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Aspects of technological obsolescence in property insurance

One of the common problems an insured is faced with in Property insurance is the inability to find an identical replacement for damaged equipment. This could be due to a range of issues such as obsolescence, stoppage of manufacture by OEM, capacity or design changes etc.

One of the common problems an insured is faced with in Property insurance is the inability to find an identical replacement for damaged equipment. This could be due to a range of issues such as obsolescence, stoppage of manufacture by OEM, capacity or design changes etc..

Under such circumstances the insured has no option but to replace the damaged item with the closest possible fit available in the market. There may also be situations wherein the insured may consciously opt for a slightly better product albeit within the price range of the original and such improvements are often “adjusted” from the claim payout.

Betterment in insurance claims refers to situations where the repairs or improvements made to a property result in its value being enhanced beyond its pre-loss condition. This can occur even if the improvements are not deliberately sought by the policyholder but are a byproduct of the repair process. At the same time general insurance provisions do not allow/provide indemnity for the “voluntary” improvements which are desirable and could be because of change in product stream based on market scenario or changes in design specifications for process improvement.

As per the principle of indemnity in Property insurance policies with reinstatement condition, the coverage is new for old, however of similar type as the damaged item. In case the insured replaces the damaged item with one which is more technologically advanced or having superior features, insurers must balance this with the principle of indemnity, which aims to restore the insured to their original financial position, not to improve their asset. Hence there would be a deduction to the loss amount payable due to betterment.

In order to minimize the application of betterment penalty to the loss amount, it is advisable to incorporate appropriate clauses which allow the insured a certain amount of flexibility when replacing damaged property to account for factors such as technological advancement and obsolescence.

We have several clauses available in the market to this effect to minimize or nullify the impact of betterment on the claim payout. An explanation of some of the prominent clauses are provided below.

The policy considers the measurable output of the property (equipment) damaged to determine the indemnity. If the output of the replaced property is the same or equal to that of the damaged property, then the insurable value considered is that of the replacement. If the replaced property has an output higher than that of the damaged property, the insurable value is determined by considering the % difference between capacities of the replaced item vs damaged item.

The insurer allows the insured to replace the damaged property with ‘dissimilar property’ even if it is used for a different purpose as long as the liability is not increased beyond the amount which would have been payable in the conventional manner of reinstatement/replacement.

The insurer allows the insured to replace technologically obsolete equipment that is no longer being manufactured by one that is based on contemporary technology and replaces the capacity of the original equipment up to a pre agreed policy sub-limit.

The insurer allows replacement of damaged property which is obsolete and unavailable by one which is similar and capable of performing the same function. Such a replacement will not be considered as a betterment under the policy. The policy also extends coverage for replacement of undamaged existing equipment which is incompatible with the new equipment installed to replace the damaged equipment.

The clause operates in a similar manner to the involuntary betterment clause the only difference being that it permits reinstatement or replacement at the same or another site at the absolute discretion of the insured. It also permits voluntary betterment if the cost does not exceed the cost to repair/replace/rebuild the damaged property.

Whilst each of the above clauses provides a certain degree of relief to the insured for replacing obsolete property with one that is in line with current technology, the insured needs to be careful with the wording in relation to whether it allows voluntary betterment, incompatibility expenses with undamaged property and flexibility as regards location of replacement or reinstatement.

On comparison the Marsh wording provides coverage that captures the above essential elements and safeguards the interest of the insured when encountered with a situation wherein replacement of obsolete property is imminent following physical damage. Clause wordings can be provided on request.

Claim example:

Imagine a process plant which suffers extensive flood damage requiring replacement of the control panels and instruments. The current control system is based on programmable logic controller (PLC) and has been in place for around 20 years. When replacement is carried out the insured decides to install a distributed control system across the plant which offers better control, integration and reliability. The DCS system costs more than the old PLC system.

Betterment coverage would cover the additional cost, ensuring that the owner/s do not have to pay the difference out of pocket.

Conclusion:

It’s always beneficial for a prudent insured to understand in advance how policy coverage will respond in the event of a claim involving betterment of technology. This is keeping in mind that there are various clauses that help provide loss adjustment certainty, mitigate betterment deduction and offer tailor made coverage based on the technology currently in

place as well as known obsolescence. This ensures that policyholders are not left with unexpected expenses due to technology changes, material availability or safety upgrades, while also providing insurers with a more predictable and smoother claims process.

Another important aspect to be considered at all times is to ensure that the sum insured provided in the policy is adequate considering the possible improvement in technology to avoid underinsurance provisions.

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