Two fire policies, one loss: average, excesses and a contractor's cabling
Northgate Garments (Pvt) Ltd runs a single garment factory in Katunayake. Its stock is insured against fire by insurer A for a sum insured of LKR 180 million and, separately, by insurer B for LKR 60 million. Neither policy has an 'other insurance' clause, but both contain a 75% average (under-insurance) condition and their own excesses: LKR 2.5 million under A, LKR 1 million under B. On 3 March a fire destroyed stock. The whole stock at risk on the date of loss was worth LKR 240 million on the basis used by both policies; the stock destroyed was worth LKR 120 million and salvage realised LKR 4 million. The fire began at a distribution board installed eleven weeks earlier by Ravi Electricals, an outside contractor, using undersized cabling. Policy A excludes 'loss caused by defective workmanship', but its fire peril is granted 'for fire however caused'. Northgate had a business interruption quotation from A but never accepted it; production stopped for seven weeks and lost gross profit is estimated at LKR 45 million.
1. Calculate what Northgate can recover from each insurer and what it must bear itself. Show how the indemnity principle, average, excesses and contribution interact.
Read the worked answer
Step 1 – fix the measure of indemnity. Salvage is deducted before average is applied: LKR 120m − LKR 4m = LKR 116m. That figure is the ceiling on total recovery, whatever the sums insured say.
Step 2 – apply each policy's average condition separately. Average compares the sum insured with the value at risk at the time of loss, not with the loss itself:
- Insurer A: 180 ÷ 240 = 75%; 116 × 75% = LKR 87m; less the LKR 2.5m excess → LKR 84.5m.
- Insurer B: 60 ÷ 240 = 25%; 116 × 25% = LKR 29m; less the LKR 1m excess → LKR 28m.
Step 3 – test for over-recovery. The two sums insured total LKR 240m, exactly the value at risk, so the averaged payments add to precisely LKR 116m. There is no double recovery and no need for a contribution adjustment. Had the aggregate sums insured exceeded the value (say LKR 300m), each insurer would still have paid its averaged share, and the rateable-proportion rule would have capped the total at LKR 116m so that Northgate could not profit from the fire.
Step 4 – what Northgate actually receives and bears. It collects LKR 112.5m and bears LKR 3.5m, which is exactly the two excesses. Excesses are not averaged and are not shared between insurers; each attaches to its own policy. Check the wording before paying: some average clauses are applied to the loss before the excess, which produces a different figure, and any declaration or 'full value' basis would displace averaging altogether.
2. Insurer A indicates it will decline, relying on the defective workmanship exclusion. Advise on proximate cause and on the insurers' subrogation position against Ravi Electricals.
Read the worked answer
What is the proximate cause? Fire is. It is the dominant, effective cause of the destruction; the undersized cabling is at most an antecedent condition that created the opportunity.
Reading the exclusion against the grant. A excludes 'loss caused by defective workmanship' yet grants fire 'however caused'. Read together, and construed against the insurer where the meaning is ambiguous (contra proferentem), the exclusion is best confined to the cost of putting right the defective work itself - the board, the cabling, the re-wiring - not to the fire damage that the defective work set off. If A intended to exclude fire started by faulty electrical installation it needed clear words such as 'loss arising from faulty design, workmanship or installation, including any fire resulting therefrom'. A denial on the present wording would be difficult to defend before the IRCSL or a court. A denial also sits badly with A having insured the risk without a survey or an electrical warranty.
Causation trap to avoid. Do not treat the contractor's negligence as the operative cause. Third-party negligence does not displace an insured peril; it is exactly what makes the subrogation right valuable.
Subrogation. On payment, A and B step into Northgate's shoes and may sue Ravi Electricals in negligence for the sums they have paid. Northgate must not release the contractor, sign a waiver or settle with him directly, or it will prejudice the insurers' rights and may lose its indemnity. Any recovery above the insurers' outlay belongs to Northgate - that is its route to recouping the LKR 3.5m of excesses. The failed board, the contractor's invoices and his workmanship warranty should be preserved now, before the site is cleared.
3. Northgate also claims LKR 45 million for lost gross profit. Advise on that element and on the wider consequences.
Read the worked answer
Is there cover? No. There was a quotation, not a contract: an offer that was never accepted, no premium paid, no policy number, no cover note, no binder. A property policy insures property; it does not indemnify lost profit unless a business interruption section is bought, because loss of profit is consequential loss, not physical damage to an insured asset.
Check for accidental coverage before refusing. Is there a 'loss of profits' or 'standing charges' extension in A's policy? A customers' or suppliers' extension? Note also that even a properly written BI policy would deduct the savings made during the stoppage (wages not paid, raw materials not consumed), so the LKR 45m is a gross figure, not a loss.
What the insured should be told. The LKR 45m is uninsured and not recoverable from A. The insurers' subrogated claim against Ravi Electricals is limited to the property damage they have paid; Northgate cannot inflate it to include profit. Its remaining routes are a direct negligence claim against the contractor for the whole loss, including lost profit, subject to remoteness and proof, and any professional-negligence claim against a broker who left the placement unbound without written confirmation.
File lesson. Where a broker obtains a quotation but no acceptance, the file must record in writing that cover does not exist, with a dated note to the client. That note, and a renewal checklist that lists unplaced covers, is what protects the broker when a loss arrives.