Interpreting Insurance Policies – Ramifications of the Ridgecrest decision 19 Jan 2015

In August 2014, the Supreme Court released its unanimous decision in the case of Ridgecrest NZ Limited v IAG in respect of a preliminary question put to it based on agreed facts.  Paul Cowey was assisting counsel in the case.

While the case dealt with a preliminary question, the reasoning of the Court is instructive in three key respects:

(a) The Court’s approach to policy interpretation.

(b) The Court’s approach to the doctrine of merger – are losses resulting from earlier earthquakes “swallowed up” in losses caused by a later earthquake?

(c) The Court’s approach to the principle of indemnity, namely if an insured recovers for later losses, does it breach this principle?

This article considers the first issue – policy interpretation. We consider the second and third issues in separate following articles.

Background

• Ridgecrest was the owner of a commercial building that suffered damage in four of the Canterbury earthquakes.
• There was separate, distinct damage caused by each earthquake. The first damaged Ridgecrest’s roof when the parapet fell from a neighbouring building. The second caused internal non-structural damage. The third earthquake damaged the shear walls which exhausted their structural capacity. It is Ridgecrest’s position that the fourth earthquake subsequently caused structural damage to the foundation (this is still to be determined).
• After each earthquake, both structural and quantity surveying evidence had been obtained by Ridgecrest.
• After the first two earthquakes repairs were begun but not completed before the next earthquake.
• The building was damaged following either the third or the fourth of the earthquakes so that the cost of the repair exceeded the sum insured.
• The policy contained a maximum liability limit of $1,984,000 for each event. This sum insured – $1.984m + GST – was significantly less than the cost of replacing the building.
• In issue was whether Ridgecrest was entitled to be paid for the damage resulting from each earthquake up to the $1,984,000 policy limit in each case or whether the losses resulting from earlier earthquakes should be treated as having been “merged” in the loss caused by the final earthquake.

Interpreting the insurance policy

The Supreme Court construed Ridgecrest’s policy with IAG in the following way:

• The policy provided for both indemnity (essentially the value of the building) and replacement cover (essentially the cost to replace the building which is more often than not a lot higher than indemnity value). It is therefore quite possible for an insured to make a profit in the sense of recovering (on a replacement basis) more than the actual (that is the indemnity) value of the building;
• The policy was to be applied event by event (i.e. loss was assessed after each earthquake rather than at the end of the policy period);
• Under the policy, the insurer could be required to pay a certain proportion of the loss before any repairs were carried out. That liability was unaffected even if such repairs were not carried out.
• The insured’s rights in respect of losses caused by the earliest earthquakes arose immediately. For the final earthquake, which was held to have made the building a “total loss”, the insurer’s obligations to pay arises after the building is restored or replaced. In other words, the insurer could be required to pay the estimated cost of repairs after the earlier earthquakes, subject to a top up payment later being made if the building was restored or replaced.
• The liability limit of $1.984m plus GST reset after each earthquake.

While the result of the Court’s analysis means insurers can be liable for more than the insured sum in any policy year, the Court imposed clear limits.

• There can be no double counting by an insured (i.e. claiming for the same damage twice). In Ridgecrest, expert evidence of the separate and distinct damage, and its estimated repair cost, was obtained after each of the four earthquakes. There is no suggestion of claiming twice for the same crack, even if it has grown.
• The claim for each event under the policy was for the estimated repair cost up to the policy limit of $1.984m. This means that an insured with replacement costs in excess of the specified sum can still be left significantly out of pocket.
• While the cap of 1.984m resets after each event, it has been assumed that value in the building remains. If a building that is a total write-off is further damaged however, it would be difficult to demonstrate any loss resulting from such further damage.
• The total of all claims cannot exceed the cost of actually replacing the building. This is an important restriction. The entitlement is to full, new for old value, but not more.

The Court’s reasoning provided helpful clarification to both insurers and insureds. As with most insurance issues however, much turns on the actual wording of the policy. It is therefore important to carefully read and understand your policy terms, both before loss occurs and afterwards.

If you would like any insurance advice please do not hesitate to contact Paul Cowey at paulcowey@parryfield.com.