By Daniel Wood
Wotton + Kearney (W+K) recently announced the winner of its Turning Point competition that explores changes and challenges in the property, energy and infrastructure market.
The winner was Nathan McLellan (pictured above), vice president of first party claims in Asia-Pacific for Liberty Specialty Markets (Liberty). McLellan, with contributions from W+K’s special counsel Matthew Foglia, wrote a paper on “The importance of clarifying LEG2 and LEG3 during the transition to clean energy”.
The LEG insurance coverage clauses take their name from the London Engineering Group who drafted them during the mid-1990s. The clauses are widely accepted by insurers globally and, according to W+K, “ubiquitous in Australian Construction All Risks (CAR) and Erection All Risks (EAR) policies.”
However, according to industry experts, the structure and language of the clauses can lead to contested outcomes and McLellan’s paper calls attention to technical nuances in LEG2 and LEG3 that warrant refinement to better suit the Australian market.
“This is in an area where there is very little law and which will inevitably be at the forefront of claims experience in the energy transition rush,” said Adam Chylek, W+K’s head of property, energy and infrastructure who described the paper as a “deserving winner.”
McLellan said the paper wasn’t about challenging the conceptual foundation of the clauses. However, he said updating and improving these clauses to enable clearer risk transfer will benefit “all parties to the insurance policy” including projects involving new construction techniques or technology. He said this would allow insurers to price a risk confidently and to set policy terms and conditions that reflect the risk that they’re taking on.
“It also allows insureds to make sure that they are very conscious and very familiar, objectively, with what risk they are transferring to the insurance market and what they continue to retain,” he said.
Understanding this important but technical topic area is not for the faint hearted.
Insurance Business asked McLellan, what it is about the structure and language of these LEG clauses that can result in contested outcomes?
“There is no short answer to this question,” he said. “The two issues that we concentrated on quite deliberately were the demarcation between defect and damage, as well as the practicalities of adjusting losses in circumstances where the qualified cover for costs associated with defects that these clauses can provide in certain circumstances, was enlivened.”
McLellan said LEG2 and LEG3 both start with an exclusion for costs arising from defects.
“It’s a broad-based exclusion and it’s only in the event of damage to insured property that a limited exception to that broad based exclusion is enlivened or activated and the precise ambit of that exception really depends on whether we’re talking about LEG2 or LEG3 in a given loss situation.”
He said LEG3 contains the cover that’s best described as the broadest from an insured’s perspective.
McLellan said the first significant LEG clause issue concerns the need for clarity about the damage required to engage the proviso.
“The need to differentiate between damage that triggers what’s called the proviso to each of LEG2 and LEG3, and that which perhaps conveniently might be described as the ordinary or foreseeable behaviour of a particular defect is important,” he said. “Mainly because there needs to be clarity about when this exception to the broad opening exclusionary language in each of LEG2 and LEG3 is enlivened.”
For example, McLellan said damage that is independent of the defect but caused by a defect impacting on other works that are being undertaken, “will plainly enliven the proviso.”
“The issue is whether claimed damage that is not independent of the defect, or put another way, where the alleged damage and the defect are one and the same, can also do so,” he said.
Despite LEG clauses making it clear that just because something is defective, it doesn’t necessarily follow that it’s damaged, he said this is still “at the heart of many of the debates that arise when these clauses are being applied.”
“Sometimes there’s a measure of controversy around whether a defective asset or a defective piece of equipment is, without something more, sufficient to trigger the policy and, thereafter, the modified cover that these LEG clauses allow,” said McLellan.
For example, he said a debate might concern damages caused by bringing together sound materials in a defective way.
“However, I think most insurers would probably say that bringing together otherwise sound materials in a defective way is not really the type of damage to which the LEG2 and LEG3 clauses were intended to respond,” said McLellan. “The view that Matt and I are contending for in the paper, is that without more, the mere fact of a defective asset or defective piece of equipment, is not necessarily sufficient to trigger cover under the policy and the LEG clauses that form part of it.”
He said removing or reducing the level of doubt in this area “will be a step forward for everyone involved.”
McLellan said the second LEG issue in his paper concerns the practicalities of loss adjusting and differentiating between what remains excluded and what is actually covered under the policy.
“In the case of LEG2 and LEG3, even where the proviso or the qualifier is engaged, what is brought back within the ambit of cover once the proviso is engaged is still limited,” he said.
McLellan said complex construction techniques or novel technologies can make this very difficult.
“LEG2 basically requires you to develop a counterfactual so that the costs that are going to be excluded are those that would have been incurred if repair or reinstatement had been taken in hand immediately before damage occurred,” he said. “LEG3, on the other hand, looks to exclude those costs that are incurred to improve the material, the workmanship, design or specification that proved to be defective.”
McLellan and Foglia hope that the London Engineering Group take on board their paper’s suggestions for the next version the LEG clauses.
“Ultimately, and I believe I can speak for Matt here, what we don’t want to see is regionally specific variations of LEG2 or LEG3 produced and adopted in different parts of the world,” said McLellan, “The better outcome would be for local concerns to be identified and articulated and then funnelled back to the London Engineering Group to consider so that any future iterations are as apt here in Australia, or Europe, or the US, as they are anywhere else in the world.”
McLellan is modest about his achievement.
“It was fortuitous that it [winning the award] went to Matt and I but there is a lot of good thought leadership out there and this competition that W+K are generous enough to sponsor is just a way of bringing it all through,” said McLellan.
“The importance of clarifying LEG2 and LEG3 during the transition to clean energy” can be downloaded here.
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