Introduction
From time to time, the production, trading, transportation, and consumption of commodities is severely disrupted by an unanticipated event which has far-reaching implications. In recent years, for example, the commodity supply chain has been disrupted by events including major economic crashes, war, politically motivated trade embargoes, widespread export bans, and environmental disasters.
What these events have in common is their ability to disrupt, with immediate effect, previously stable markets and supply chain infrastructures. During these periods of major disruption, many businesses will be looking to their cargo, storage, and other physical commodity insurances to provide protection against loss and damage which occurs as a result. Equally, businesses will be expecting their insurance to provide cover in respect of unrelated loss and damage which happen to occur during these unusual periods.
However, in an environment where many businesses are facing unprecedented challenges as a result of the disruption, including in the case of the present pandemic staff shortages and mandatory work-from-home measures, the proper placement and operation of insurance policies may be more challenging than ever.
This is important because many insurance claims fail not due to the nature of the loss asserted being outside the scope of the coverage, but due to ‘technical’ failures at either the time of placement, during the day-to-day administration of the policy, or during the claim process itself.
These types of issue apply equally to all English law-governed commodities insurance policies regardless of the commodity insured, and are as applicable to energy commodities such as liquefied natural gas (LNG), crude oil and petroleum products, and ‘hard’ commodities such as metals, minerals, and ores, as they are to ‘soft’ commodities such as grains, oil seeds, food oils, and sugars.
Considering the enormous pressure the insurance market comes under as a result of these types of major events, insurers can be expected to scrutinise potential technical and administrative defences more closely than ever.
This article focuses on the ways in which major disruptions to the commodity supply chain could indirectly trigger common barriers to recovery under physical commodity insurance policies, and provides a ‘checklist’ of points to consider when placing, administering, renewing, or claiming under a policy during, and in the immediate aftermath of, such events.
Placing and renewing insurance for physical loss and damage of commodities
When you take out an insurance policy, English law imposes a duty to provide insurers with a ‘fair presentation’ of the risk insurers are being asked to cover. This is a duty of ‘utmost good faith’, and, crucially, it applies equally when an existing policy is being renewed (even if the renewal is on identical terms).
What this means in practice is that before the cover is placed (or renewed), you must provide insurers (either directly or via your insurance broker) with all ‘material’ information relevant to the risk(s) which you want to be covered. Information is ‘material’ if it would influence a prudent insurer’s decision on (i) whether or not it is willing to accept the risk and provide the cover, and (ii) if so, on what terms (for example, the amount of the premium payable, the level of any excess, and the limits on coverage).
A failure to give a fair presentation of the risk will allow the insurers to either avoid coverage altogether or (depending on circumstances) to reduce the amount the insured is entitled to receive.
In a ‘business as usual’ environment, providing a fair presentation of the risk may be straightforward. However, during a period of significant disruption, it is prudent to pause and consider how, if at all, that disruption has altered the way in which your business operates, and the risks to which your goods are exposed. For example, have storage or transit times increased? Are facilities such as pipelines, terminals, or warehouses which you rely on to keep your goods safe operating in the usual way? To the extent that you have traditionally protected your goods via collateral managers, independent surveyors, and security personnel, are these services still available in their previous form and are standards being maintained? What about the political situation and civil order in the places where your goods will be stored or will transit through?
These are the types of considerations that are likely to be of great interest to your insurers, and during the present pandemic and other periods of major disruption, you can no longer assume that the information you have provided in previous years will still be up-to-date and accurate.
If possible, we recommend that personnel with responsibility for placing insurance speak to traders and operators in order to determine what the ‘new normal’ looks like for each commodity which needs to be covered, and think about any new or altered risks which you may want to include in your policy as a result.
Provide as much detail as you can to insurers upfront, and consider asking them what (if any) additional types of information they expect you to provide in light of the new conditions under which you are operating. While a detailed and ‘upfront’ approach could result in higher premiums in the short term, this is likely to be preferable to finding yourself without coverage later on.
Operating an existing policy
All going well, you will not currently be facing physical loss of or damage to your goods, or expecting to have to make an insurance claim. However, following a large-scale crisis such as the Covid-19 pandemic of 2020, an outbreak of hostilities, or a major environmental incident, events are likely to unfold rapidly, and as the supply chain and the infrastructure supporting it come under increasing pressure, it is sensible to be prepared for every eventuality. As a first step, this includes ensuring that your existing policy is on suitable terms and is being administered properly.
Conditions precedent
One of the most commonly encountered obstacles to making a recovery under a physical loss and damage policy is a failure to comply with the conditions precedent to coverage which are set out in the policy. These conditions precedent are mandatory, and if they are not followed, coverage will not be available.
Often these conditions precedent are focused on ensuring the insured has taken reasonable steps to keep the goods safe from physical loss and damage. However, they can cover any subject matter including, for example, an obligation to make regular ‘declarations’ to insurers about the quantity and value of goods within the scope of the policy.
If you can, take a moment to consider the conditions precedent to your coverage. Can these still be complied with in light of the disruption? For ease of reference, here are some considerations based on the types of condition precedent which we see frequently. However, this list is not exhaustive and every policy will be different:
a. What is the maximum period of time that goods can be stored at the loading and unloading port? Are these limits likely to be exceeded considering the disruption (for example, because ports or terminals are closed or congested, or because you cannot find an off-taker for your goods)?
b. Where periods of storage or transit are likely to be longer than usual, is there an increased risk for goods that need to be stored in special conditions? For instance:
i. Can the spreading and turning of cargoes which are prone to heating, sweating, or combustion be carried out in the usual way?
ii. For cargoes that need to be either heated, refrigerated, or frozen during the sea voyage, can the vessel sustain these conditions during extended delays as a result of (for example) diversion, port congestion, or quarantine?
c. Have you agreed with insurers that your goods will be independently monitored by a collateral manager or independent inspection company? Can these arrangements be sustained if, for example, the disruption has resulted in the relevant country imposing curfews or other restrictions on the movement of people?
d. Have you undertaken to report to insurers at regular intervals on the quantity and value or condition of the goods covered by the policy? If your goods are no longer accessible, how will you validate these matters and report to insurers going forward?
If you are concerned that you may be unable to comply with any of the conditions precedent in the insurance policy, we recommend that you speak to your insurers urgently. It may be possible to agree to a period of exemption from these requirements, or the insurers may be willing to agree to insure the goods on different terms (perhaps in return for an additional premium).
Alternatively, if the conditions precedent can, in principle, be complied with, it is still worth talking to the people within your organisation who are responsible for performing the conditions precedent in practice. Emphasise the importance of compliance, and see if you can put a system in place so that the correct people will be notified if the position changes.
Exclusions
If you can, we also recommend that you refresh your memory of the exclusions to coverage which apply under your policy.
The way in which an organisation does business can change over time, and insurers are not always kept up to date about these changes. Where a company has been using the same insurers for an extended period, or the same policy has been renewed over a number of years, it is not unusual to find that a policy excludes coverage for risks which the insured now considers to be an ordinary part of its business. Equally, in the new environment in which you are working, exclusions which were not previously problematic may no longer be suitable.
Exclusions to coverage are bespoke, and you will need to check your policy to find out which exclusions apply to your business. However, to kick-start the process, here are some common exclusions to consider:
a. Some policies exclude cover for loss and damage arising out of communicable disease (or steps taken in response to the threat of communicable disease). An exclusion of this kind will be highly relevant following disruption caused by an epidemic or pandemic. Does it apply in your case?
b. What are the geographical limits of your policy? Can these be complied with under present conditions? For instance:
i. If you plan to move goods by sea, the vessel owner may have insisted on a right to divert the vessel in order to avoid the newly arisen risk (these types of clauses have become common following the outbreak of the two Gulf wars, for instance, and following major health crises such as Ebola and COVID-19). Does this permit owners to divert your goods to a port or country which is excluded by your policy?
ii. For industries such as crude oil and petroleum products, if you are facing a material lack of storage, will you be required to discharge goods into facilities in new jurisdictions?
c. For goods in storage in a silo, warehouse, or terminal, is there a per location limit on the quantity or value of the goods? To the extent stocks are building up due to supply chain disruption or a reduction in demand, goods outside of this limit will be excluded from coverage. (It is also important to familiarise yourself with how a ‘location’ is defined in the policy. Separate warehouses or tanks in the same facility, for example, may be treated as a single location).
d. For certain types of risks, are losses beyond a fixed financial limit excluded? For example, it is common for misappropriation risks, or risks arising out of the inherent nature of the goods, to be subject to a cap on liability. Are those caps realistic in the new environment that your business is now operating in?
We recommend that you speak to your insurers urgently if any of the exclusions in your policy are no longer acceptable to your business. It may be possible to agree to an extension of coverage.
You may also wish to remind relevant colleagues of the applicable exclusions so that concerns can be raised internally at the earliest opportunity.
Making a claim
Notification of actual and potential claims
Claims procedures may contain specific instructions about when, how, and to whom an actual or potential claim must be made. There may also be requirements about what documents and information you have to provide with a claim notification, and how regularly insurers must be updated following an initial notice of claim.
Hopefully, you will not be thinking about making a claim at this time. However, considering the unique risks which can arise following a major disrupting event, it is sensible to be prepared. In particular, please remember that bringing a claim correctly may be a condition precedent to coverage. If so, a simple mistake in the notification process could result in the loss being uninsured.
Some practical steps to consider before a claim arises include:
a. How do you know if you might have a claim? Due to disruption to the supply chain, you may be unable to access your goods in the usual way. Should you consider a protective notification on the basis that you do not currently know the quantity or condition of your goods? Are there emergency measures which you can put in place in order to assess these matters?
b. Create a claim notification checklist which sets out the key steps and time limits for making a claim under each policy, and circulate this list to all relevant personnel.
c. Check with brokers and insurers whether the postal, fax, or email addresses set out in the policy for claim notifications are still being monitored. If not, how should claims be notified during the period of disruption? Equally, if a hard copy notice is required, can this still be given? Market participants will recall, for example, the major disruption to international courier services following the eruption of Eyjafjallajökull in Iceland in 2010.
d. If specific documents and information have to be supplied in order for a claim notification to be valid, can this be achieved considering staff shortages, disruptions to postal services, and so forth? If not, tell insurers immediately. It may be possible to agree on an interim procedure which will apply until the disruption is over. If insurers are not cooperative, consider whether you should send a reservation of rights now, or include suitable reservation wording in any future claim notification.
Finally, as soon as there is a risk that a claim might arise:
a. Notify insurers immediately, even if you are not certain that loss or damage has definitely occurred. It is better to be safe than sorry.
b. Begin the process of gathering documents and information about the incident straightaway, and ensure they are stored in one place. Even if these documents and information are not required immediately, they may be relevant later. The immediate aftermath of an incident (and before new distractions arise) is the best time to gather these materials, and having everything to hand now will reduce the risk that the time required to analyse the material and process the claim is not lost trying to locate information.
Acting as a prudent uninsured
Even if you are confident that your existing policy will cover all of the risks you are likely to face as a result of the disrupting event, remember that if you suffer loss and damage, English law imposes a duty to act as a ‘prudent uninsured’.
This means that as soon a risk of loss or damage arises, you must take reasonable steps to mitigate your losses, as if you did not have insurance coverage in place.
The purpose of this approach is to reduce the amount which insurers have to pay you, and to give your insurers the best possible chance of recovering all or part of the moneys they have paid you from any third party who contributed to your loss. If you do not comply with this obligation, then the amount you are entitled to recover under the insurance policy may be reduced in proportion to the losses you could have avoided had you complied.
The steps you need to take will vary on a case-by-case basis. However, here are some initial considerations that may be relevant:
a. Has a third party with whom you have a contract caused or contributed to your actual or expected loss (for example, a vessel owner, a storage keeper, a collateral manager, a terminal operator, a security provider, or a customer)?
b. If the answer is ‘yes’ (or maybe), carefully consider your rights under the relevant agreements. Make sure that you insist on performance of the agreement in accordance with its terms (even if you know this will be impossible in practice), and give any required contractual notices on time.
c. If the relevant agreement contains a time limit for making a claim, make sure this is complied with and that your claim does not become ‘time-barred’. Be mindful that due to the disrupting event, the relevant courts may be closed or subject to delays. If you can, take advice from local lawyers on how to preserve time limits in the newly altered environment sooner rather than later.
d. If the relevant third party wants to find an amicable solution, that is fine. But make sure you let the insurers know, and do not agree to any extension of time for performance or compromise of your claim without first asking for the insurers’ approval.
We appreciate that during difficult times of major disruption, you may be relying on contract counterparties to cooperate with you in order to find a solution. Giving notices may feel inconsistent with that.
However, this risk has to be balanced against the risk of compromising your insurance coverage. Therefore, you will need to give some thought to how you manage the message to your counterparties. For example, you might accomplish this by using open channels to satisfy your obligation to act as a prudent uninsured, while using ‘without prejudice’ channels to explain that you are still open to finding an amicable solution.
Conclusion and summary
Every insurance policy is on different terms, and will operate differently.
However, we hope that the above is a helpful reminder as to how simple administrative and technical mistakes can present an obstacle to coverage and how the ways in which a major disrupting event and the local or global response to it may require a change to both the terms of your coverage and the way in which you operate your relevant policies.
Client Alert 2020-213
