Insurance: reinstatement, betterment, and exclusions in cyber policies

In Endurance Corporate Capital v Sartex [2020] EWCA Civ 308, the Court of Appeal considered the measure of recovery under a property loss and damage policy. It also considered when a deduction should be made for betterment. The decision illustrates the importance of including express wording in policies regarding both the measure of loss and betterment.

Background

The case concerned a fire at an industrial premises. The policyholder sought the cost of reinstating buildings and machinery under a property loss and damage policy. See our article on the first instance decision here.

Measure of loss

The insurance policy contained no provision fixing the measure of loss.

The Court of Appeal rejected insurers’ arguments that the policyholder had to show an intention to reinstate to be entitled to the cost of reinstatement. The insurer contended that the policyholder had not shown a fixed and settled intention to reinstate the property, so was only entitled to the market value of the property. The market value was less than the cost of reinstatement.

There is no general requirement for a policyholder to demonstrate a fixed and settled intention to reinstate, to be entitled to the cost of reinstatement. The Court of Appeal distinguished the case from Great Lakes v Western Trading, in which the policyholder did need to show a fixed and settled intention to reinstate. Great Lakes concerned an unusual situation in which a fire had increased the value of the property; that was not the case in Sartex.

Betterment

When will a reduction be made to reflect the fact that a policyholder is getting something new for old? The Court of Appeal distinguished between optional improvements and those that are incidental. If the improvement is optional, its costs are not recoverable. Even if the improvement is unavoidable though, a discount may be made where the policyholder enjoys a quantifiable financial gain. In other words, incidental benefits that are not financial, or those that cannot be measured, do not have to be accounted for by a policyholder. The Court of Appeal was clear that the onus was on the insurer to provide evidence quantifying the financial gain to the policyholder.

Implications

The decision will not be welcomed by insurers for two reasons. First, it makes clear that there is no general requirement that a policyholder must show a fixed and settled intention to reinstate, to be entitled to the cost of reinstatement. Second, the judgment confirms that reductions for betterment will not be made in all cases where the policyholder obtains a benefit. And an insurer is expected to adduce evidence quantifying the financial benefit to the policyholder.

Betterment exclusions in cyber policies

Cyber insurers will be interested in the commentary in Sartex regarding betterment. Cyber policies may provide cover for the reinstatement of computer systems following an incident. Insurers are likely to be concerned that, following a cyber attack, insureds should not use insurers’ money to pay for a complete replacement of an old computer system with the most up-to-date and expensive system. To this end, cyber policies routinely include exclusions entitled “Betterment” which exclude “any updating, upgrading, enhancing or replacing” of computer systems to a level beyond that which existed before the cyber attack. It might be thought that such a ‘Betterment’ exclusion restricted the recoverable reinstatement cost to the cost of the original old computer system.

The Court of Appeal has stated, however, that “there is no betterment…where an old machine is destroyed of a kind which can only reasonably be replaced by buying a new machine because there is no market in which a machine of a similar age can readily be found.” In that case, “the additional cost (of a new machine over and above the likely cost of an old machine, had it been available) is unavoidable.” On that view, it might be argued that a “betterment” exclusion does not apply to the replacement of old computers with new where that is unavoidable, because that is not ‘betterment’ at all.

It would of course still be open to insurers to argue either (a) that the replacement with a new computer system was not unavoidable, where old computers of the type damaged can still be obtained, (b) that the ‘betterment’ exclusion still excludes the cost of any new features of the new system that were not part of the old, and/or (c) that the insured must give credit for any savings capable of quantification in monetary terms that the new system will bring (for example, reduced maintenance or running costs). But the burden of proving such matters will lie with the insurers, and it may require complex expert evidence to do so.

Finally, it may be possible for Insurers to get around the above points in Sartex by adapting the wording of “betterment” exclusions to state, for example, that, where replacement with a better system is unavoidable, insurers will indemnify only up to the market price of the previous system. Such a provision would have to be carefully drafted, so as to avoid any suggestion that the insurers were seeking to restrict the insureds’ right to recover an indemnity on the reinstatement basis. This, per the Court of Appeal’s decision in Sartex, is the insured’s default entitlement.

Overall, the Sartex decision reinforces the importance of including express provisions dealing with both the measure of loss and betterment.