What cover is there under a material damage policy if the insured property is damaged on more than one occasion during the policy period? In a decision released last week, Ridgecrest v IAG, the Supreme Court ruled that an insured was entitled to more than the limit of liability under the policy, because the policy reset the limit each time a new earthquake caused damage.
In light of the Supreme Court’s decision, the following issues should be considered in reviewing the extent of insurance cover under a material damage policy:
- Does the policy contain a limit of liability (or sum insured) for each event, or does it contain an aggregate limit of liability?
- If the limit of liability is for each event, in what circumstances is the limit reset under the policy?
- If the limit of liability is in the aggregate, is there a clause automatically reinstating cover following each loss?
- Are there also limits of liability for individual properties?
- Are any of the limits of liability intended to be an estimate of replacement value or based on valuations obtained, or are they simply an agreed sum?
As always, we are happy to provide specific advice about the structure and wording of particular material damage policies.
Ridgecrest owned a commercial building in Christchurch that was insured under a material damage policy with IAG.
A number of major earthquakes struck during the policy period. The first earthquake caused some damage to the building. IAG began repairs, but did not complete them before the second earthquake. That earthquake caused further damage. Again, IAG started repairs, but did not complete them before the final earthquake, which damaged the building beyond repair.
What did the policy say?
As is common, Ridgecrest’s policy gave both indemnity and replacement cover:
- Under the indemnity clause, Ridgecrest was entitled to payment either of the amount of its loss, or the estimated cost of restoring the building to its condition immediately before the damage (“old for old” cover).
- Under the replacement clause, Ridgecrest was entitled to the cost of repairing the building to its condition when new, or the cost of replacement if the building could not be repaired (“new for old” cover).
The policy required Ridgecrest to actually restore or replace the building before it could claim under the replacement clause. However, the parties proceeded on the basis that IAG rather than Ridgecrest would repair the damage caused by the earlier earthquakes.
The policy also contained a limit of liability of $1.9 million for each event causing damage. Here, each earthquake was a separate event to which the $1.9 million limit of liability applied.
What did Ridgecrest claim?
An insured will normally seek to claim under a replacement clause rather than an indemnity clause, because new for old cover is typically greater than old for old cover. That is exactly what Ridgecrest did here.
Ridgecrest first claimed under the replacement clause for the cost of repairing the damage caused by the earlier earthquakes. It claimed the full cost of repairs, including the cost of repairs that had not been undertaken (and now could not be undertaken because of the final earthquake). These costs were at least $310,000, but less than the $1.9 million limit of liability for each earthquake.
Ridgecrest also claimed under the replacement clause for the cost of replacing the building after it was damaged beyond repair in the final earthquake. Because the cost of replacing the building was more than the $1.9 million limit of liability, it only claimed $1.9 million for replacement costs for the final earthquake.
IAG accepted that it was liable for the full $1.9 million in relation to the final earthquake. However, it said that its liability for the earlier earthquakes was limited to the cost of repairs actually undertaken, and that it was not liable for the cost of repairs that had not been undertaken.
Was IAG liable under the replacement clause for repairs not undertaken?
The Supreme Court accepted that Ridgecrest could not claim under the replacement clause for repairs that were not in fact undertaken.
But unlike the Court of Appeal, the Supreme Court allowed Ridgecrest to make a new argument. The Supreme Court ruled that because the final earthquake prevented the earlier repairs from being completed, the replacement clause could not apply to the damage caused by the earlier earthquakes. The Supreme Court said that this took the replacement clause “out of the way”, and that the indemnity clause instead applied to the damage caused by the earlier earthquakes.
This meant that Ridgecrest could claim for damage to the building under the indemnity clause for the first two earthquakes, and then claim for damage to the building under the replacement clause for the final earthquake – even though Ridgecrest had not claimed under the indemnity clause, and even though IAG had incurred repair costs for the earlier earthquakes on the basis that the replacement clause applied.
Was IAG’s liability limited by the doctrine of merger?
IAG argued that the doctrine of merger should be imported from marine insurance, with the effect that Ridgecrest’s partial loss claims in relation to the first earthquakes are merged into the total loss claim resulting from the final earthquake. The Court rejected this, ruling that it was inconsistent with Ridgecrest’s policy, which reset the limit of liability after each earthquake.
A windfall to Ridgecrest?
So does this mean that Ridgecrest could recover more than its actual loss? No. The Court ruled that under the indemnity principle, Ridgecrest was not entitled to more in total than the replacement cost of the building. It held that “there can be no double counting”, and that Ridgecrest cannot recover twice for the same damage. The replacement cost of the building sets a cap on the claims for damage arising from multiple earthquakes in the policy period.
Critically, the parties did not intend the limit of liability of $1.9 million for each earthquake to be the agreed replacement value of the building. If it had been the agreed replacement value, then Ridgecrest would likely only have been entitled to claim a maximum of $1.9 million for damage caused by all of the earthquakes in total.
The decision cuts a middle ground through a difficult question of policy interpretation. Ridgecrest is entitled to claim up to the $1.9 million limit of liability for each of the earthquakes. However, Ridgecrest is limited to claiming under the indemnity clause (rather than the replacement clause) for the first two earthquakes. IAG is also protected to some degree by the application of the “no double counting” rule, which prevents Ridgecrest from claiming for the same damage twice, and from claiming more in total than the replacement cost of the building.
Will the decision have a substantial effect in the commercial market?
Some commentators have said that the Court’s decision will have a significant impact on claims and underwriting practices. Others have said that it is not a game-changer, because the particular policy wording at issue is not common.
In our view, the Ridgecrest policy was somewhat unusual, in that IAG’s only limit of liability was for each event. Many material damage policies instead contain a limit in the aggregate for all damage caused by all events during the policy period.
However, this difference may be less significant than first appears. This is because the policies with aggregate limits also typically contain a term automatically reinstating the limit after each loss. The High Court has separately ruled that these automatic reinstatement clauses mean that an insured may be able to claim more than the aggregate limit under the policy if there are multiple losses during the period of insurance.
We understand that these High Court decisions are under appeal. It remains to be seen whether the courts will apply the Supreme Court’s analysis of the Ridgecrest policy to material damage policies with aggregate limits and automatic reinstatement clauses. If so, the Ridgecrest decision will be of much broader significance in interpreting and applying material damage policies.