Average, Business Interruption and a Dirty Dust Extractor
Kilbride Textiles Ltd operates a mill. Its material damage policy has a sum insured of €1.2m on a reinstatement basis. The actual reinstatement cost of the buildings, plant and stock at the time of loss is €1.8m. The policy contains an average (underinsurance) condition. In June 2024 a fire destroys the finishing shed, causing €450,000 of direct damage measured on a reinstatement basis, and interrupts production. The business interruption section has a separate sum insured of €600,000, an indemnity period of 12 months, and states that the BI sum insured is not subject to average. Before the fire annual turnover was €3.5m and the gross profit ratio was 30%. The company expects to lose 40% of turnover for six months. The loss adjuster finds the fire started in a dust extraction unit not cleaned for 14 months, contrary to a condition requiring monthly cleaning.
1. Calculate the material damage settlement applying the average condition. Show your workings and explain the basis of the calculation.
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The average condition compares the sum insured with the value at risk at the time of loss. Because the policy is on a reinstatement basis, the value at risk is the reinstatement cost of the property insured, not its market value or book value.
- Sum insured: €1,200,000
- Value at risk (reinstatement cost): €1,800,000
- Loss: €450,000
Average ratio = €1,200,000 ÷ €1,800,000 = 2/3.
Settlement before excess = €450,000 × 2/3 = €300,000.
The insured is therefore treated as its own insurer for one-third of the loss. The policy excess, if any, is then deducted from the €300,000. The insurer should also check whether the policy contains an 80% average condition. Even on an 80% basis, the sum insured of €1.2m is below 80% of €1.8m (€1.44m), so average would still apply. The settlement is €300,000 before excess.
2. Calculate the business interruption loss for the six-month period and explain whether the cleaning breach can defeat or reduce the BI claim.
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The BI calculation starts with the gross profit that would have been earned but for the fire.
- Annual turnover: €3,500,000
- Gross profit ratio: 30%
- Annual gross profit: €3,500,000 × 30% = €1,050,000
- Six-month gross profit: €525,000
- Reduction in turnover for six months: €3,500,000 × 40% × 6/12 = €700,000
- Loss of gross profit: €700,000 × 30% = €210,000
The BI sum insured is €600,000 and is not subject to average, so the €210,000 is within the limit, subject to any BI excess and any increased cost of working.
The cleaning breach is serious. The fire started in a dust extraction unit that had not been cleaned for 14 months, contrary to a condition requiring monthly cleaning. The insurer must examine the status of that condition. If it is a condition precedent to liability, breach can entitle the insurer to decline the material damage claim. If it is a warranty or a condition going to the risk, the insurer may be discharged from the date of breach. Because the BI loss flows from the same fire, a valid defence to the material damage claim would usually also defeat the BI claim. The insurer should not, however, simply assume the point: it should check the policy wording, whether the breach was material and whether the insured was given clear notice of the condition.
3. Discuss the insurer’s subrogation position against the maintenance contractor and any obstacles.
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If the insurer pays the claim, it is subrogated to Kilbride’s rights against third parties responsible for the loss. If the maintenance contractor was negligent in failing to clean the dust extraction unit, the insurer may pursue the contractor in Kilbride’s name for the insured loss.
Obstacles include:
- Contract terms. The maintenance contract may contain a waiver of subrogation or a limitation of liability. If Kilbride agreed not to sue the contractor, the insurer’s rights may be limited.
- Causation. The insurer must prove that the contractor’s failure caused the fire. The insured’s own failure to supervise cleaning may amount to contributory negligence and reduce recovery.
- Policy conditions. Kilbride must not prejudice the insurer’s subrogation rights. If it settles with the contractor without the insurer’s consent, the insurer may reduce the claim.
- Recoverability. The contractor may be uninsured or have insufficient assets.
The insurer should obtain the maintenance contract, preserve evidence and issue proceedings within the limitation period. It should also consider whether the insured’s own breach of the cleaning condition gives the insurer a defence, because that may affect both the claim and any recovery.