How to avoid insurance coverage disputes following electric and gas outages


New York, NY, USA – October 31, 2012: On the second night without power, the Lower Manhattan skyline appears as a silhouette over the East River from Brooklyn Heights promenade. The Hurricane Sandy storm surge combined with spring tides at the full moon caused the East River to flood and disable vital power supply equipment at the 14th Street Con Edison plant. (Photo: iStock)

Forced, unplanned or accidental outages are significant financial events for electric and gas utilities and their insurance companies.

Not only can such outages prevent utilities from fulfilling their service contracts, but they can also generate soaring expenses when they require utilities to purchase energy from spot markets.

Insurance for forced or unplanned outages can provide valuable financial protection, but insurance and claims executives need to be aware of several issues that can give rise to coverage disputes.

Unique insurance products

Policies that insure against losses arising from these kinds of outages are unique insurance products. They tend to have primarily first-party insurance components to them, but in some cases may have liability aspects as well. These insurance products can also be uniquely tailored to a policyholder’s business risks.

Most outage policies contain arbitration provisions for dispute resolution. Consequently, and as a result of the nuances related to these policies, there is little case law providing judicial guidance as to how these policies and their terms and conditions are to be interpreted under various loss scenarios.

Outage policies are often triggered by an unplanned outage event. Many policies define the scope of coverage using outage codes recognized by the North American Energy Reliability Corporation (NERC). For example, triggers of coverage have been defined under some policies as follows:

  • SF (Startup Failure): An outage that results when a unit is unable to synchronize within a specified startup time following an outage or reserve shutdown.
  • U1 (Immediate): An outage that requires immediate removal of a unit from service, another outage state or a reserve shutdown state. This type of outage usually results from immediate mechanical/electrical/hydraulic control system trips and operator-initiated trips in response to unit alarms.
  • U2 (Delayed): An outage that does not require immediate removal of a unit from the in-service state, but requires removal within six hours. This type of outage can only occur while the unit is in service.
  • U3 (Postponed): An outage that can be postponed beyond six hours but requires that a unit be removed from the in-service state before the end of the next weekend. This type of outage can only occur while the unit is in service.

Scope of coverage

An issue that may arise when determining the scope of coverage under an outage policy is whether the utility properly classified the outage. What if the insured placed its unit into a U3 state when in fact the issue prompting the outage did not need to be addressed within the week?

Related: 18 tips for what to do before, during and after a power outage

This raises the question of whether the policy intended to insure the subjective actions of the insured — i.e., the act of placing the unit into a U3 state. Or did the policy intend to insure an objective event — i.e., an event that actually needed to be addressed immediately? Or is the standard a hybrid of these two — for example, a situation that a reasonable insured would have believed required immediate attention based on the information available at the time.

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Winter power outage

Coverage for power outages can be limited if a supplier fails to comply with “prudent utility practices.” (Photo: iStock)

Outage classifications

Another issue that may arise is how to classify a particular event. Interestingly, the NERC publishes guidelines that include examples offering guidance to appropriately classify disruption events. These guidelines can serve as a legislative history to give further meaning to the NERC outage definitions. Unfortunately, they can also provide fodder for disputes when the insurer and insured disagree as to whether an NERC example is analogous to the facts of a particular claim. Sometimes an outage can resemble more than one NERC example.

Outage policies frequently restrict coverage when an insured fails to comply with “prudent utility practices.” This can take the form of an exclusion for unplanned outages “caused by willful disregard of prudent utility practices in the operation and maintenance of” the facility.”

Or, the policy might contain a condition whereby the insured agrees to follow prudent utility practices, such that a failure amounts to a breach of a condition precedent to coverage. Determining whether failure to follow prudent utility practices will limit or bar coverage can be fact-intensive and may require a root cause analysis.

Where insured’s action prudent?

Retention of standard of care experts as well as individuals who are familiar with NERC guidelines and the operation of power plants and generators for the industry at issue are often necessary to determine whether the insured’s actions were imprudent. Thus, a careful review of company records will be necessary to gain a full understanding of all relevant maintenance and care instructions, including manufacturers’ recommendations and inspection reports, which may be obtained through detailed document requests to the insured.

Some outage policies exclude coverage for events that the insured should have reasonably anticipated prior to the policy period. For example, a policy may state that the insured represents there are “no known defects in material or workmanship that are likely to lead to an insured event.”

Fact-intensive inquiries, expert opinions

Is, for example, knowledge that a similar unit sustained a catastrophic failure at a competitor’s facility, knowledge of a known defect? What if the insured receives a manufacturer’s recommendation that a unit be inspected for a specific defect during the next scheduled outage? This is an example of another policy provision that will lead to fact-intensive inquiries, detailed document requests, and require one or more experts to assist in policy application decisions.

Outage insurance policies offer considerable advantages for utilities as well as growth opportunities for insurance companies. To get the best results, however, insurers should carefully review their policy wordings and, where necessary, consult legal counsel to align coverage with underwriting expectations and avoid claims disputes.

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Jane E. Warring is a senior counsel at Clyde & Co US LLP, and Robert W. Fisher is a partner at Clyde & Co US LLP, where they advise on insurance coverage issues and handle disputes involving forced outage policies, large property losses, business interruption claims, subrogation and construction matters, and other issues.