Property insurance: successive losses

In another of the many insurance cases arising out of the Christchurch earthquakes in 2010 and 2011, the Supreme Court of New Zealand (that country’s highest court) has recently provided helpful guidance on the measure of indemnity in property insurance cases where there have been successive losses.

The Supreme Court held that, on the facts in Prattley Enterprises, what was insured was the indemnity value of the building and it would be a clear breach of the indemnity principle for the insured (Prattley) to recover more than it had lost, that is what the building was worth when the sequence of earthquakes started.

This decision provides comfort to insurers that, in similar circumstances, the indemnity principle should prevent recovery for unrepaired damage overtaken by a subsequent total loss or for amounts which exceed what was lost.

Damage and insurance

Prattley owned a building, close to Cathedral Square, in Christchurch which was used for commercial purposes, namely, the generation of rental income. This building suffered moderate damage in the earthquake of 4 September 2010 and remained in use until it suffered further damage in the Boxing Day earthquake of the same year. From that point, the building was not occupied. Prior to any repairs being carried out, the building was severely damaged in the earthquake of 22 February 2011 and was demolished in September 2011.

The “total building sum insured” was NZ$1,605,000 and the policy provided that:

“You will be indemnified by payment or, at our option, by repair or by replacement of the lost or damaged property. Subject to the reinstatement of amount of insurance extension our liability will not exceed the total sum insured ...

We will repair or reinstate the building to as reasonably equivalent appearance and capacity using the original design and suitably equivalent materials.”

Reinstatement cover in excess of indemnity value was available, but this option was not taken up by Prattley.

Claim

Prattley claimed on the insurance and, after limited negotiations and competing valuations of market value of the building, the parties settled the claim for NZ$1,050,000 plus GST in “full and final settlement” of the insurance claim.

However, Prattley subsequently sought to reopen the settlement, claiming a further NZ$2,338,000. It argued that the settlement had been entered into under a common mistake as to the correct measure of indemnity and should, therefore, be set aside under the Contractual Mistakes Act 1977. The basis of its claim was that the policy responded to the cost of repairs or replacement and Prattley was entitled to recover separately and cumulatively up to the policy limits for the damage caused by each of the earthquakes.

Prattley’s claim was unsuccessful in both the High Court and Court of Appeal, although the measure of indemnity applied was different in the High Court (market value) from the Court of Appeal (reinstatement, best assessed by the depreciated replacement value of the building).

Supreme Court decision

The Supreme Court held that the settlement could not be reopened, there was no common mistake and the settlement was distinctly favourable to Prattley.

The Supreme Court concluded that the wording of the key clauses in the policy was standard and the obligation of the insurer was to “indemnify” Prattley for damage suffered. Prattley’s primary entitlement was to indemnity by payment, but the insurer, at its option, was entitled to provide indemnity “by repair or replacement”. However, the fact that this option was available to the insurer did not signify that the indemnity was necessarily to be calculated by reference to the cost of repair or replacement.

The calculation of what is required by way of indemnity varied depending on the circumstances, but was always calculated against the background that the purpose of an indemnity payment was to make good the insured’s actual economic loss. If the property was destroyed and was not to be reinstated, the most obvious basis for calculating indemnity was its market value, particularly in the case of a property held for investment purposes. This was the basis upon which the settlement sum was calculated.

The Supreme Court accepted the findings of the High Court that Prattley’s loss was in fact only in the region of NZ$520,000, being the pre-event value of the land and building and demolition costs less the post-demolition value of the land, so as to leave Prattley with land and money equating to the pre-event value of what it had before the earthquakes. On this basis, it found that, due to reliance on an erroneous valuation, Prattley was paid out more than double its entitlement and had no legitimate grounds for complaint.