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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 [2014] 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.

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

In an earlier article – Insurance Policy Intepretation – 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.

In this article, we considere the ramifications of the decision in respect to whether earlier losses caused by an earthquake automatically merge/combine with later losses, so that an insured cannot claim for multiple losses.
IAG argued that, regardless of the policy wording, unrepaired losses from each earthquake “merged” in the later loss suffered when Ridgecrest’s building become irreparable. As a result, Ridgecrest was only entitled to receive payment of the sum insured from IAG (rather than payment for earlier unrepaired losses plus the sum insured, if the building was replaced). This was on the basis of the Marine Insurance Act 1908 which provides that where a partial loss has not been repaired and is followed by a total loss, the insured can only recover in respect of the total loss.

IAG however could not point to any case where this principle had been applied to a non- marine insurance case..

Most marine insurance policies are “time policies”. This means a vessel or cargo is insured against perils of the sea during a voyage. It was the practice that an insured only obtained rights in respect of loss caused at sea at the end of the policy period, usually at the destination port.

The Supreme Court looked at the New Zealand decisions dealing with merger. Having analysed those, it decided that the “merger” principle had no application to Ridgecrest, given Ridgecrest’s policy wording, as application of the principle is shaped by the relevant policy wording. Ridgecrest’s policy wording was clear that Ridgecrest’s rights in respect of each loss suffered in each earthquake accrued immediately after the earthquake, rather than being deferred as with marine policies.

As noted in our earlier article, actual policy wording is therefore critical in understanding an insured’s rights and obligations and, in particular, whether “merger” may apply or not. If you would like any insurance advice please do not hesitate to contact Paul Cowey at paulcowey@parryfield.com.

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.