International Marine Claims Conference - Dublin 26 th October 2005

1. International Marine Claims Conference - Dublin 26th October 2005 Builders’ Risks – Proposed changes Chris Zavos

2. Introduction • Institute Clauses for Builders’ Risks (01/06/88) • Cover purchased by yards or owners (usually in the case of upgrades and conversions) • First developed in 1963, amended in 1972 and again in 1988

3. What prompts change? (1) • IUMI Singapore October 2004 • Horrendous losses from October 2002 to January 2004

4. What prompts change? (2) “Diamond Princess” – US$ 310 million

5. What prompts change? (3) “Pride of America” – US$ 228 million

6. What prompts change? (4) • Premium October 2002 to January 2004 – US$ 125 million • Losses October 2002 to January 2004 – US$ 740 million • More recently • LNG cargo tanks – Chantiers De L’Atlantique • And …

7. What prompts change? (5) Hurricanes Katrina and Rita US$ 250m ?

8. What prompts change? (6) • Market response • Rating, deductibles • Coverage • Pre-risk surveys – JH143 • The 1988 clauses • Under scrutiny • Clarity and contract certainty • Flexibility

9. A short history (1) • Introduced in 1963, amended in 1972 • Cover against all risks of “loss of or damage to the subject matter insured including the cost of repairing, replacing or renewing any defective part condemned solely in consequence of the discovery therein during the period of this insurance of a latent defect” • Amendments in 1972 • Termination upon “delivery to Owners” • Incorporation of Institute Full Value Clauses

10. A short history (2) • New exclusion • “Notwithstanding anything to the contrary which may be contained in the Policy or the clauses attached thereto, this insurance includes loss of or damage to the subject matter insured arising from faulty design of any part or parts thereof but in no case shall this insurance extend to cover the cost or expense of repairing, modifying, replacing or renewing such part or parts, nor any cost or expense incurred by reason of betterment or alteration in design.” • Amendments in 1988 • “all risks of loss of or damage to the subject matter insured caused and discovered during the period of the insurance” • New exclusion • “In no case shall this insurance cover the cost of renewing faulty welds”

11. A short history (3) • Earthquake and volcanic exclusion • narrower than “warranted free of claim arising from earthquake or volcanic eruption, or tidal wave arising therefrom” • The process of change • The committee includes Claims and Average Adjusters • Facelift or re-write … • Consultation • Release draft in late 2005 • Consult until April/May 2006 • Finalise for a 1/5 or 1/6 release

12. The issues on the 1988 clauses (1) Page 1 – is it ever completed?

13. The issues on the 1988 clauses (2) • Who is the assured • Yard? Owner? Contractors? • “and/or … and/or”? • Is there cover for simple discovery of a latent defect? • Interaction between latent defect cover and the faulty design exclusion • Constructive total loss? • Unrepaired damage

14. The recent authorities • Not many, but two important ones • State of Netherlands v Youell 1998 • Application of paint to submarines built for the Dutch navy • Excessive thickness in the primer coating • Both yard and navy insured under BAR insurance • Composite rather than joint cover – failings of yard could not be visited on the Dutch navy • Shell UK v CLM Engineering 2000 • Breakdown of insulating gel • Cover for pure economic loss? • Both cases settled without the Court being asked to determine whether de-bonding of paint or breakdown of gel was “damage”

15. The new clauses (1) • Format – 6 sections • General provisions – definitions, premium, due diligence, measure of indemnity, subrogation • Section A • Principal all risks cover and exclusions • Section B • Liability cover – P&I and RDC • Section C • War risks cover effective from launch • Section D • Strikes, terrorism, political motive and malicious acts cover effective on inception • Section E • Optional buybacks in respect of Section A exclusions

16. The new clauses (2) • Assureds, other assureds and subrogation • Who is it/are they? “affiliates, contractors, sub-contractors and those from whom the assured may receive instructions to insure” or “as may be required” • BP Exploration v Kvaerner 2005 • A wide “other assured” clause will not in itself be sufficient to give cover • the insured operator “must have assumed a contractual obligation to such contractor to procure the benefit of cover for him”. • Cover for contractors where • Written contracts with the assured • Contracts provide for contractors to have the benefit of cover

17. The new clauses (3) • But • Cover no wider than provided for in the written contract • No greater rights under the insurance than the assured • No waiver of subrogation to the extent contractor required to take out liability cover • Due diligence • New • Duty to exercise: • By the assured in the choice of sub-contractors • By all assureds in the conduct of operations • Objective test and Underwriters not liable for loss attributable to a failure to exercise due diligence

18. The new clauses (4) • Works value/CTL • Sum insured defined in the slip – escalation limited to 10% (unless otherwise agreed) • Based on a “Works Value” comprising: • Labour cost • Material cost • Contractor cost • Plus an agreed percentage by way of overhead

19. The new clauses (5) • When does a CTL arise? • Attempt to mirror standard form build contracts • Builder relieved of obligation to build when vessel “determined” or “deemed to be” a total loss (which includes a CTL) • Cart driving the horse? • CTL will now arise where the costs of recovery/repair exceed the “Works Value” at the time of loss

20. The new clauses (6) • The principal insuring clause • Remains an “all risks” form • But all risks of “physical loss” or “physical damage” • English insurance definition of damage? - at least “a physical change in state leading to a loss of value or usefulness” • Reinforces the position at law and makes clear that no cover for pure economic loss. Compare offshore construction wordings • Australian authority that “loss of usefulness” may be damage, but not physical damage • Define “damage”???

21. The new clauses (7) • Latent defect • “this insurance is against all risks of loss or damage to the subject-matter insured caused and discovered during the period of this insurance including the cost of repairing, replacing or renewing any defective part condemned solely in consequence of the discovery therein during the period of this insurance of a latent defect”. • Is discovery enough in the absence of consequential damage? • Steel J in Shell v CLM Engineering thought not • Section A likely to exclude claims for repair or rectification of latent defects and defective design, whilst allowing claims for consequential damage

22. The new clauses (8) • Costs of rectifying latent defects and defective design will be optional buybacks in Section E, where there has been consequential damage – akin to the Additional Perils Clause • Renewing faulty welds and costs of betterment or alteration in design will remain excluded as presently

23. Summary • 1988 clauses draw heavily on their 1963 predecessors • Probably no longer appropriate to multi-million dollar constructions • New form will • Enable a more flexible approach • Provide clarity in a number of areas which are inherently uncertain • Provide “contract certainty” • Comments and questions welcomed