How to navigate insurance and manufacturers' warranties

14 February 2019

Answer: "A riddle wrapped in a mystery inside an enigma."

Winston Churchill’s famous 1939 quote described the machinations of Soviet Russia at the dawn of World War 2. But it could justifiably be applied to the apparent tangle of manufacturer warranties, policy wordings and LEG exclusions that come into play should a piece of high-spec equipment – say, a gas turbine – suffer a malfunction.

When complex and expensive machines working in the heart of many process plants go wrong, the insured’s understanding of how its construction insurance interacts with all the other contractual elements can often be hazy. This is especially the case when prototypical equipment is involved.

In order for an insurance claim to be made – and the quicker the better as this equipment can take months to repair - the words and meanings must be deciphered. The mystery inside the enigma needs to solved.

The process can seem time-consuming and burdensome, which is why many insureds work closely with advisors, such as construction insurance brokers, who have the technical knowledge needed to ensure the smoothest possible process.

What the insured needs to know about construction insurance

It should come as no surprise that an integral piece of equipment, such as a gas turbine, comes with equally complex risk and construction insurance considerations. They should be at the forefront of risk managers’ minds when engaged in construction risk management.

Read part one of this two-blog series, Prototypical Equipment: How to Get the Best EAR Construction Insurance Terms for details about how insurers may seek to apply restrictive conditions to the coverage when equipment is considered to be unproven or prototypical.

Typically, the insurer may seek to apply a defects exclusion clause (commonly referred to as a DE clause or a LEG clause). These clauses also apply commonly to proven process machinery insurances.

The LEG clauses were written by the London Engineering Group, and designed specifically for electrical and mechanical biased insurances. These clauses operate in a similar way to the ‘DE’ clauses that were produced by the UK CAR Group specifically intended for use in building and civil engineering biased insurances. Both are important but for process equipment it is the LEG clauses that are commonly incorporated into the insurance policy, thus understanding the extent of exclusion and coverage is the crucial first step:

LEG 1/96

The narrowest form of cover. The clause excludes all loss or damage due to:
Defective design, plan, specification, materials or workmanship. 

LEG 2/96 

Excludes all costs rendered necessary due to: Defective design, plan, specification, materials or workmanship. Should damage occur, the cost excluded is limited to the cost that would have been incurred if replacement or repair had been put in hand immediately prior to damage.

The simple test for this clause is that cover excludes the defect rectification costs which would have been incurred immediately before the damage occurred.

LEG 3/06 

The broadest form of cover. This clause excludes all costs rendered necessary due to: Defective design, plan, specification, materials or workmanship. Should damage occur, the cost excluded is limited to the costs incurred to improve the original design, plan, specification, materials or workmanship.

The simple test is that betterment or improvement is excluded.

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Damage as a result of defects during the construction of a project can often be significant, with costs to repair potentially running into millions of pounds. It is critical for insured parties of a construction project to fully understand and appreciate the subtle (but important) differences in construction insurance available and how it is affected by LEG exclusions.

The insured may have the option of selecting which exclusion is most appropriate to its project and its level of construction risk. But typically, employers require LEG 2/96 coverage as a minimum.

In order to give an insurer the confidence to provide LEG 2 or 3 cover, product/workmanship warranties from a manufacturer or supplier will be brought into play.

The following questions will be among those that an insurer will want answered, before accepting a warranty for prototypical equipment:

  • What does that particular warranty actually provide?
  • Where are its contractual limitations?
  • Who pays in the first instance? Time is money when it comes to process plants, and delays to start up can be expensive.

What if an item of equipment under warranty malfunctions?

Where the warranty has been granted by an equipment supplier or manufacturer, the warranty should seek to ensure that the purchaser receives equipment that is fit for purpose. In other words, it should be defect-free.

The insurance cover provided under the policy will only respond to damage.

The diagram below shows the interface between defects and damage. Where this interface occurs (and where the defect causes the damage) some insurances will pay first and then seek to recover all or a part contribution from the warranty provider. In the event of a defect only, the warranty will be the first and probably only call for recovery.

Manufactuer's warranties

Where damage has occurred, the usual insurance claims process should apply - the insured notifies the insurer of the damage, the claim will be accepted and then if the claim is deemed to have affected an item under warranty, then insurers may then seek to recover money owing from the manufacturer or supplier under warranty; this is known as subrogation.

Subrogation is the right of the insurer to recover in the name of the insured. It will have indemnified the insured as per its legal obligation to do so. That being the case, it will stand in place of that insured and avail itself of all the rights and equitable remedies of the insured.

While an insured would be expected to co-operate with its insurers during any subrogation, the insured will have received its claim payment. It is then the job of the insurers to take on the main burden of the recovery process.

Beware: Insurers can only subrogate to the extent of the cover they provided. So on a LEG 2/96 claim the insured will still need to recover the costs of correcting the damage that would have been incurred had the repair works been undertaken immediately before the damage took place (as this is excluded under LEG 2/96).

Typically, a construction policy might not be as extensive as a manufacturer’s warranty in that it does not cover non-damage issues nor betterment nor improvements.

Should an issue arise where there has been no physical loss or damage, there won’t be an insurance claim. Similarly, if LEG 1/96 is applied as a defect is found to be the root cause of the damage, there won’t be an insurance claim. The insured must therefore pursue the contractual remedy only.

Talk to an expert

Every project is unique and will require its own construction site risk assessment and bespoke insurance cover. Equipment to be incorporated into a project, whether prototypical or not, are highly specialised and expensive pieces of engineering.

To get the most effective EAR coverage for your project, work with your construction insurance broker to examine all of your related risk and insurance issues.

To discuss your needs, contact Cameron Smith, Construction Associate, JLT Specialty, on +44 (0)207 4595 517 or email cameron_smith@jltgroup.com

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