Equipment breakdown coverage: it’s the modern-day descendant of what has been traditionally referred to as boiler and machinery insurance. And today’s businesses need it just as much as they did in the old days.
In fact, Denis O’Shea, assistant vice president of Hartford Steam Boiler Inspection & Insurance Company (HSB), said that these days, the term “boiler and machinery” is really a misnomer in that modern policies cover much more than just boilers and production machinery.
It’s also an area of insurance about which many agents and buyers remain uninformed in comparison to other commercial coverages.
“The truth is that just about any business needs equipment breakdown coverage,” O’Shea said. “If all you had was an electrical system, an air-conditioning system and some electronic equipment to produce or track inventory, you would need equipment breakdown insurance. It’s also true you don’t need to be a building owner to need it.”
HSB was founded in 1866, in an era when steam powered the industrial revolution, and catastrophic boiler explosions occurred about once every four days in the U.S.
“People were getting killed, plants were getting destroyed, business income was being lost,” O’Shea said. “The people that founded [HSB] were business people that decided to create an organization where the objective was to design a better boiler and then a system whereby the object would be periodically inspected to ensure that the equipment was being properly maintained and serviced.” The company’s engineering judgments were then backed up with an insurance policy.
Throughout the first half of the 20th Century, the coverage evolved to include a broader range of equipment. In the 1980s, products began to evolve even more rapidly with the development of technology such as computers and other devices that use electronic components.
“The coverages were broadened to cover not just what was in the basement but what was in the boardroom,” O’Shea said.
The equipment breakdown policy of today covers certain core groups of equipment. One group is comprised of electrical systems, which can represent a major component of a building’s total value.
“The average value of an electrical system within a facility could range between eight to 15 percent of the building’s total value,” O’Shea said. “Electrical systems are prone to breakdown caused by something known as electrical arcing, which is essentially a big short-circuit.” A significant portion—as much as 25-50 percent—of the entire electrical infrastructure of a building can be damaged in an electrical arcing event.
A wide range of electronic equipment or equipment that has some type of electronic component is also covered. Transformers, electrical switch gears, motors, voltage regulators and generators; as well as all types of business equipment which is more electrical than mechanical in nature, like computers, fax machines, copiers and telephone systems; fit into this group.
A number of losses originate at utility companies as a result of utility equipment failure or poor power quality. Such “accidents” can cause insured equipment to fail due to power surges or low-voltage conditions.
Tony Trivella, western regional vice president of HSB, described a machine shop in Arizona where a failure originated with utility-owned equipment. When a utility transformer shorted out, a power surge came into the machine shop and damaged a computer-controlled CNC machine, a type of lathe. The power surge damaged computer chips that controlled the board to the CNC lathe. Since it was an older machine and the manufacturer was no longer in business, parts were not readily available, resulting in an extensive search for replacement parts.
“We not only pay for the loss to equipment that failed due to an accident, but if the equipment is shut down, as in the case of that CNC machine, and that results in the insured suffering a loss of profits and continuing expenses, which is what we call business interruption, then that is also covered under our policy,” Trivella said. “Probably as much as 50 percent of all the losses that we pay have some business interruption component to them.”
Surges can create microscopic damage to silicon chips inside electronic equipment. “I’ve seen electron microscopic photography of silicon chips, and they literally look like the surface of the moon, pocketed with all these little craters,” O’Shea said. “That’s from the silicon literally melting when it gets hit by a surge.”
“Up here in Northern California and the Silicon Valley, some of these high-tech facilities require really pure power at prescribed frequencies and with very few voltage swings,” Trivella said. “If you get anything other than that, that has a potential of damaging fragile production equipment that can go into the millions of dollars to replace.”
Mechanical equipment, including production machinery, compressors, gears, fans, blowers and pumps, is also covered.
Most buildings have some type of central air-conditioning system, and a large number of business operations—notably restaurants, institutions such as schools and hospitals, and facilities that preserve food or other perishables—rely on air-conditioning and refrigeration systems.
“In the West a lot of what we cover is related to the agricultural industry, food processing, cold storage, that sort of thing,” Trivella said. “One of the issues that we have really seen a lot of this year has been food spoilage or food contamination as a result of equipment failure.”
Trivella described a recent spoilage situation in California’s Central Valley, where a utility transformer failed, arced and caused a power surge at an insured’s facility. “As a result, 16 motors shorted out, and those motors were supplying refrigeration to three cold storage rooms at the location,” he explained. “This facility was storing cantaloupes, and approximately 43,000 boxes of cantaloupes were spoiled as a result of a lack of refrigeration.”
While one doesn’t hear too often about boiler explosions these days, most large buildings still have boilers, if only for hot water heating purposes.
“Hospitals obviously, dry cleaners where high-pressure steam is necessary, all have boilers,” Trivella said. “There’s a lot of boiler and pressure vessel equipment in offices, but because it’s part of the building infrastructure, most people don’t even realize it’s there.”
Unfortunately, boiler explosions do still occur. Because they have enormous destructive potential, in most states, cities and municipalities, boilers and pressure vessels, and sometimes other devices, such as air-conditioning in New York City, are required by law to be periodically inspected.
“Inspection service is still an important component of equipment breakdown insurance,” O’Shea said. “It’s a unique line of insurance within a commercial insurance arena that’s focused on prevention and trying to keep accidents from occurring so that we don’t have potentially catastrophic events.”
According to O’Shea, there are currently several notable trends in the equipment
breakdown market. The first of these relates to the packaging of coverage. Rather than the coverage only being available as a monoline insurance policy, increasing numbers of insurance companies now offer it either as an endorsement or as an integral element of a package product, such as a businessowners policy.
O’Shea estimates that of the 200 companies that currently offer equipment breakdown coverage, perhaps only a dozen of those carriers in the U.S. offer it on a monoline basis.
Noting that HSB is always willing to entertain business on a monoline basis, O’Shea pointed out that the company also does business through reinsurance and outsourcing arrangements.
Second, exposures are changing. This is due in particular to an increase in equipment which utilizes some type of “electronic brain,” microprocessor or low-voltage circuitry. This trend has significantly increased the risk of equipment failure because of power surges, power quality problems and other types of physical factors, including moisture, heat and cold.
Third, there have been changes in equipment values, both from a property damage standpoint and from a business income standpoint. As businesses acquire more and more equipment, operations become increasingly dependent upon that equipment. This can create significant business income exposures.
“Just like any commercial property and casualty coverage, it is a fairly competitive market,” Trivella said. “We followed the soft market conditions that the rest of the p/c industry followed for the last 15 or so years. In the last year we’ve seen signs of a market firming along with the rest of the p/c industry.”
O’Shea said that premiums vary, depending on how the insurance is being purchased. “If you look at it in terms of percentage of total property liability and workers’ compensation premiums, [it's] a relatively small fraction of the total premium dollar,” he said. “The issue with this coverage really isn’t its expense. The issue is that not enough people understand machinery, equipment and technology, what can go wrong with it, and what it can potentially cost.”
Because many agents, brokers and buyers may not understand equipment breakdown coverage, businesses opt for self insurance. Trivella agreed that this market has been underserved in the past, but noted some recent changes.
“In the old days, it used to be hard to sell those businesses that don’t own their own buildings an equipment breakdown policy,” Trivella said. “Today, there’s plenty of equipment exposure that a business has regardless of whether or not they own their building. The whole trend towards equipment being an important component, an essential component in the operation of a small business, has really raised the awareness of commercial insureds toward equipment breakdown coverage.”
“The problem is when a building catches on fire, it makes the news. When the [voice mail] system of a business gets hit by a power surge and it’s destroyed, it doesn’t make the news,” O’Shea said. “It’s not the kind of thing that’s very visible. There seems to be a chronic problem where people underestimate the severity potential of equipment breakdown losses.
“Our files are filled with many, many examples of five- and six-figure equipment breakdown losses,” O’Shea concluded. “For someone that has a modest amount of net retained earnings, that’s a significant loss.”