In two earlier articles – Insurance Policy Intepretation – Ramifications of the Ridgecrest Decision and Combining Earthquake Losses – Ramifications of the Ridgecrest Decision, we looked at some of the significant findings of the Supreme Court in that case in respect to policy interpretation and “merger” of multiple losses.
In this article, we considere the ramifications of the decision in respect to whether the insurance principle of “indemnity” automatically prevents an insured claiming for multiple losses.
The Indemnity Principle
Insurance policies are policies of indemnity. They are an agreement between an insurer and an insured person to protect/compensate the insured for particular defined risks. The principle of indemnity is that an insured person cannot recover more than the loss under the insurance policy.
The words of Brett LJ in Castellain v Preston 1883 11QBD 380 (CA) at 386 have been frequently quoted as the starting point of the argument:
“… the contract of insurance contained in a marine or fire policy is a contract of indemnity, and indemnity only, and that this contract means that the assured, in case of a loss against which the policy has been made, shall be fully indemnified, but shall never be more than fully indemnified. That is the fundamental principle of insurance, and if ever a proposition is brought forward which is at variance with it, that is to say, which either will prevent the assured from obtaining a full indemnity, or which will give to the assured more than a full indemnity, that proposition must certainly be wrong”.
When this case was decided, recovery under insurance policies could only be made on an old for old basis. A building could not be insured for more than its depreciated value at the time of loss.
This resulted in a practical problem however. A building owner with no additional funds would be unable to rebuild a destroyed building if the insurance proceeds were limited to the building’s depreciated value.
In response to this problem, replacement cost insurance cover developed, which was offered as a separate policy and later as an optional endorsement. Such insurance went beyond the old notion of indemnity, and insured the difference between actual cash value and the full replacement cost – depreciation that has already occurred.
Such policies allow recovery on a new for old basis. A new for old insurance policy clearly will place the insured in a better position following an insured loss than they were in before.
There was recognised however that there might be a potential moral hazard caused by an insured being able to obtain more than a mere indemnity for damaged property, and the risk of intentional damage so an insured could profit from their “loss”.
Frequently, policies provided for the payment of the indemnity value as a cash payment, with the obligation to pay the full replacement cost being postponed until the insured completed the rebuilding or repairs. The Supreme Court in Ridgecrest accepted that this was the scheme of the Ridgecrest policies.
Many commercial policies now separately identify the indemnity value and the replacement value, with replacement value cover provided as an optional endorsement. Presumably because of consumer demand, in residential policies they are rarely, if ever, separated. New for old policies are well accepted in New Zealand, for chattels, motor vehicles etc. In these cases an insured is entitled to what is known as “betterment” (receiving new for old).
Although not referred to in the decision, the Court did hear argument about whether an insured is under an obligation to spend insurance payments on the repair of damage. It has long been the position that an insured may do as they please with sums paid by the insurer, and there is no implied term requiring monies to be spent in any particular manner (unless contractually bound to do so).
This being the case, an insured cannot be seen as obtaining a windfall just because repairs were not and will never be carried out.
The Supreme Court was not attracted to use the principle of “indemnity” to whittle away policy entitlements. The Court instead endorsed “…An approach based firmly on the policy wording as to the resetting of liability limits”.
Having decided that the Ridgecrest policy reset after each earthquake, the Court held that recovery of loss caused by successive earthquakes did not offend the principle of indemnity. This is subject to three restrictions:
- No double counting (i.e. an insured cannot recover for the same damage twice)
- The loss from each event, i.e. earthquake, will be subject to the contractual limit (in this case $1.984m); and
- The total of all claims cannot exceed the cost of replacing the building.
The Court of Appeal in the post Ridgecrest decision of QBE Insurance (International) Limited v Wildsouth Holdings Limited  NZCA 447 noted that the Supreme Court did not consider the principle of indemnity to rest on the doctrine of merger, but to stand alone. In applying the principle, the importance of factual detail was highlighted. Where the cost of a repair is reduced by subsequent loss, the value of the first claim must also reduce. This was contrasted with the facts in Ridgecrest where the damage from each earthquake was separate and distinct, and the cost to repair was therefore unaffected by subsequent happenings.
Although there will undoubtedly be further occasion for the Courts to consider the full ambit of the principle of indemnity, the Supreme Court have made it clear the starting point is to be the entitlements set out in the policy. It would appear that the Highest Court has little enthusiasm to use the principle of indemnity as a launching point to rewrite liability provisions in insurance policies.