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Policy wording to watch out for

In the first of a series of articles on the ambiguity of policy wording, Dr Allan Manning and Peter O’Brien from LMI consider two terms which are frequently encountered and often misunderstood.

It is a trite observation that insurance policies must be interpreted against the facts of each matter and in the context of the policy as a whole. Certain terms are capable of more than one meaning, depending on the context in which they are used, and may attract different meanings in different circumstances.

‘Damage’ (unqualified) versus ‘Physical damage’
The scope of policies providing cover for damage, especially in the context of product liability, can vary substantially where the word damage is not qualified by the word physical.

As a general rule, a mere physical alteration or change, not necessarily permanent or irreparable, that results in an impairment of the value or usefulness constitutes damage.

In the leading case of Ranicar v Frigmobile Pty Ltd (1983) Tas R. 113 (1983), a consignment of scallops was stored at a temperature which gave rise to an enzyme activity and a chemical oxidation of fats, but did not result in a significant difference in the edibility, taste, smell, texture or appearance of the scallops. Notwithstanding the absence of tangible damage, in terms of quarantine regulations, the scallops could not be exported. The court heard that their ‘usefulness was impaired’ and, accordingly, there had been damage to the scallops.

The Ranicar decision, which has been referred to with approval in a number of cases and by academic authorities, was endorsed by the High Court of New Zealand in Technology Holdings Limited v IAG New Zealand Limited and Anor (2008) NZHC 1227. The court found that ‘diminution in value or functionality’ is sufficient to constitute damage. However, the court went on to say that where the policy required physical damage there is, arguably, an additional element to the definition of damage in that ‘something must have happened to the property itself, followed by the impairment of value or usefulness, for damage to occur’.

In the case of Switzerland Insurance Australia Limited v Dundean Distributors Pty Ltd (1998) VSC 244, an electrical brownout caused a drop in the electrical power supply to a computer system, which meant that the computer system could not be operated to retrieve the insured’s accounting details. The policy required that physical damage be established. The court found that the ‘physical change to the alignment of magnetic particles’ constituted physical damage, although there was no permanent or irremediable damage to the hardware or software of the computer system.

Despite the lenient interpretation applied in the Switzerland Insurance case, a policy requiring physical damage requires some form of physical impairment as opposed to a mere reduction in value or functionality.

It follows that a policy requiring physical damage is likely to provide more restrictive cover than a similarly worded policy requiring damage.

In next month’s Broker Buzz our experts will consider interpretations of indemnity versus reinstatement in insurance policies.