A natural question that arises is why a provision is made to insert a limit when, in fact, the limit is part of, and not in addition to, the policy limit. The answer is to accommodate those businesses whose properties are scheduled and not all of the properties are exposed to utility services losses. The same rationale applies to businesses with properties written on a blanket basis and not all locations are confronted with the utility service exposure.

 

The criteria for coverage under this endorsement are (1) loss or damage to covered property (e.g., building, the named insured's business personal property, or personal property of others) as described in the schedule of the endorsement, exclusive of any electronic data; (2) caused by the interruption of service to the described premises; and (3) the interruption must result from direct physical loss or damage by a covered cause of loss to the selected property exposures (e.g., water supply, communication supply, or power supply services).

 

Assume, for example, a grocery store purchases this coverage, subject to a broad causes of loss form. If it sustains a power supply outage that causes spoilage to foodstuffs due to an act of vandalism at the supplier's premises, coverage would apply, subject to any deductible, because the criteria for coverage has been met.

 

Thus, (1) there was loss or damage to the insured's covered business personal property; (2) there was an interruption of service to the described premises; and (3) the interruption resulted from direct physical loss or damage by vandalism, a covered cause, to the power supply services.

 

It is important to emphasize that all of the criteria must be met. If, for example, the power outage were caused by flood or artificially generated electric currents, neither of which is covered by the ISO forms, coverage would not apply for any loss or damage to the insured's covered property.

 

Utility Services—Time Element

 

If a business decides one or more of its locations is a candidate for utility services—direct damage coverage, it also should consider time element coverage if one of the business income or extra expense coverage forms is applicable. In fact, the time element exposure is often a more important consideration than is the direct damage exposure.

 

To obtain coverage for loss of business income and/or extra expenses caused by interruption of service to the described premises resulting from direct physical loss or damage by a covered cause of loss to the appropriate utility services selected, it is necessary to attach the Utility Services—Time Element endorsement, CP 15 45.

 

A condition precedent for attaching that endorsement is that the named insured must also have purchased some form of business income and/or extra expense coverage. The appropriate coverage forms to which the Utility Services—Time Element endorsement can be attached are Business Income (and Extra Expense) Coverage Form Business, Income (Without Extra Expense) Coverage Form, or Extra Expense Coverage Form.

 

A review of the Utility Services—Time Element endorsement reveals that it contains the same schedule of exposures (water supply, communication supply, and power supply, with or without overhead transmission lines) as appears in the direct damage endorsement. The definitions of "water supply service," "communications supply services," and "power supply services" also are identical to the definitions contained in the direct damage endorsement.

 

However, it is the scope of coverage that is significant. When this endorsement is purchased, coverage under the appropriate business income and/or extra expense coverage form is extended to apply to (1) a suspension of operations at the described premises; (2) caused by an interruption in utility service to that premises; and (3) with the interruption in utility service resulting from direct physical loss or damage by a covered cause of loss to the property described as indicated by an X in the endorsement's schedule—water supply, communication supply property, or power supply property.

 

It is important to keep in mind the purpose for he direct damage and time element utility services endorsements. Since the basic, broad, and special causes of loss forms specifically preclude coverage for certain kinds of utility services damage and time element, it may be necessary to purchase either or preferably both of the utility services endorsements, one covering direct damage and the other time element.

 

Utility services time element coverage can be obtained only when the policy includes one of the business income and/or extra expense coverage forms. The utility services time element coverage is not activated unless there is an otherwise covered loss involving the Utility Services—Direct Damage form. This is the same requirement that applies to business income and extra expense coverage written in conjunction with property policies; that is, until there has been otherwise covered physical loss or damage to property from a covered cause, time element coverage is not triggered.

 

Overhead Transmission Lines

 

An important question that needs to be considered is whether coverage should include overhead transmission lines. Before that decision can be made, however, one needs to determine what overhead transmission lines are and whether there is any difference between these and overhead power lines. Maybe they are the same. The insurance forms certainly are not going to give the answer. And, how many insurance buyers and their representatives have ready access to sources that can explain the difference? Do not consult search engines or dictionaries, since they are quagmires for this purpose.

 

In reviewing another, non-ISO utility services coverage form, "power supply services" is defined to mean transmission lines, excluding overhead transmission and distribution lines. What begs the question here is what the difference(s) may be between a transmission line, overhead transmission line, and a distribution line. It is an enigma that needs to be resolved if someone is interested in purchasing the appropriate coverage.

 

After querying one seasoned electrical engineer, the following was his response regarding the difference between overhead transmission lines and overhead power lines: "Overhead transmission lines are very high voltage lines used to transmit power over long distances, typically the kind of high towers one sees traversing the countryside. By using high voltage, smaller wires can be used. Usually the power emanates or terminates in substations, which then distribute the power to overhead power lines, which are those commonly seen on poles around town. The power can be both high and low voltage."

 

Here is another question for which an answer should be sought: could the transmission lines of a utility be considered equipment used to supply service to the described premises from a source away from the described premises? (This same question applies when a form includes reference to a distribution line.) The reason this question is important is, as was explained earlier, because of the utility services exclusion found in the basic, broad, and special causes of loss forms. In other words, if the power failure originates at the described premises because of the failure of equipment used to facilitate the utility service to the premises from a source away from the premises, coverage is excluded without the special coverage endorsements for utility direct damage and time element losses.

 

Let's say an insured maintains property insurance under a Building and Personal Property Coverage Form with a Special Causes of Loss form. As a result of high winds and tornadic conditions, the overhead power lines on poles in a given town become disengaged, including those at the business premises of the insured who had purchased the foregoing coverage. The question here is whether the insured has coverage for damage to the wires and power failure brought about by the winds. Much will depend on whether the transmission lines are considered to be equipment used to supply utility service to that business premises. If they are considered to be equipment, then the Utility Service—Direct Damage form would be necessary.

 

Of course, if the downed power lines were to cause a fire or other ensuing loss, coverage would apply to the ensuing loss or damage. Ensuing loss is customarily covered by property forms.

 

Let's assume further that the insured does not believe that the power lines to its place of business are considered to be furnished equipment of a utility but is sold on the idea that purchasing Utility Services—Direct Damage and Time Element coverages is a good idea. The question is to buy or not to buy the coverage that includes overhead transmission lines. Cost will likely be the major obstacle. If the power lines servicing the business premises are considered equipment (important for purposes of the utility services exclusion) and considered to be overhead transmission lines for purposes of Utility Services—Direct and Time Element coverages, it would be advisable to select coverage for the inclusion of overhead transmission lines.

 

The reason purely and simply is to avoid any argument that may arise when there is an otherwise covered loss brought about by interruption of service resulting from direct physical loss or damage from a covered cause. In other words, it might be worth the extra cost in purchasing coverage to include overhead transmission lines (whatever that means) simply to avoid any argument over coverage.

 

Spoilage Coverage

 

Those businesses confronted with possible loss to perishable stock can also obtain coverage. Spoilage Coverage endorsement, CP 04 40, covers loss by the (1) breakdown or contamination from mechanical breakdown or mechanical failure of refrigerating, cooling, or humidity control apparatus equipment at the described premises; (2) contamination by a refrigerant; or (3) power outage either on or off the described premises due to conditions beyond the insured's control.

 

This coverage endorsement, which is available only with the Building and Personal Property Coverage Form and Condominium Commercial Unit-Owners Coverage Form, applies solely to direct damage and not to time element loss. The endorsement's schedule requires the description of the property and the deductible. If coverage applies on a selling price basis, this needs to be designated by an X in the schedule since the valuation loss condition is amended to take the selling price into consideration. Also, if the insured has a refrigeration maintenance agreement, this also needs to be declared in the schedule if the insured purchases coverage against spoilage from breakdown or contamination.

 

This provision has a similar effect to a protective safeguard condition. If the maintenance or service agreement is terminated without notice to the insurer, the insurance is considered to be suspended at that location. This means that if a loss were to occur involving spoilage, coverage likewise would not apply.

 

Given the broad coverage provided by the Spoilage Coverage endorsement, CP 04 40, some insureds may find it unnecessary to also want to purchase time element coverage. In those cases where time element is also an important exposure, insureds will have to look elsewhere for that coverage since no ISO forms are available for that purpose.

 

Spoilage coverage along with loss of business income is available, however, under the Equipment Breakdown insurance offered by ISO. Presumably, these policies of other insurers likewise offer this coverage. Under the 2006 edition of the ISO Equipment Breakdown forms, coverage is available for spoilage loss caused as a result of service interruption by private or public utility resulting from breakdown, along with loss of business income.

 

The purchase of Utility Services—Direct Damage coverage requires certain criteria before a claim is considered to be covered. There must be (1) loss or damage to covered property described in the endorsement's schedule; (2) the loss or damage must be caused by an interruption in utility service to the described premises; and (3) the interruption must be caused by direct physical loss or damage by a covered cause to the property described—water supply, communication supply, or power supply.

 

If there is any potential problem here for insurers, it is likely to be with whether the insured supply source has sustained direct physical loss or damage. This subject is discussed in more depth later in this article. For the moment, what needs to be discussed are the court cases that have dealt with utility services exclusion.

 

Court Cases Upholding the Exclusion

 

The only court cases that appear to have been rendered involve older policies with provisions that are different from the standard ISO-type. These cases, therefore, may not be overly helpful in terms of how provisions may be construed by the courts today. They do, however, point out where arguments may arise in future disputes.

 

Interestingly, most of the cases have ruled against coverage, simply because business owners did not purchase the extra direct and time element coverages. Their only recourse has been to obtain coverage based on ambiguities, which can be a long-shot. One such case is Lyle Enterprises, Inc. v. AXA Re Property and Casualty Co., No. 04-75099 (U.S. Dist. Ct. E. D. MI 2005), which involved a claim following a mass blackout in 2003 that affected southeast Michigan, Ohio, Pennsylvania, and New York, as well as Canada. As a result of this blackout, the plaintiff grocery store was without power for approximately thirty-eight hours. Its losses were estimated to be $102,567 in stock, $7,000 in lost business income, and expenses of $3,642 related to the loss of power.

 

The insurer denied coverage based on a power failure exclusion that precluded coverage for failure of power or other utility service supplied to the described premises, however caused, if the failure occurred away from the described premises. The grocery store countered the denial by maintaining that coverage applied in light of the ensuing loss clause forming a part of that exclusion. The ensuing loss clause stated that if the failure of power or other utility service resulted in a covered cause of loss, the insurer would pay for the loss of damage caused by that covered caused of loss. The insurer responded by stating that loss of the food product by thawing was caused by a power outage of undetermined origin which was not a covered cause of loss. The court agreed that what had happened did not result in a covered cause of loss. The power failure also occurred away from the premises.

 

One of the cases relied on by the court in the Lyle Enterprises case was Gies v. City of Gering, 695 N.W.2d 180 (Neb. Ct. App. 2005) where the court also found the policy to preclude coverage based on a power failure exclusion. In this case, a broken cable on a utility transformer several blocks away from the insured's property caused the loss of one phase of the three-phase power being supplied to the insured property. Eventually, continued operation of several electric motors at the insured's premises caused them to overheat and stop working. The damaged motors were used to power refrigeration equipment. The power failure exclusion precluded coverage and there was no resulting covered cause of loss.

 

Utility Service Coverage Still of No Help

 

In Four Star Brothers, Inc. v. Allied Ins.Co., No. 04-CV-73401-DT (U.S. Dist. Ct. E.D. MI 2006), the issue arose following that same blackout that confronted the grocery store in the foregoing Lyle Enterprises case. When electrical service was restored, there was a power surge that caused damage to a computer and two compressors in the store. (According to the 2007 changes to the ISO causes of loss forms, this kind of loss would now be excluded if the surge would not have occurred but for an event causing the power failure.) The insurer here paid for the insured's equipment losses but denied liability for loss to the inventory and stock.

 

Interestingly, the insured in this case had also purchased a so-called Utility Services—Additional Coverage endorsement. This endorsement stated that the insurer would pay for loss of or damage to covered property described in the declarations for utility services, including loss of business income or extra expense caused by the interruption of service to the described premises. The interruption, however, had to result from direct physical loss or damage by a covered cause of loss to the property described and located outside a covered building. The property described was power supply services that encompassed utility generating plants, switching stations, substations, transformers, and transmission lines. The endorsement also stated that coverage did not include overhead transmission lines unless otherwise designated in the declarations.

 

The insured maintained, however, that it could prove the power supply services ceased and that those services ceased because the utility generating plants, switching stations, substations, transformers, or transmission lines stopped providing power. The insured also argued that loss of power being supplied to the utility constituted a direct physical loss to the utility and the reason why the utility discontinued supplying electricity was a question of fact for the jury to decide.

 

The court, however, found no merit to the insured's arguments. First, the mere cessation of power supply services at the utility and the fact that services to the insured ceased as a result did not demonstrate a direct physical loss. Second, the evidence did not support the insured's argument that there was a direct physical loss. Finally, even if there were to have been a direct physical loss to the utility's equipment, the insured failed to demonstrate how such direct physical loss or damage resulted from a covered cause of loss to one of the service providers, as required by endorsement providing additional coverage.

 

The court offered the following example of how that additional coverage endorsement would apply: the utility's property suffered a direct physical loss or damage by windstorm (a covered cause of loss) and, thereafter, electric service from the utility to the insured's store was interrupted due to such windstorm damage and the insured's perishable goods spoiled.

 

Potential Problem for Insurers

 

What can be a potential foreseeable problem for insurers not only with regard to these utility services endorsements but also in relation to all property coverages is the insurance policy's reference to "direct physical loss or damage" or separately as "physical loss" or "physical damage." Physical loss or damage is a common and essential term used throughout policies. To have coverage under a property policy, the one seeking payment must sustain physical loss or damage to covered property from a covered cause. Physical loss or damage is also the prerequisite for time element coverage.

 

What is becoming an increasingly troublesome question for insurers is what is necessary to show that there has been physical loss or damage to property under a property coverage form. Over the years, some insurers have tried to grasp onto the liability policy's definition of "property damage" to help make their point. In other words, they would argue that physical loss or damage in a property policy means that there must be physical injury to or destruction of tangible property. Of course, the glitch with this approach is that the liability policy definition of property damage also means the loss of use of tangible property not physically injured or destroyed, along with loss of use following physical injury or destruction. And, as is common with property policies, loss of use is commonly excluded. Relying on a liability policy for a solution involving a property policy, therefore, is like dealing with apples and oranges. It creates more confusion and will simply not work.

 

Insurers, therefore, may have to search for another solution to the reference of physical loss or damage in property policies or simply leave it as is and rely on the chances that not too many courts will view it as an ambiguity to the favor of insureds.

A case that illustrates the issue of ambiguity with reference to a utility services problem is Wakefern Food Corp. v. Liberty Mut. Fire Ins. Co., No. A-2010-0713 (N.J. Super. App. Div. 2009). This is another case that was an outgrowth of the August 2003 electrical blackout noted earlier, which was the impetus for the Lyle Enterprises case.

 

The named insureds (plaintiffs) owned and operated a group of supermarkets in five northeastern states. As a result of problems with the interconnected North American power system (the electrical grid), and the four-day blackout, the named insureds suffered losses from food spoilage, including loss of business. The insurer denied coverage, contending that the policy applied only in case of physical damage to off-premises electrical plant and equipment. Also, although the power grid was physically incapable of supplying power for four days, the insurer contended the insured suffered no physical damage and, therefore, there was no coverage.

 

During this period of the blackout, the named insureds had in force, as part of the property coverage, a services away from covered location extension, which extended coverage for consequential loss or damage resulting from an interruption of electrical power to the named insureds' supermarkets. Specifically, this extension read in pertinent part as follows: