Risk Management
Equipment breakdown coverage
This oft-misunderstood coverage is a necessity for many clients
By Donald S. Malecki, CPCU
Boiler and machinery insurance has been around since 1866. But despite its longevity, it has remained somewhat of an enigma to many prospects, with the possible exception of the very large manufacturers; processors; power and light companies; and those organizations, such as some universities, that generate their own power.
One way that some producers capitalized on selling this complex coverage to the small and mid-sized risks was to let someone more experienced handle the entire matter.
Here is how it was done. Agents of record would supply the underwriter with the names and addresses of businesses housing boilers. The agents would then contact their insureds and let them know when insurance company representatives would visit them to inspect their boilers. That generally ended the agents’ role in the process. Producers did not have to know anything about boilers or how coverage applied.
Those who would make the on-site visits were the underwriter and company engineer (often the same person). They were so well versed in boilers and related machinery that the underwriter could accept the risk and quote the premium on the spot.
If the boiler of a steam type was in a building or structure with public exposure, it probably required a state inspection. When a prospect compared the state inspection fee against the insurance quote, the latter almost always was somewhat higher. But with a state inspection, there is no insurance if something like an explosion were to occur.
At this point, the agents would likely have to be called upon to provide their sales pitch—explaining the significance of not only an insurance company inspection but also insurance if something goes wrong. It did not take too much effort.
Equipment breakdown insurance
It still may be possible to sell a lot of boiler and machinery insurance using this same method. Today, however, boiler and machinery insurance no longer exists. The new term is equipment breakdown insurance. The reason for the change is that through the development of all kinds of electrical, mechanical, communication and computer equipment, it is now possible to offer insurance on a wider scale.
The problem is that short of state-required inspections, it may be difficult to sell this insurance. One has to understand the coverage concepts and the available forms, and that is not easy. Take the latest (2006) ISO Equipment Breakdown Protection Coverage Form. It offers 10 coverages and 21 exclusions. (To be fair, about six of these exclusions apply because of the possible overlap with property coverage forms.) With the attention span of insurance buyers being very short, it is going to take a special effort for agents to find buyers.
What is particularly unsettling is the word “breakdown.” Webster’s Seventh New Collegiate Dictionary defines “breakdown” in part to mean: “to become inoperative through breakage or wear.” If wear is the reason for a breakdown, do not count on coverage!
The reason is that this coverage form, and most property coverage forms for that matter, specifically excludes coverage for loss because of depletion, deterioration, corrosion, erosion, and wear and tear. Agents and other people involved in the insurance business can understand the rationale for this exclusion. The question is whether insurance buyers can.
Not all-loss coverage
Some insurance buyers may believe that when equipment breaks down, coverage for resulting loss is automatically provided. They fail to realize that such a loss, while bound to happen in time, is not likely to be the subject of insurance, or loss by chance.
Insurers, furthermore, have the ability to modify their policies by restricting coverage when it is otherwise warranted. (This is referred to as an underwriting tool, something that insurers seem to be introducing with more regularity.) A case in point is Commonwealth Insurance Company, et al., v. Stone Container Corporation v. Industrial Risk Insurers, 351 F.3d 774 (U.S. Ct. App. 7th Cir. 2003).
A paper manufacturer sustained an $80 million loss when one of its pulp and paper plants exploded. It maintained that its property all-risk policy issued by IRI provided coverage. It turned out that this specific loss was not to be covered because of a special exclusion for ruptures of pressure vessels.
The rationale for the exclusion was the manufacturer’s poor loss history. As a result, the many insurers that had written insurance for its property refused to cover its boilers against explosion.
One would think with an operation as large as this manufacturer, that it would have recognized the fact that boiler explosion losses were not covered. Then again, a primary purpose for boiler insurance is in the event of explosions. Apparently, the insured did not realize explosions were not covered, since it also alleged that IRI had a duty to disclose the existence of a coverage gap. To the contrary, however, the court held that it is the insured who has the burden of knowing the contents of its insurance policies.
What is breakdown?
If there is any consolation here, it is that the Equipment Breakdown form of ISO will pay for resulting “breakdown.” This means, for example, if through wear and tear there is direct physical loss that causes damage to the covered equipment that necessitates its repair or replacement, coverage will apply. But if through wear and tear or corrosion the equipment simply stops functioning, no coverage should be expected.
It is important, therefore, to understand precisely what “breakdown” means. This may be a time-consuming endeavor for some agents because, while this term is defined to encompass certain types of losses, it also is defined to not mean certain kinds of events. To be exact, there are seven kinds of events that, if they occur, are considered not to be “breakdown.”
An elevator is equipment to service a building or structure. It therefore would qualify for equipment breakdown coverage. Unfortunately, in at least one case involving elevators covered by an equipment breakdown form, coverage was not available. The case is 515 Associates LLC v. Travelers Indemnity Company of Illinois, 160 Fed. Appx. 147 (U.S. Ct. App. 3d Cir. 2005).
An apartment complex in New Jersey contained three passenger elevators that were installed in 1962. The problem arose in 1999 when there was a major elevator failure. The owner employed the services of a consultant to determine the cause of the malfunction. The consultant, who shared his findings with the owner’s insurer, stated that the cause appeared to be electrical but it was virtually impossible to determine the direct cause.
The insurer also retained the services of a consultant to investigate the claim. His observation was that the equipment was “very old, in need of replacement and has served out it useful life and is breaking down due to age.” The insurer hired another consultant who agreed with the earlier consultant and stated that the elevator control system failure was “age-related.” His report further stated that the elevators were approximately 40 years old and that the life expectancy was approximately 25 years.
Unfortunately, the owner failed to provide any evidence to prove that the failure was an accident meaning “a sudden and accidental breakdown.” At the time the breakdown occurs, it also must become apparent by physical damage that repair or replacement of covered equipment is required.
The insurer agreed that the policy in question covered an accident and that the meaning of “sudden and accidental” is “unexpected or unintended.” The insurer, however, contended that the breakdown in question fell outside the definition of “accident” because the policy stated that an accident is not “depletion, deterioration, corrosion, erosion or wear and tear, unless a sudden and accidental breakdown occurs.”
Delivering the bad news, the court stated that there was no evidence supporting a conclusion other than a finding that the cause of the failure was due to age and deterioration of the equipment and not to an “unexpected or unintended” breakdown. However, this begs the question of why the insurer continued to provide insurance for old elevators that were destined to fail.
Conclusion
This article may appear to some to be nothing but “sour grapes.” To the contrary, the intent is to make clear to the agent that selling equipment breakdown insurance is a minefield. It is an excellent source for sales, but it is likely to take someone who is well versed in the subject to do it.
It makes good risk management sense to offer equipment breakdown insurance, but it is going to take more than sales ability to keep out of trouble, given the complexity of these forms.
The author
Donald S. Malecki, CPCU, has spent 48 years in the insurance and risk management consulting business. During his career he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates LLC, an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.