The Supreme Court has clarified the meaning of a widely used term in property insurance, namely the requirement for "sudden [...] physical damage." This is a coverage condition that must be met in order to claim insurance payouts. Due to the extensive use of this term, the ruling will have significant practical implications for a wide range of insurance matters across various land-based industries.
Background
In December 2019, an unusual noise was detected from the so-called "runner chamber," which is the chamber that encases the runner driving the turbine at the Rygene hydropower plant near Grimstad. The turbine was subsequently shut down, and further investigations revealed significant damage to the runner chamber. The power plant had to close for repair work, and the power company then claimed approximately 76 million Norwegian kroner in compensation from its insurance company to cover repair costs and business interruption (loss of income).
There was no doubt that the runner chamber had been subject to degradation over several decades. The insurance company therefore rejected the power company's claim for insurance coverage, citing that the power plant had not suffered any "sudden [...] physical damage," which was a fundamental condition for compensation under the insurance contract.
The power company brought court proceedings against the insurer. While the power company did not dispute that the runner chamber had been subject to long-term degradation, it argued that the damage occurred suddenly when it became detectable in December 2019, and that there was a sudden failure of the turbine at that point in time, which could not have been detected or anticipated earlier on, thus giving the power company a legitimate need for insurance cover. As regards the degradation occurring long before December 2019, the power company argued that this did was not physical damage, but rather the cause of the later damage.
The Supreme Court's considerations and ruling
The crucial question for the Supreme Court was whether the physical damage fulfilled the requirement of "sudden [...] physical damage" within the meaning of the insurance contract. The Supreme Court answered this question in the negative.
If physical "damage" had occurred with the initial weaknesses 30-40 years ago, the time elapsed would prevent the damage from being considered "sudden." However, if the relevant "damage" had occurred over a day or two in December 2019, the condition of "sudden" damage could be more pertinent. Thus, the core question of the case was: When did the relevant "damage" occur within the meaning of the insurance contract?
The Supreme Court adhered to the definition of damage that has been established in long-standing legal theory and practice from the Financial Services Complaints Board, namely that damage means a negative, physical alternation of the insured object. Damage occurs when the cause of the damage materialises in negative physical consequences on the object's material, surface, construction, or structure.
In light of this relatively broad definition of physical damage, it is not surprising that the Supreme Court concluded that the "damage" to the Rygene hydropower plant was not sudden. The damage had begun to develop several decades ago when concrete was washed out, resulting in corrosion in the steel structure. The Supreme Court could therefore conclude that the damage was not "sudden" without needing to pinpoint the exact time span encompassed by the word "sudden".
The Supreme Court's ruling provides a practically important clarification of the concept of "damage" . The ruling aligns with what has been the prevailing law, but which, until now, has only been expressed in practice from lower courts and the Financial Services Complaints Board. However, several questions that are likely to lead to disputes in the future remain. Firstly, the upper limit for the time span that may be considered "sudden" was not clearly defined and therefore not significantly clarified. Secondly, the Supreme Court stated that a gradual development of damage could result in, and thus be the cause of, a new and independent (and potentially sudden) damage to the same insured object. The power company's challenge in this case, was that such an approach could not succeed because the Supreme Court believed it was appropriate to view the case as "a continuation of the same gradual development of damage." Thirdly, the Supreme Court pointed out the relatively uncontroversial notion that gradual development of damage on one object could lead to sudden damage on another object. The two latter points show the importance of determining what constitutes one and the same damage (on the same object), and it is not difficult to see that there is potential for continued disagreements between policyholders and insurers.
Implications for policyholders, particularly in the power industry
This is the first time the Supreme Court has addressed the interpretation and application of the insurance condition "sudden damage." There is already some appellate court practice on the matter, as well as numerous decisions from the Financial Services Complaints Board. The Supreme Court has largely confirmed the same legal understanding that can be derived from such previous practices, which is also expressed in legal theory. Furthermore, the Supreme Court has clarified that gradually occurring damages to an object can cause (sudden) damage to other objects, but not in case of continuing damage to the same object. The concept of damage cannot, according to the wording, practice, or legal theory, be linked to when hidden damage is discovered – the crucial factor is when the damage occurs. Damages that develop hidden and over time will therefore not fulfill the requirement of "sudden damage," even if they appear both unexpected and surprising when they are finally detected. It is also uncommon for insurance companies to assume the risk for such damages, which in most cases are due to an originally weak construction or a lack of maintenance and oversight.
For power plant owners, the condition of "sudden physical damage" presents some particular challenges. This is because some key components with an assumed very long lifespan are often built in or buried, making it very difficult for the policyholder to detect the onset of damage development. For hydropower plants – whether they are small-scale or large-scale – components such as runners, turbines, and pipelines may often be built in or buried, or otherwise shielded from external influences. Another example of damages that may be difficult to detect could be small cracks in the blades of wind turbines. These may often go undetected unless the entire blade is taken down and examined.
On the other hand, cracks and breaks can occur suddenly in a structure due to material fatigue, which may be caused by a casting defect, under-dimensioning, or something else. Such inherent and latent defects are not naturally considered as "damage," but if they result in a failure, a crack, or similar, they may have led to damage, which is often regarded as "sudden" when it occurs. It is the "damage" that, according to the insurance terms, must occur suddenly, while the "cause" of the damage does not need to be.
For components that are built in or buried, it often takes a lot for them to be exposed to sudden physical damage, although it can certainly happen in the form of damages caused by landslides, floods, lightning, operational causes, foreign objects in the waterway, etc. If such events occur, it will often be a matter of "sudden" and covered damage. However, in our experience, it is a more practical scenario that power plant components fail not due to clearly identifiable and external events, but rather due to damage development that has been ongoing for some time and suddenly manifests itself to the policyholder – for example, when a small crack develops into a larger crack that ultimately leads to complete failure. This may be due to design flaws, material defects, incorrect installation, insufficient maintenance, etc., which are often excluded from insurance coverage under their own terms.
As the condition of "sudden physical damage" is incorporated into a number of insurance terms, we expect that the issues raised in the Supreme Court will continue to arise in the future. To avoid coverage disputes, it would be natural to consider whether the terms should be amended. One possible way to resolve this issue seems to be to only require that a "physical damage" occurs. This would avoid the assessment of when the damage first occurred and how long it took to develop. For insurance companies, this would represent an expansion of coverage, but the expansion could be mitigated by excluding the gradually developing damage that insurers do not wish to cover, namely damages that the policyholder could be expected to take precautions against (e.g., damage caused by corrosion). Additionally, some of the risk associated with older power plants could potentially be mitigated by implementing stricter age deductions for old components.
Thommessen assisted the insurance company, which was acquitted in all instances, most recently in the Supreme Court ruling on 7 November 2024.
