pipelines, cables etc; andin order to avoid excessive damage dueto the forces of nature (especially water),it is common practise to restrict thelength of trench which may be open atany one time. The corresponding policyendorsement stipulates the lengths ofindividual trenches, as well as the totallength of all trenches combined, whichmay be totally or partially open at anyone time. In the event of a claim, onlydamage which occurs to the agreedlength of totally or partially opentrenches is indemnifiable. In the case ofpipelines which have been partially laidbut not properly connected, the endorse-ment also states that the open ends ofthe pipes shall be provisionally sealed atthe end of each working day or whenthere is any immediate danger offlooding. Otherwise, the expenses forclearing and cleaning pipe sections ofmud or silt are not covered.

Road constructionSimilar to the construction of pipelines,conduits and mains, roads without finalsurfacing are susceptible to water damage(the base materials washing away). There-fore, the road construction endorsementrestricts policy liability to certain agreedlengths of work faces which are uncom-pleted at any one time.

5.5 Advance Loss of Profits insurance (ALOP)

23

This type of insurance may also beencountered under the name CAR/EARLoss of Profits, Delayed EarningsInsurance, Delayed Opening of Business,Delay in Start-up, Loss of Rent, andLoss of Interest. It is a business incomeprotection cover with the aim of cover-ing the principal’s loss of gross profitresulting from a delay in completion ofthe construction and/or erection works.A prerequisite for granting ALOP is foran underlying CAR, EAR or CWARpolicy to be in force. Normal workingdelays are not covered under ALOP.

Cover

Cover is limited to the actual loss ofgross profit sustained resulting from adelay in the completion of the project;the delay itself must be caused by a losscovered under a CAR, EAR or CWARpolicy. However, the ALOP cover doesnot embrace the full extent of perilscovered under CAR, EAR and CWARpolicies (see the exclusions).

Insured party

The insured party is only the principalor owner of the project to be constructedor erected as defined in the underlyingCAR, EAR or CWAR policy.

Exclusions

The special exclusions for ALOP are thatinsurers shall not be liable for lossesresulting from delay due to:

• extensions and alterations of coverageas granted to the material damagesections of CAR, EAR and CWARpolicies, unless otherwise specificallyagreed in writing;

• restrictions imposed by publicauthorities;

• alterations, modifications andimprovements to the insured worksthat were effected after the occurrenceof the material damage accident;

• shortage of funds, penalties, delays ofsupplies, late completion, non-completion, loss of contract;

• loss or damage to existing property orobjects in the care, custody or controlof the insured; loss or damage to thecontractors’ plant and equipment; lossor damage to operating media andfeedstock;

• earthquake, volcanic eruption,tsunami, hurricane – unless otherwiseagreed in writing.

Sum insured

The sum insured is usually either theexpected annual gross profit, revenuerent or fixed costs which obviously haveto be defined case by case.

Period of insurance

The period of insurance is identical tothat of the underlying CAR, EAR orCWAR policy, excluding themaintenance period.

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Loss settlement

The period of delay – which serves as thebasis of indemnity – starts at the date onwhich the project would have beencompleted had no accident occurred, butnot earlier than the originally plannedcompletion date of the constructionand/or erection works as defined in theCAR, EAR or CWAR policy schedule. Itends with the actual date on which theproject is completed, but not exceedingthe length of time it takes with theexercise of due diligence and dispatch torebuild, repair or replace such part of theproperty which has been lost or damagedto its condition immediately prior to the

occurrence of the accident. After receiptof sufficient evidence that a delay hasbeen caused by an accident insuredunder the CAR, EAR or CWAR policy,indemnification is made on the basis ofthe actual incurred loss of gross profit orrental income for the actual period ofdelay. However, this period must notexceed a certain period of indemnity(usually 12 months) which is agreedupon inception of the policy. As theALOP policy is subject to a time excess,the indemnifiable amount has to bereduced in the same proportion as theperiod of delay less the time excess bearsto the period of delay.

Initial estimated construction period

Only one claim per policy

Acc

iden

t

An

tici

pat

ed c

om

ple

tio

n d

ate

Delay

Act

ual

pro

ject

co

mp

leti

on

dat

e

Acc

iden

t

Acc

iden

t

Acc

iden

t

There can be no more than one claim under ALOP cover. This is because there is onlyone project completion date, regardless of the number of material damage losses. It isthis single delay that triggers the insured’s single ALOP claim.

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6. Renewable covers

Renewable covers are concluded forinstallations, equipment and machineryonce they are ready for commercialoperation, ie after completion of con-struction/erection and upon successfultesting and commissioning. Policies areusually renewable annually. Hence,contrary to non-renewable covers, it ispossible to review the terms and condi-tions every 12 months.

Such policies have their own peculiaritiesin respect of the actual scope of covergranted. These are more fully describedin the following chapters on the indivi-dual types of cover generally available.However, similar to non-renewablecovers, all renewable policies are subjectto certain general conditions and generalexclusions. Some examples are as follows:

General conditions

• The insured shall take all reasonablesteps to maintain the insured propertyin efficient working order and toensure that no item is habitually orintentionally overloaded. The insuredshall fully observe the manufacturers’instructions for operation, inspectionand overhaul, as well as governmental,statutory, municipal and all otherbinding regulations in force concern-ing the operation and maintenance ofthe insured plant and machinery.

• In the event of any material change inthe original risk; alteration, modifica-tion or addition to an insured item;departure from prescribed operatingconditions, whereby the risk of loss ordamage increases; or changes in theinsured’s interest (such as discontinua-tion or liquidation of the business, orbeing placed in receivership), thepolicy shall be voided unless itscontinuance is agreed in the form ofan endorsement signed by theinsurance company.

• In the event of any occurrence whichmight give rise to a claim under thepolicy, the insured must immediatelyadvise the insurers and supply allparticulars and proofs of claim as maybe required.

General exclusions

• Damage arising out of wilful act,wilful negligence by the insured or itsmanagement.

• Faults or defects existing at the time ofcommencement of the insurancepolicy which are within the knowledgeof the insured or its management.

• Loss or damage for which the manu-facturer or supplier of the property isresponsible either by law or undercontractual obligations.

• Nuclear risks: losses arising fromionising radiation or contamination byradioactivity from any nuclear fuel, orfrom any nuclear waste from the com-bustion of nuclear fuel, as well aslosses caused by, or contributed to, orarising from nuclear weapons material.

• Political risks such as war, civil war,civil commotion etc.

In many cases it is easier to establishcorrect premium rates for renewablecovers than for non-renewable risksbecause proven machinery have manycommon features and are often subjectto similar claims. Therefore, statisticalanalysis has enabled premium ratingmanuals to be established for varioustypes of machine or branches ofindustry. However, due to fast technicaldevelopments, underwriters today facelarge problems in rating new or proto-type machinery, for here little or nostatistical analysis is available. Thus insuch cases, the involvement of anengineer with in-depth knowledge of thenew technology is indispensable.

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6.1 Contractors’ Plant and Equipment insurance (CPE)

Particular exclusions

In addition to the general exclusions,CPE policies exclude mechanical andelectrical breakdown. However, if anaccident occurs as a result of such abreakdown, these consequences areindemnifiable. Further exclusions are:normal wear and tear; lack of oil orcoolant; deposits of rust; exchangeabletools and parts; fuel etc; vehicles licensedfor general road use; waterborne vessels;total or partial emersion in tidal waters.

Sum insured

The sum insured is the new replacementvalue of all plant and equipment insuredunder the policy, including all freightcosts, custom duties and erection costs.

Loss settlement

In case of a partial loss (ie a claim whichdoes not exceed the actual value of themachine at the time of the accident), allrepair costs are indemnified which arenecessary to restore the machine to itsoperating condition immediately beforethe accident (less the agreed excesscarried by the insured). Should theactual value of the machine or partthereof be increased due to the repairs,the indemnifiable amount is reduced bytaking depreciation into account.

In case of a total loss (ie when thedamage exceeds the actual value), theindemnity is the actual value at the timeof the loss (less the excess and anysalvage).

Depreciation is a very important factorin the settlement of plant and equipmentclaims. Especially in the case of mobileplant, working enviroments are oftenextremely hard. Consequently, manytypes of plant have a limited life spanand depreciation is much more rapidthan for stationary machines.

Construction and erection works oftencall for the use of heavy, specialisedmachinery such as tunnel boringmachines, earthmoving equipment,cranes, pumps, air compressors etc. It is possible to cover such plant andequipment by way of an appropriateendorsement under CAR, EAR orCWAR policies. However, specific itemsof plant are usually only on oneconstruction/erection site until theparticular job for which they aredesigned for is completed. Obviously,such jobs do not last for the wholeconstruction/erection period and theplant is moved on to the next site assoon as its job is finished. Therefore, inmost cases, cover granted by means of anendorsement to the CAR, EAR orCWAR policy would not be suitable,because such policies are limited to lossor damage caused at one particularconstruction/erection site only. It ispreferable to issue an annually renewableContractors’ Plant and Equipmentpolicy, because it caters for plant andequipment used at different locations.

Cover

Cover is on an “all risks” basis, and isbasically for unforeseen and accidentalphysical loss or damage due to externalcauses (see the particular exclusions).

Insured party

The owner of the insured plant andequipment.

Main hazards

The main hazards are: fortuitousworking accidents, fire, burglary, theft,faulty operation, natural perils such asearthquake, storm and flood, collisionand overturning.

6.2 Boiler and Pressure Vessel Explosion insurance (BPVE)

28

This type of insurance provides protec-tion against the dangers of explosion andcollapse of boilers and pressure vessels.The policy is widespread in marketsinfluenced by the United Kingdom. It isnot so well known in other marketswhere cover is more often provided byway of a Machinery Breakdown and Firepolicy.

Cover

The cover embraces material damage toboilers and pressure vessels. In addition,it includes cover for material damage toother property belonging to the insured,third party property damage, and fatal ornon-fatal injuries to third parties notemployed by the insured, always pro-viding that such loss is a consequence ofa boiler or pressure vessel explosion orcollapse. However, the classical policyexcludes damage or liability caused byfire preceding or following explosion, as well as natural hazards such as wind-storm, typhoon and hurricane, orvolcanic and seismic events.

By way of policy endorsement, flue gasexplosion (explosion of ignited flue gasesin boiler furnaces, flues or stacks) maybe covered.

Insured party

The insured party is the owner of theplant.

Main hazards

As the name says, the main hazards areexplosion and collapse, which are oftencaused by excessive internal pressure orlack of water. The definitions of theseterms are as follows:• Explosion: the sudden and violent

rending of the plant by force ofinternal steam or other fluid pressure(other than pressure of ignited fluegases unless otherwise agreed inwriting) causing bodily displacementof any part of the plant together withforcible ejectment of contents.

• Collapse: the sudden and dangerousdistortion (whether or not attended byrupture) of any part of the plantcaused by a crushing stress by force ofsteam or other fluid pressure (otherthan the pressure of ignited flue gasesunless otherwise agreed in writing).

Particular exclusions

The most important particular exclu-sions are damage or liability caused by:explosion of flue gas (unless otherwiseagreed: see “Cover”), hydraulic tests;other tests exceeding the maximumpressure permitted by the inspectingauthority; wilful setting of safety valvesabove that specified by the authorities;failure of individual tubes; and wear andtear.

Sum insured

The classical BPVE policy usuallyembraces three different sums insured:• material damage (value of the boilers

and/or pressure vessels);• surrounding property

(limit of indemnity);• third party liability

(limit of indemnity).Some BPVE policies show only oneoverall sum insured for the three covers.In such cases, indemnification followsthe same sequence until the overall suminsured is exhausted: for example, if theoverall sum insured is fully used for thematerial damage loss, there is no coverfor surrounding property or third partyliability.

Loss settlement

The basis of loss settlement for materialdamage claims is the cost of repairsnecessary to restore the property to itscondition immediately before theaccident occurred, less salvage or – incase of total loss – the actual value of theproperty, also immediately before theaccident occurred. Surrounding propertyand third party liability claims are settledin accordance with the actual loss,subject to the limits of indemnity. Anagreed monetary excess is deducted fromthe indemnifiable amounts.

6.3 Machinery Breakdown insurance (MB)

29

Machinery Breakdown (MB) insuranceoffers protection against sudden andunforeseen physical loss or damage tomachinery which has been erected and isoperational or at rest. It is basically anaccident insurance and cannot beconstrued as a “life insurance” formachines. This is because machines haveonly a limited life span due to wear andtear: therefore, machinery owners mustdepreciate their machines annually andestablish reserves for replacement.

Cover

Following an insured event, the policypays for all repair costs, provided thecost of repair does not exceed the actualvalue of the machinery at the time of theloss. In the case of a total loss (ie when-ever the repair costs exceed the actualvalue of the machinery), the actual valueis indemnified.

Insured party

The owner of the machinery.

Main hazards

The main causes of damage coveredunder MB policies include: fortuitousworking accidents; a machine’s tearingapart due to centrifugal force; shortcircuits; defects or faults in design, mate-rial or manufacturing; and incorrectoperation.

Particular exclusions

In addition to the general exclusions,MB policies also exclude corrosion,erosion, wear and tear; breakdown dueto testing or intentional overloading;damage for which the manufacturer orsupplier is responsible either by contrac-tual obligations or law; exchangeable andconsumable items such as fuel, tools,belts, cutting edges etc; hazards coveredunder other types of insurance such asfire, explosion, earthquake, theft, burgla-ry etc.

Sum insured

The sum insured is the new replacementvalue of the insured machinery whichcan be defined as the cost of replacing amachine by a new one of the samecapacity, including transport and erec-tion costs as well as taxes and customsduties.

Loss settlement

More than 90% of MB claims are partiallosses. In case of a partial loss (ie a claimwhich does not exceed the actual valueof the machine), all repair costs areindemnified which are necessary to re-store the machine to the operating con-dition immediately before the accidentoccurred, less the agreed excess, which isborne by the insured, and any salvage.The indemnity includes the costs of newparts where necessary, dismantling andre-erection costs, ordinary freightcharges, and custom dues and taxes.However, whenever the actual value of amachine or part thereof at the time ofthe loss is increased by the repair, theindemnifiable amount is decreased bytaking depreciation into account. Thisrefers in particular to the rewinding ofelectrical motors, re-blading of rotorsetc.

In the very rare case of a total loss (iewhen the damage exceeds the actualvalue), the indemnity is the actual valueat the time of the loss, less the excess and salvage.

6.4 Loss of Profits following Machinery Breakdown insurance (MLOP)

30

Similar to Loss of Profits following Fire,MLOP covers the financial consequencesof a machinery breakdown.

Cover

The cover is limited to the actual loss ofgross profit sustained due to a losscovered under an MB policy, and alsoinsures costs incurred in reducing theamount of a claim.

Insured party

The insured party is the owner of themachinery as defined in the MB policy.

Particular exclusions

The particular exclusions are basicallythe same as in the MB policy. Inaddition, the MLOP policy does notcover any increase of loss of gross profitdue to: bodily injury; circumstanceswhich are in no causal connection withthe accident (eg delay incurred in ob-taining import licences, foreign exchangeetc); extensions or improvements of themachinery effected after the occurrenceof the accident; lack of capital; or anyrestrictions imposed by public authori-ties.

Sum insured

The sum insured is the gross profitwhich is the annual total of net profitand standing charges. If required, covercan be extended to include wages andsalaries which are added to the standingcharges. The total sum insured is

determined every year on the basis of theinsured’s accounts. As exact figures arenot known until after the end of theyear, the sum insured is calculated provi-sionally, on the basis of the precedingyear’s accounts. This provisional figureusually includes a safety margin in orderto avoid underinsurance. When the exactfigures become available, an adjustmentis made.

Period of insurance

The period of insurance is identical tothat of the underlying MB policy –usually one year. Though the actualperiod of indemnification may vary fromcase to case, it rarely exceeds 12 months.

Loss settlement

The settlement of claims in plants withvery regular production using commonproduction lines is fairly straightforward.In plants with fluctuations of productionand/or where the loss may be reduced byusing existing reserve capacity during orafter an insured event, settlement be-comes rather complex.

Claims must be documented by suffi-cient evidence that the interruption wasin fact caused by an accident coveredunder an MB policy. Indemnification ismade according to the actual incurredloss of gross profit for the actual periodof interruption, less an amount calcu-lated proportionally on the basis of thetime excess stipulated in the policy.

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Production

Variable costs such as● energy● raw materials● transportation

Standing charges:All costs which accrue irrespective ofwhether the plant is operational or not eg● interest● rent, amortization, leasing● salaries and wages (optional)

MLOP: sum insured (gross profit)

0%100%

Break-even point

Net profit

Gross profit = net profit + standing charges

Turn

ove

r

Indemnifiableperiod

MLOP: basic principles of loss settlement

Previous year Running year

Standardturnoverperiod X (T/0x)

Actual turnoverin period Y

Dat

e o

f ac

cid

ent

Repair time

Time excess

TimePeriod A12 months

Res

um

pti

on

of

full

turn

ove

r

Shortfallin turnoverperiod Y (T/0y)

Turn

ove

r

Loss adjustment formula:

(T/Ox – T/Oy) ✕ Z ✕Repair time – time excess

Repair time

whereby Z (ie rate of gross profit) = Gross profit in period A

Turnover in period A

The indemnifiable amount is the sum produced by applying the rate of gross profit (Z)in period A to the amount by which the turnover during the indemnity period fallsshort of the standard turnover (turnover in period X minus actual turnover in period Y).

6.5 Deterioration of Stock insurance (DOS)

32

DOS is special insurance for the protec-tion of perishable goods stored in ware-house-type cold stores or rooms. Thepolicy is not intended for goods storedin retail shops/stores.

Cover

Cover is for perishable goods (eg meat,fish, vegetables, fruit) stored in coldstores which suffer damage as a conse-quence of an insured machinery break-down accident. Such damage occurs as a result of rise or fall in temperature, achange in the concentration of gases orthe action of refrigeration media escap-ing from the equipment in cold stores,due to a breakdown of the refrigerationsystem or by the loss of cooling media.

The policy may be extended to includelosses caused by failure of the publicpower supply, providing that the powersupply is usually reliable and that anemergency power plant is available.

Insured party

The insured party is the owner of thegoods in store (who is not necessarily thesame as the owner of the cold storeitself ).

Particular exclusions

The particular exclusions pertaining tothe DOS policy are shrinkage, inherentdefects or diseases of the stored goods,natural deterioration or putrefaction ofstored goods, improper storage andpackaging, deviations from designer’sspecifications, overloading of storagechambers beyond their maximum ratedcapacity, and failure of the public powersupply unless otherwise agreed byendorsement.

Sum insured

The sum insured for goods stored for alengthy period of time is normally theestimated selling price on the expecteddate of sale. In respect of frequentlychanging stock, the sum insured is thepurchase price for the maximum amountof goods stored at any one time. In thelatter case, the sum insured and pre-mium is determined on the basis ofmonthly declarations.

Period of insurance

DOS policies are usually concluded for12 months. However, the policy schedulemust show the storage period(s) and theanticipated sales date(s) of the goods instore.

Loss settlement

Depending on the sum insured (esti-mated selling price or purchase price),the indemnity (in the event of a loss) iseither:a) the difference between the estimated

average selling price for the insuredperiod and the proceeds obtainedfrom the goods affected by theaccident; or

b) the difference between the purchaseprice and the proceeds obtained fromthe goods affected by the accident.

If at the time of loss the goods are ofgreater value than the declared suminsured, the indemnity is reduced in thesame proportion that the sum insuredbears to the amount required to beinsured.

The excess which is usually defined as apercentage of the loss is deducted fromthe final loss settlement figure.

6.6 Computer All Risks insurance (COMP)

33

The Computer All Risks policy offerscomplete protection for entire computerconfigurations. Due to the inclusion ofso-called “internal damage” (incorrectoperation, negligent or malicious actsetc), the standard policy is not suitablefor personal and portable computers,which should only be insured againstexternal damage (fire, forces of natureetc).

Cover

The policy is of an all risks nature,covering unforeseen accidental loss ordamage from any cause whatsoever otherthan those specifically excluded. It isdivided into three sections:• Material Damage to the computer

configuration itself;• Loss of Data and Data Media covering

the data material itself (tapes, discs,punch cards etc) and the reconstructionof such data as a result of an insuredmaterial damage accident;

• Additional Costs for the continuationof computer operations following aninsured material damage accidentusing other installations includingrent, overtime and data media.

The Loss of Data/Data Media and Addi-tional Costs sections are optional, butcover cannot be purchased without thecorresponding Material Damage section.

Insured party

As computers are either bought, leasedor rented, the insured party may be theowner, or the leasing or rental company,depending on who concludes the policy.

Main hazards

The main hazards are fire, water damage,theft and faulty or incorrect operation.

Particular exclusions

The particular exclusions for each of thethree sections are listed below.

Material Damage section:• loss or damage for which the seller,

lessor or maintenance company isresponsible;

• loss or damage resulting from the useof the insured object after damage hasoccurred but before permanent repairhas been effected;

• normal wear and tear, gradual deterio-ration due to normal atmosphericconditions;

• seismic activities (however, earthquakecover may be included by specialagreement);

• consequential loss of any kind, or lossof use.

Loss of Data/Data Media section:• normal wear and tear of media;• erroneous programming, perforating,

loading or printing;• discarding or erasing of data which has

not been caused by insured damage.

Additional Costs section:• costs for loss containment unless

otherwise agreed with the insurer;• costs arising from circumstances which

are not connected with the insuredmaterial damage;

• consequential loss such as loss ofmarket or interest.

Sums insured

Material Damage: the new replacementvalue of the computer configuration.Loss of Data/Data Media: a reasonablelimit of indemnity based on the estima-ted cost of a loss.Additional Costs: A limit of indemnitybased on the estimated costs per daymultiplied by the number of workingdays per year, or alternatively, a first lossbasis.

Loss settlement

Material Damage claims are settled onthe same basis as described underMachinery Breakdown. Loss ofData/Data Media and Additional Costsclaims are settled according to the actualloss, but obviously cannot exceed thelimits of indemnity stipulated in thepolicy.

6.7 Low Voltage and Electronic Equipment All Risks insurance (LVEE)

34

This insurance basically follows theMaterial Damage section of theComputer All Risks Policy, and offersprotection for all types of electronicequipment such as telephone exchanges,electronic measuring equipment andhospital equipment.

Cover

The policy covers unforeseen accidentalloss or damage on an all risks basis.

Insured party

The owner of the insured equipment (orin certain cases the renting or leasingcompany).

Main hazards

The main insured perils are incorrectoperation, burglary, theft, faulty designand material, short circuit, excessivevoltage, fire, forces of nature exceptseismic activities (however earthquakemay be included by way of endorsement)and any damage caused by water.

Particular exclusions

These are the same as the MaterialDamage section of Computer All Riskspolicies.

Sum insured

The sum insured is the new replacementvalue of the electronic equipment asspecified in the policy schedule.

Loss settlement

Loss settlement follows the conditions asstipulated for Machinery Breakdown.

7. Reinsurance

7.1 Forms and types of reinsurance

36

Engineering reinsurance methods are nodifferent from those used for otherclasses of insurance such as fire orcasualty. Reinsurance is either placed ona facultative basis, an obligatory basis ora combination of the two.

Forms of reinsurance

Facultative reinsurance is the oldest formof reinsurance. Risks are reinsuredindividually, whereby the insurancecompany can freely decide if it wants toreinsure a particular risk or not. Thereinsurer, too, may decide without anyobligation whether he wants to accept inreinsurance, or decline the offered risk. Facultative reinsurance is used in caseswhere, after the insurer has used up bothits retention (the amount which it isprepared to bear for its own account)and the capacity available to it underobligatory reinsurance programmes (ifany), there is still a surplus amountneeded to make up the risk’s total suminsured. It is also used for risks or perilswhich are excluded from obligatoryreinsurance programmes.

Obligatory reinsurance is treaty (contract)reinsurance for portfolios. In obligatoryreinsurance, the direct insurer is obligedto cede to the reinsurer a contractuallyagreed share of the risks defined in thereinsurance treaty. The reinsurer isobliged to accept that share: hence theterm “obligatory”. The reinsurer cannottherefore refuse to provide insuranceprotection for an individual risk fallingwithin the terms and conditions of thetreaty. Nor may the direct insurer decidenot to cede such a risk to the reinsurer.As a rule, obligatory reinsurance treatiesare terminable on an annual basis.

Types of reinsurance

In every type of proportional reinsurance,premium and claims are shared betweenthe insurance company and the reinsurerin the same proportion as stipulated inthe contractual agreement. According tothe type of contract, this proportion isidentical for all risks ceded to thecontract (quota share), or it can varyfrom risk to risk (all other proportional

reinsurance). Therefore, if a reinsureraccepts 90% of a risk, for example, andthe retention of the insurance (ceding)company is 10%, both premiums andclaims are distributed in the same ratio90:10, ie proportional to thecorresponding commitments.

In proportional reinsurance, the pricethe reinsurer pays for receiving thebusiness is the “reinsurance commission”.This commission, which the reinsurerpays to the ceding company, is normallyexpressed as a percentage of the originalgross premium. Originally, the ideabehind this commission was to help theinsurance company with its acquisitionand operating costs – which a reinsurerdoes not have to the same degree. Suchcosts include agents’ commissions,administration, and claims adjustingcosts (except external expertise and courtcosts). However, in today’s competitivemarketplace, the nature of the reinsur-ance commission has become morecommercial, and underwriting resultsform part of the criteria for agreeing onthe actual percentage.

In non-proportional reinsurance, noproportional distribution of premiumand claims is fixed between the cedingcompany and reinsurer in advance.Distribution of a claim depends on theactual claims amount. The amount of aclaim which a ceding company is pre-pared to bear for its own account iscontractually agreed. This is known asthe “deductible” or “excess point”. Thatpart of a claim which exceeds thisdeductible is borne by the reinsurer upto an agreed limit. As price for thisreinsurance cover, the reinsurer expectsto receive an adequate portion of theoriginal premium. In calculating thisprice, the reinsurer takes into accountthe claims experience made during theprevious years (= experience rating) orthe future loss expectancy according tothe kinds of risks involved (= exposurerating). The reinsurer is only obliged topay when the reinsured portfolio orreinsured risk suffer losses which exceedthe excess point.

7.2 Engineering reinsurance

37

Although in recent years there has been acertain trend towards non-proportionalreinsurance, engineering risks are mainlyreinsured on a proportional basis. Thereasons lie in the nature of the portfolios,which are usually unbalanced (mixtureof non-renewable and annually renew-able risks; long-tail – ie several yearsduration – for CAR and EAR risks; therelationship between premium generatedand exposure; and the large reinsurancecapacity needed to cover risks with ex-tremely large sums insured). Some largeinsurance companies do have non-pro-portional reinsurance programmes buttheir portfolios are large and diversified,giving enough balance to enable them toconclude such programmes.

The form of proportional reinsurancecover most commonly encountered inengineering reinsurance is the surplustreaty, although quota share treaties arealso widespread. Quite often, these twotypes of treaties are combined into onereinsurance programme. Proportionalfacultative reinsurance plays a very impor-tant role for the placement of amountswhich exceed normal treaty capacities.

Quota share treaty

In quota share treaties, the reinsureraccepts a fixed percentage (ie quota) ofall insurance policies which fall withinthe scope of the contractually specifiedterms and conditions of the treaty. Thisquota is decisive for the distribution ofliability, premium and claims betweenthe ceding company and the reinsurer.

This type of reinsurance treaty is easy tooperate and administration costs are low.Its disadvantage is that it does not takeinto account the different reinsuranceneeds of a ceding company becauseeverything is tied to fixed percentages. Inparticular, quota share reinsurancetreaties do not help to balance aportfolio; that is, they do not limit theexposure posed by peak risks (forexample, those with very high sumsinsured). By the same token, the quotashare treaty may function in areas wherereinsurance cover may not be reallynecessary. Under certain circumstances,this can restrict the ceding company’sprofit. Despite these disadvantages thistype of treaty is often used to coverengineering risks – especially when a

1200

600

900

300

Reinsurer'squota share30%

Reinsured'sretention70%

Cu

rren

cyu

nit Risks

Liability

Risk sharing under a quota share treaty

38

new class of business is being marketedor the engineering portfolio is in thedevelopment phase. As in such casesclaims experience is not available, calcu-lation of the premium can be uncertain.With quota share treaty reinsurance, thereinsurer assumes part of this uncer-tainty. In addition, quota share treatiesare suited to keep the risk of randomfluctuation and the risk of change over awhole portfolio within acceptable limits.

Surplus treaty

With the surplus treaty, in contrast toquota share treaties, the reinsurer doesnot participate in all risks. The cedingcompany retains risks up to a certainmaximum limit (called a “line”) for itsown account. The retention can varyaccording to the type of risk. Liabilityfor amounts which exceed the cedingcompany’s retention (ie amounts inexcess of one line) are assumed by thereinsurer. The reinsurer’s maximum

liability must be established as well: thisis done by forming “surpluses” defined asan agreed number of lines, where oneline is equal to the ceding company’sretention for that particular type of risk.The same ratio which results when a riskis distributed into the retention andreinsurance cession is then used indistributing liability, premiums andclaims between the ceding company andthe reinsurer.

The surplus reinsurance treaty is anexcellent aid for the insurance companyin creating a balanced portfolio. Becausethe retention can be set according to thetype of risk and the claims expectancy,this type of treaty allows the insurancecompany to bring a risk it has acceptedinto line with its financial means. Thedisadvantage of the surplus treaty is thatit is complicated to administer. Costs aretherefore high unless computer supportis available.

14.3%9.1% 3.2%

75%

1200

900

60062.5%

46.4%

Risks

21.4% 22.7% 24.2% 25% 37.5% 53.6%

Cu

rren

cyu

nit

Reinsured1 line = 300

Reinsurer3 lines = 900

eg Facultativereinsurance

100%

25%

75%

300

1500

64.3% 68.2% 72.6%

Liability

Risk sharing under a surplus treaty

7.3 Engineering treaty wordings – terms and conditions

39

The wording of engineering reinsurancetreaties is basically the same as for otherlines of business. However, the under-writing and reinsurance for engineeringrisks is in some ways different fromtraditional lines. These differences can besummarized as follows:• lack of spread due to the relatively low

number of risks;• exposure to technological changes such

as new materials, new methods ofconstruction, prototype design, newdimensions, higher temperatures etc;

• often above average exposure tohazards of nature and the long-tailnature of CAR and EAR insurance.

These points make it worthwhile toexamine the following treaty terms andconditions:

Conditions of cessions

In other lines of business such as fire orcasualty, many markets have associationsor bodies which prepare policy wordingsand rating tariffs that are generallyfollowed by local insurance companies.Apart from a very few markets, this doesnot hold true for engineering. Further-more, in many insurance companies,engineering insurance does not producea large share of the premium income.Consequently, because of cost reasons,underwriting is often handled by theMiscellaneous department. Thisobviously restricts the accumulation ofknow-how. On the other hand, aprofessional reinsurer such as Swiss Rewith a separate Engineering departmentis able to accumulate a wealth ofunderwriting know-how because of itslarge, world-wide portfolio. Therefore, itis not unusual for the reinsurer toprovide its ceding company with policywordings and rating guides with thecorresponding underwriting informationand instructions. The relevant clause inthe treaty wording reads as follows:

“The Reinsurer furnishes the Companywith the policy conditions and ratingprinciples for the business ceded to thistreaty; the Company binds itself to applytheir rules and premium rates”.

Claims consultation

In order that the ceding company maydraw on the reinsurer’s world-wideexperience in the settlement of claims, a claims consultation clause is oftenincorporated into the treaty wording:

“Claims affecting this treaty are settledin consultation with the Reinsurerwhenever a claim is likely to exceed…(an agreed amount). This consultationshall commence at once whenever aclaim of the aforementioned magnitudeis brought to the knowledge of theCompany”.

Treaty capacity

Compared to fire, engineering reinsur-ance treaties are usually quite unbal-anced. A typical fire treaty produces apremium volume-to-capacity ratio ofaround 1 :1 or 1 :2 whereas the ratio forengineering treaties is around 1 :10 andcan even reach 1 :30 or more. The mainreason for this is that cessions of CARand EAR risks are erratic because of theirnon-renewable nature, and their sumsinsured can vary from modest to extreme-ly high.

The annually renewable risks such asMachinery Breakdown and ComputerAll Risks present a more balanced rangeof sums insured, and treaty capacity isusually based on a company’s portfoliofor these classes of business.

Clearly, capacity may be increased byconcluding a second surplus treaty overand above an existing first surplus; butunless the number of cessions is largeenough and the relationship of suchadditional capacity to the average ex-posure is fairly balanced, it is preferableto make use of facultative capacity forsums exceeding the first surplus treatylimits, because engineering risks areoften heavily exposed and one single lossmay ruin treaty results for many years.

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Portfolio withdrawal in case of treaty

cancellation

In most property treaties, the portfolio isoperated on a “clean-cut” basis. Thissystem is not suitable for engineeringbusiness because especially in respect ofCAR and EAR, policies can be of manyyears’ duration. The premiums earnedincrease with the gradual completion ofthe works, with a disproportionate shareallocated to the final stages of construc-tion or erection, where the major losspotential lies (higher values at risk).Calculations of the unearned premiumcan be made; but as they have to bemade individually for every risk, this canbe very time-consuming. Therefore, asfar as CAR and EAR are concerned, risksare run-off to their natural expiry. Forannually renewable covers such as Machinery Breakdown, treaty covercontinues to the next original policyrenewal date.

Table of retentions

Engineering treaties usually have a tableof retentions. Its main purpose is tocreate an optimal balance in the compa-ny’s retained account and to limit rein-surance treaty capacity for heavy riskswith a large loss potential. It also stipu-lates that third party liability (whenwritten in conjunction with and formingpart of CAR, EAR and BPVE policies) isretained and ceded in the same propor-tion (percentage) as the material damagesection of such policies.

It is important for the table of retentionsto be used properly, and for the cedingcompany and reinsurer to discuss itsfunction and application together.Incorrect application can result in a low

ceded premium volume and unusedtreaty capacity. The following examplesillustrate how the table of retentionsshould be applied.

For the purpose of these examples, wewill assume that a surplus reinsurancetreaty is in force with the followingcapacity:

Maximum retention: 100 000 for thebest class of risk1st surplus capacity: 10 lines equal to1000 000

a) Machinery Breakdown insurance,

treaty reinsurance cession example

Risk: Beer breweryTotal sum insured: 5 000 000 comprising 25 machines plus auxiliaries such aspiping, instrument panels etc.Highest value of the individual machines: 1 000 000Premium rate: 5‰ of 5 000 000 = 25 000

We will assume that a beer brewery isclassified as a risk where 100% of theretention may be used.

One cession method would be to cedeeach insured machine separately accor-ding to their individual sums insured. Asmany items would have sums insuredwhich are equal to or less than the reten-tion, the treaty would only be exposed tomachines which have individual sumsinsured in excess of 100 000. This isantiselection, and contrary to the princi-ples of a proportional treaty.

Another method would be to base thecession calculation straightaway on thetotal sum insured. This would producethe following result:

Sum insured Premium %Retention 100 000 500 21st surplus (10 lines) 1 000 000 5 000 20 Facultative placement 3 900 000 19 500 78Total 5 000 000 25 000 100

41

This method results in too little retainedpremium for the ceding company, andquite often, an unnecessary facultativeplacement.

The best method is to make initialcalculations based on the machine withthe highest sum insured (in this example1000 000) and apply the resultingpercentages to the total sum insured:

In case of a claim, distribution would bein exactly the same proportion, ie 10%of the claim is allocated to the retentionand 90% to the 1st surplus treaty.

When comparing the cession methodsdescribed above, one notes that the last method fulfills certain important criteria: full treaty capacity has been used as far as possible, premium hasbeen correctly allocated, and there is noantiselection because all machines havebeen ceded proportionately. Additionally,there is no need for facultative reinsurancein this example, which obviously willsave administrative costs.

One can of course argue that the reten-tion and treaty capacity have beenexceeded. However, in Machinery Break-down treaty reinsurance, it is not reallythe total sum insured that counts.

Cession calculations are governed by themachine with the highest individual suminsured because plants insured underMachinery Breakdown are very rarelysubject to total losses. Most claims arepartial and affect one machine only.Therefore, although the limits haveeffectively been exceeded, there is noundue overexposure to the retention orthe treaty.

The cession method described aboveonly applies to Machinery Breakdown. It cannot be used for other classes ofengineering business. For instance, CARand EAR cessions are based on the totalsum insured of the material damagesection of the cover plus all endorse-ments which carry a sum insured. This isbecause contrary to Machinery Break-down, such risks can suffer a total loss.

b) Contractors’ All Risks Insurance,

treaty reinsurance, cession example

Risk: Road worksSums insured: Construction works (estimated total contract value): 2 900 000Debris removal (limit of indemnity): 50 000Contractors’ Plantand Equipment: 50 000 Total sum insured: 3 000 000

TPL limit: 200 000 Premium rate: 6‰ of 3 000 000 = 18 000

We will assume that the table ofretentions allows 75% of the treatycapacity for this type of risk. Theretention is therefore 75 000 (75% of 100 000).

Retention : 100 000 = 10 % of 1 000 000 1st surplus (max. 10 lines) : 900 000 = 90% of 1 000 000

Retention/treaty cession

Sum insured Premium %Retention 10% of 5 000 000 500 000 2 500 101st surplus: 90% of 5 000 000 4 500 000 22 500 90 Total 5 000 000 25 000 100

Retention/treaty cession

Sum insured TPL Premium %Retention 75 000 5 000 450 2.5 Surplus 10 lines 750 000 50 000 4 500 25.0Facultative placement 2 175 000 145 000 13 050 72.5 Total 3 000 000 200 000 18 000 100

7.4 Recent developments in reinsurance

42

The traditional types of reinsurancedescribed previously in this chapter arewidely used at present for placing engi-neering risks. These types of reinsurancewill definitely continue to be applied inthe future but they will be comple-mented by alternative risk transfer viafinite reinsurance. Finite risk reinsuranceis based on the same instruments astraditional reinsurance. However, it doeshave certain distinguishing character-istics. These include: • the assumption of limited risk by the

reinsurer; • a multi-year contract period; • sharing the result with the primary

insurer; and • the explicit inclusion of future

investment income in agreeing theprice.

These features open the way to new waysof looking at insurance and reinsurance,and are generating increasing interestamong insurance companies.

• Assumption of limited (finite) risk by thereinsurer: In finite risk contracts, the primaryinsurer (cedent) transfers two things:first, the risk that losses will be settledsooner than expected, commensuratelyreducing investment income from thereserves formed to cover those losses,and second, a limited but significantunderwriting risk. In reality, the under-writing risk is the risk that actuallosses paid over the term of the finitecontract may turn out to be greater

than expected.• Multi-year contract term:

Many traditional reinsurance contractsare agreed, at least initially, for a one-year period (though they may run for much longer). However, multi-yearcontracts can provide cedents withlong-term cover under reliable condi-tions, and furnish finite risk reinsurerswith a continued flow of premiums.This provides both parties with consi-derably greater latitude for negotiatingprices and conditions, and secures along-term partnership.

• Sharing of result with the cedent: A substantial part of the profits accru-ing over a multi-year period is paidback to the cedent, so that there is aclose connection between the cedent’sown loss experience and the actual costof reinsurance. In this way, the cedentreceives “compensation” for the limi-tation of the risk assumed by the finiterisk reinsurer.

• Future investment income as a pricingcomponent: Expected investment is explicitlydefined as a factor in the premiumcalculation. This consideration of thetime value of money has a specialeffect in certain types of liabilitybusiness, where settlement may takedecades.

Finite risk reinsurance adds a newdimension to a community of risks: riskfinancing over time as opposed to a risk-balancing proposition on an annual basisas seen in conventional reinsurance.

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Assumptionof limited riskby reinsurer

Sharingof resultwith cedent

Explicit inclusionof investmentincome

Multi-yearcontract term

Finite risk

reinsurance

Features of finite risk reinsurance products

Among other things, finite products can:• stabilize reinsurance costs and capacity

availability;• smooth result fluctuations;• expand underwriting capacity;• provide (partial) protection against as-

yet-unreported claims; and• optimize the balance sheet.

Finite products can also be combinedwith traditional reinsurance solutions inblended covers. The advantages of suchblended covers: a single reinsuranceprogramme under which insurers canarrange a price for each specific type ofrisk; and this not only for a period ofseveral years, but also for risks fromseveral different lines of business. Also,primary insurers utilizing such coversprofit from reduced transaction costs forrisk protection.

45

8. Engineering and Swiss Re

A fax, the computer signals anincoming e-mail, the telephone rings:

“Can you help me? I need reinsurancecover for a large construction risk. It’s aUSD 100 million development with two35-storey office towers on top of a 3-floor shopping centre podium with 5basements situated in the heart of a largecity. The site is triangular in shape with a10-storey 30-year-old hotel about 10metres away on one side, a newspaperprinting plant on another, and a 6-lanehighway on the third side. The insuredneeds full design cover and all the usualextensions as well as vibration andALOP. We want to quote 6‰ on TCV.What do you think and how muchcapacity do you have available?”

“In two months time we are holding aseminar for our insurance agents. Thesubjects are Machinery Breakdown andMachinery Loss of Profits Insurance.Can you delegate a speaker from SwissRe?”

“Our engineering insurance portfolio hasgrown substantially over the past twoyears. The administration of reinsuringthe risks individually on a facultativebasis is becoming too costly. Can youhelp us to set up a reinsurance treatyprogramme?”

“We have just had a large loss during theerection of a power station. Thecircumstances of the claim are ratherunusual. Could you please assist us inthe claims handling?”

“Our new engineering underwriter is anengineer, but has limited experience inengineering insurance matters. May wesend him to you for a few weeks fortraining?”

Every day, Swiss Re’s Engineering depart-ment is faced with requests for technicalassistance and for quotations for risks ofvarious degrees of complexity rangingfrom relatively simple housing projectsto multi-million dollar petrochemicalrisks and power stations.

For us, service, expertise and professio-nalism are paramount. That’s why SwissRe Group employs over 50 civil,mechanical and electrical engineersworldwide for handling facultative risks,a product management/developmentteam, several experienced treatyunderwriters, and a back-up team ofcompetent account administrators. Mostof our engineers previously worked inconstruction, erection and plant opera-tion. The in-depth, specialised know-ledge gained in such working environ-ments is of immense value in recognisingspecial hazards and perils in relation toengineering insurance coverages.

In Zurich, our people are divided intomarket groups that specialise in theneeds of their respective regions. Theengineering account managers andusually their deputies travel extensivelyin the markets to assess our clients’needs, deal with treaty and facultativeunderwriting, carry out risk inspections,provide claims handling services, andarrange seminars and workshops.

Contact us for more information aboutour worldwide engineering activities or if you would like copies of our specia-lised publications dealing with the variousclasses of engineering business. We arehere to help you.

© 1997Swiss Reinsurance Company,Zurich

Title: Engineering insurance andreinsurance. An introduction.

Author: Peter HowardProduced by: Public Relations andLanguage Services

Graphic design: Markus Galizinski,Zurich

Photos: Blue Planet, Zurich (page 19 lower)Bildagentur Baumann,Würenlingen (pages 20 lower, 32)Bucher-Guyer, Niederweningen(page 7 upper)IBM Switzerland, Zurich (page 33 upper)Liebherr, Biberach (pages 14 upper, 27 upper)Markus Galizinski, Zurich(pages 1, 4, 6, 8, 10, 12, 25, 35, 44) Tony Stone, Munich (pages 7 lower, 22 upper, 34 upper)Swiss Re (others)

Further copies and a list of otherSwiss Re publications (“Publica-tions”) may be obtained from:Swiss Reinsurance CompanyPublic RelationsMythenquai 50/60CH-8022 ZurichTelephone: +41 1 285 21 21Fax: +41 1 285 20 23E-mail: publications@swissre.comInternet: http://www.swissre.com

(12/97, 3000 en)

Peter Howard is an AccountManager in the Engineeringdepartment at Swiss Re in Zurich.He joined Swiss Re in 1977 aftermoving to Switzerland from theUnited Kingdom. Following initialreinsurance training in one ofSwiss Re’s market departments, hetransferred to the Engineeringdepartment in 1981. His currentresponsibilities include marketingand underwriting Engineeringreinsurance products in the Nearand Far East.

Peter Howard gratefully acknow-ledges the support of numerouscolleagues at Swiss Re in thepreparation of this publication.Special thanks, however, go toMax Bommeli and Dr. Hans Mahrlawhose helpful suggestions andtechnical assistance in editing themanuscript are most sincerelyappreciated.