Cover for Loss Mitigation & Rectification: When Prevention is Better Than the Cure

Various General and Financial Lines insurance policies contain clauses that entitle the policyholder to start incurring costs before the normal policy trigger occurs, with a view towards mitigating the insurer’s potential liability under the policy. Some common examples include:

• Engaging experts to investigate the presence of damage or a defect, and advise on the cause of same before further damage occurs;


• Engaging lawyers to review documentation and circumstances surrounding a dispute, undertake initial liability assessments and commence informal settlement negotiations to resolve the dispute before formal legal proceedings are issued;


• Installing temporary protective measures to ensure damaged or defective structures do not pose a risk of further damage or injury; and


• Renting alternative premises or equipment where there has been damage that is causing ongoing loss of gross profits.

One of the more frustrating scenarios a policyholder can experience is when a sequence of events has transpired that will almost certainly lead to a formal claim being issued and the insurer insists on the insuring agreement being “triggered” before taking any steps to investigate or assist to mitigate the matter.

Liability policies in the ordinary course will only enliven where the definition of “claim” is met under their policy. “Claim” is often defined as a third-party demand for compensation, or the commencement of proceedings,

Depending on the reasonable likelihood of a “claim” being met, the policyholder in this position can justifiably feel as though its insurer is gambling on whether matters will resolve prior to the insurer being contractually obligated under the policy to respond to the claim. Policyholders may feel that they are doing as much purely to avoid incurring any costs.

Insurers often promote themselves on the basis that they seek to genuinely partner with their policyholders. An underwriter’s willingness to include Loss Mitigation & Rectification cover under a policy is a clear example of a commitment to a genuine partnership. It demonstrates that the insurer is willing to work with the policyholder, even if it means incurring additional expenses upfront, so that the issue can be resolved quickly, as cheaply as possible.
Most policyholders look to their insurer to take a proactive role at a pre-emptive stage because:

• They have commercial relationships that they are trying to preserve and therefore want to wait for circumstances to occur, just to satisfy a policy trigger point, that result in further loss or conflict;


• They are looking for a business partner that is pragmatic, understands their commercial needs and is willing to take a collaborative approach in helping policyholders through difficult times;


• There is genuine concern on the part of the policyholder as to how the costs might escalate if, for example, that particular structure that was assessed as defective falls down, or if a third party to a commercial dispute is forced to issue formal legal proceedings because the policyholder couldn’t afford to settle a dispute without access to insurance funds;


• Most policyholders are unsure of the precise scope of their common law duty to mitigate their own losses. By involving the insurer in this process, the policyholder can avoid any arguments that they failed to properly mitigate their liability; and


• Most policyholders are not in the business of managing insurance or legal claims and they are reliant upon the insurer’s expertise and resources such as their network of panel experts including loss adjustors, lawyers, forensic accountants, builders and the like.

Insurers have become more reluctant to offer Loss Mitigation & Rectification cover for certain policy classes. For instance, there is far less appetite under design consultants, architects, engineers, principal arranged or annual contractors’ design and construction professional indemnity policies. This is because, there has been a trend for Loss Mitigation to act as a quasi “defects liability fund”.

Sophisticated policyholders and those who have experienced reasonable sized claims in the past will also appreciate that they have a mutual interest in keeping their total claim costs down. Losses are taken into account by insurers when determining renewal premiums, that includes the policyholder’s claims history for 5 years or greater.

In the current hard market conditions (see here for details ) there is added incentive to keep claim costs to a minimum as we are seeing rate increases imposed on an exponentially higher basis for clients who have recently experienced large losses.

Taking steps to mitigate further losses or the quantum of a claim can therefore be mutually beneficial for policyholder and insurer alike.

We consider that there is always an argument for having some level of Loss Mitigation & Rectification cover under your policies. The rationale is simple: if you can identify a risk that is worth covering after the policy is triggered, you should look to cover costs that can minimise the effects and costs of that risk. In reviewing Loss Mitigation & Rectification cover under your insurance program, it is worthwhile considering the following:

• Availability of the cover: are mitigation expenses covered under the policy wording as standard, is there an optional extension or endorsement to incorporate the cover, what insurers are happy to provide the cover;


• What limits can be provided: mitigation cover is typically sub-limited. It is therefore important to consider what types of expenses your business might incur in attempting to pre-emptively resolve an issue, and whether applicable sub-limits are adequate to cover those costs. In this same vein, it is important to check whether the loss mitigation limit or sub-limit is provided on a single event/claim basis, or for all events/claims arising in the one policy period;


• Cost of the cover: some insurers will look to charge additional premium for mitigation cover, particularly if it is provided by way of optional extension or endorsement;


• Deductible/excess: is there a deductible/excess that applies to mitigation expenses and, if so, is it the same as other deductibles/excesses under the policy;


• Notice requirements: most loss mitigation clauses stipulate that the policyholder must give notice to the insurer of the circumstances of the potential claim and seek the insurer’s prior written approval before incurring any mitigation expenses. Policyholders should seek to include a requirement that this consent not be unreasonably withheld; and


• How is the likelihood of the loss occurring assessed: most loss mitigation clauses stipulate that it must be “reasonably likely” that a loss or claim will arise without insurer intervention, before mitigation expenses can be incurred and claimed.
  
  This type of language imposes a “reasonable person” test that objectively looks at all relevant circumstances. On this basis and the prior written notice requirement, it is recommended that policyholders engage in open and honest discussions at an early stage about where a matter has the potential to go wrong or get worse, without insurer intervention and some form of policy response.
  
  Policyholders should review the claims conditions section of the policy to see what dispute resolution mechanisms are in place for circumstances where the policyholder and insurer disagree as to the reasonable likelihood of a claim eventuating.
  
  A compromise for both policyholder and insurer alike is to require referral of questions of fact and law to a Queen’s or Senior Counsel who will accept submissions from both sides before reaching an impartial decision.