Supreme Court insurance case: no to assignment of replacement benefits

A majority of the Supreme Court has ruled that it is not possible to assign replacement benefits in an insurance policy:  Xu v IAG New Zealand Limited [2019] NZSC 68 (3 July 2019). In the view of your humble correspondent, the minority view is to be preferred. The case presents an opportunity to review some of the underlying principles. This review is useful because these ideas may resurface if a later Court picks up the minority opinion. You can read a summary of the case prepared by the Court/ its staff here. In this article, editorial views are put forward.The principal issue in Xu was whether the entitlement to replacement was capable of being assigned where the customer, as assignor, had not incurred the cost of replacement at the time of the assignment. The assignment occurred at the time of a sale and purchase of the property between the assignor and assignee.The subject was considered in Bryant v Primary Industries Insurance Co Ltd [1990] 2 NZLR 142 (CA) which held that a right to replacement benefits was conditional on the insured incurring the cost of repair could not be assigned where the insured party has not incurred that cost.Under an classical insurance policy the insurer indemnifies the insured in respect of the loss or damage. The insured is put in the position it would have been in if the loss or damage had not occurred. Where property is involved, generally, this form of cover requires the insurer to indemnify the insured for the indemnity value of the property. Often that will be less than the cost of purchasing the property new at the time of the loss.Commentators have said previously, as has your humble correspondent, that replacement type insurance is a different beast altogether. In the event of an accepted claim, it represents a boon to the customer, who receives something new for something old. If this involves a one-hundred year old mansion being rebuilt as-new then the difference is significant by an order of magnitude.  A premium of $600 may result in building costs in the millions.This is not betterment because betterment by its nature is not covered. Betterment is an uplift on an indemnity where doing what is necessary under the policy necessarily results in an increase of value of the property. It sits to the account of the insured.By contrast, replacement as-new may involve the insured receiving from the insurer something significantly more valuable than it otherwise would have obtained under a traditional indemnity policy. It is not an indemnity at all. From the insurer's point of view, it is closer to a gamble. In individual cases the insurer writes the risk without having specific information about the total replacement costs for a building if it is destroyed. (The market value is not a point of reference.) Put differently, the amount required for replacement is not solely an incident of the loss. It is the function of a contractual commitment to be liable for certain costs, whatever they happen to be, if a certain thing happens and other criteria are met.There is a principle of insurance law that an insurance policy is not capable of being assigned by the insured without the consent of the insurer. The reason for this rule is that an insurance policy is personal to the insured. The insurer has had the opportunity to assess the risk of the individual being insured. It cannot make this assessment of the new person who takes its interest under an assignment. That person might have a bad claims history. It might be a customer the insured does not wish to deal with. (Insurers may transfer policies to other insurers under a legislative scheme which required Court approval.)So much for insurance law principles. Then there are the classical laws of property, including rules of law regulating assignments. A chose in action may be assigned. On the face of it, a claim under an insurance policy--certainly an outstanding claim for an indemnity only--is a chose in action, like a debt. It is a thing capable of being assigned, as a matter of law.How then to treat an assignment of a replacement type policy? This question draws together rules of insurance law and rules of property law. It is also useful to understand the economics of the situation.Until the time of the Canterbury earthquakes, competition in the retail insurance sector led to insurers offering unlimited replacement cover for property. This risk was passed on to reinsurers. Insurers made money on the margin between the reinsurance premium and the premium charged to the customer, less their costs. These margins have always been, and remain, tight.Since the time of the earthquakes, market practices in New Zealand have changed. Generally, cover of this nature is not offered. This change is linked to the cost of reinsurance. The cost of reinsurance for full replacement cover means that the insurer could not make an adequate margin. This means they could not operate prudentially: they would not have enough premium income to pay claims and make a surplus.So, opposition by insurers to moving away from the Bryant approach is understandable. There will also be a more immediate issue about a cohort of similarly affected people wishing to advance assigned claims on the same basis. Even if there are only about one hundred claimants, complete replacement in every case could presumably add up to tens of millions across the sector.The present case will not have been one that invoked a great deal of sympathy for the claimant. The Courts will have proceeded on the reasonable assumption that the claimant-purchaser-assignee received legal advice on the possibility that he would not receive the replacement benefit he received under the assignment, on the basis of Bryant. Presumably the claimant was not counting on a change of law by an appellate Court.Replacement  is often expressed in the insurance policy to be dependent on the customer having already paid for the reinstatement. In reality, this is generally not what happens because almost no one has sufficient surplus funds to pay for those works and then wait to be reimbursed. The actual concept in play is a little different. This requirement represents a commitment to pay for replacement works that are planned and then implemented. Generally, that process is coordinated by the insurer and its representatives. This way, it is in control of the cost. All of this is subject to the specific terms of the insurance policy.These are reasons to read down this requirement. This kind of reading-down occurs where a provision in an insurance policy conflict with its basic purpose. I say that this occurs because an insurance contract is not an ordinary commercial agreement, it is one that is intended to effect the transfer of a particular risk.For example, Courts have read down a requirement on an insured to take reasonable care and stipulations about "alteration of the risk" during the currency of the policy. You cannot agree to deliver 10 widgets and then say you have a discretion to deliver 8. The Court will require you to deliver 10. So, you cannot insure someone against their own negligence and then except cover when they are negligent. The minority approached this issue on the basis that by the time of the agreement for sale and purchase of the property, the right to claim replacement under the policy had accrued. This analysis is preferable because regarding the right as having accrued reflects the reality that building works are not generally carried out and then reimbursed. The right to require performance of a contractual commitment arises in accordance with the terms of the contract--in this case, upon the occurrence of loss or damage covered by the policy. The identity of the claimant should not matter because by that stage, the subject-matter is not personal.Reinstatement of this kind cannot be described as personal. While there are many decisions to be made, they are capable of being resolved objectively and so are not dependent on the whims of the person requiring the works to be carried out or paid for. Neither the person nor the property need to be assessed for risk. The damage has already occurred.In summary, I consider that the better approach is to regard the right to obtain reinstatement as purely contractual in nature. It is not an indemnity. All talk of the indemnity principle should be jettisoned. As a contractual right, it is capable of being assigned on ordinary principles. The minority achieved this outcome by regarding the rights as having accrued at the relevant time. For the issue to resurface, market practices must change once again. That is likely to be a while away. By then, a differently composed Court may take the opportunity to revisit Bryant.Steve KeallBarrister4 July 2019

NZ Court of Appeal rules against insurer in Canterbury Earthquake case

The Court of Appeal has ruled against an insurer in a Canterbury earthquake case: Skyward Aviation 2008 Limited v Tower Insurance Limited [2014] NZCA 76 (Randerson, Harrison and Miller JJ, 20 March 2014, judgment delivered by Harrison J).

• Download Microsoft Word document
• Download PDF
• Audio file: [audio https://dl.dropboxusercontent.com/u/64094145/Episode%204.mp3]
• Listen to iTunes podcast

Summary

The Court of Appeal has held that on a proper construction of "basis of settlement" provisions contained in the insurance policy in issue, the policyholder had the right to decide whether to rebuild or repair on site, or to rebuild elsewhere, or to buy another house, once it had been established that the house was not economically repairable. It reached this decision with reference to, amongst other things, the policyholder's ownership interest and specifically its "legitimate interest" in remaining in its chosen neighbourhood. The Court also held that if the policyholder purchased another house, the insurer was bound to pay the cost of that house up to the cost which the policyholder would notionally incur in repairing its existing house to the same condition and extent as and when new and up to the same area as shown in the certificate of insurance. On the evidence, these notional repair costs were significantly in excess of the market value of the existing dwelling, which on the face of it conferred a significant financial advantage on the policyholder, although not, the Court said, in breach of the indemnity principle.

Background

The policyholder company, Skyward, purchased a residential dwelling in Christchurch in 2009 for $450,000. Skyward insured the property with Tower, an insurer, under a full replacement value policy. The certificate of insurance did not state a sum insured, providing instead that the house was insured for its full replacement value based its surface area.

The  property was badly damaged in the 2010/ 2011 Canterbury earthquakes. It was situated within a statutory area called the "Red Zone" where repair of any property was uneconomic.

The insured subsequently elected to sell the land to a government agency known as the Canterbury Earthquake Recovery Authority ("CERA") for $291,000. The insured also received its maximum statutory entitlement from the Earthquake Commission ($100,000 plus GST), and an interim payment of approximately $165,000 from Tower. This interim payment was for the house damage based on the cost of purchasing a comparable house elsewhere (taking into account payments from all sources), without prejudice to Skyward’s right to claim more.

The dispute

The insured and insurer could not agree on the measure of the insured loss under the policy.

Tower contended that it had the right to choose from a number of settlement options under the policy. Specifically, it was obliged to pay only the fair price of a replacement house elsewhere of comparable size, construction and condition as the insured's dwelling was when it was new. It said that the pre-earthquake market value of the property was $492,000.00, divided between land at $275,000.00 and house and chattels at $217,000.00. It said that Skyward could buy a similar house (excluding the land) for $365,000.00. The combined payments from the EQC and Tower provided sufficient funding for this cost to be paid, thus satisfying Tower's obligations under the policy.

The insured contended that it was entitled to payment of an amount equal to the estimated costs of rebuilding or repairing its house on the land.  Skyward said that the house could be repaired on the site at a cost of $682,525.00 or rebuilt elsewhere to regulatory standards for $770,960.00.

Accordingly, there was a difference of about $300,000 in the parties' calculations of the relevant measure of loss.

The issues to be determined

The parties remitted the following questions to the Court for determination in this context (paraphrased):

1. How was the amount payable by Tower to be calculated if an insured party’s claim was to be settled by Tower paying the cost of buying another house;
2. Was it Tower’s choice whether the claim was to be settled by paying the cost of buying another house or, if Tower settled by making payment, whether it is to be made based on the cost of rebuilding, replacing or repairing the house; and
3. In the circumstances, did Tower make an irrevocable election to settle Skyward’s claim by making payment based on the full replacement value?

It is worth noting that the Court of Appeal dealt with the second question first, then the first question, and regarded the third question as irrelevant in light of its answers to the first and second questions.The policy wordingThe relevant provisions of the policy stated:"HOW WE WILL SETTLE YOUR CLAIMWe will arrange for the repair, replacement or payment for the loss, once your claim has been accepted.We will pay:the full replacement value of your house at the situation; orthe full replacement value of your house on another site you choose. This cost must not be greater than rebuilding your house at the situation; orthe cost of buying another house, including necessary legal and associated fees. This cost must not be greater than rebuilding your house on its present site; or the present day value; as shown in the certificate of insurance.We will only allow you to rebuild on another site or buy a house if your house is damaged beyond economic repair." (emphasis added)"Full replacement value means the costs actually incurred to rebuild, replace or repair your house to the same condition and extent as when new and up to the same area as shown in the certificate of insurance, plus any decks, undeveloped basements, carports and detached domestic outbuildings, with no limit to the sum insured.""Present day value means the cost at the time of the loss or damage of rebuilding, replacing or repairing your house to a condition no better than new and up to the same area as shown in the certificate of insurance, plus any decks, undeveloped basements, carports and detached domestic outbuildings, less an appropriate allowance for depreciation and deferred maintenance, but limited to the market value of the property less the value of the land as an unoccupied site."The basis of settlement provisions also contained this statement: "in all cases: ... we have the option whether to make payment, rebuild, replace or repair your house."The basis of settlement issueThe Court of Appeal stated that the relevant provisions of the policy effectively provided for four different alternative bases for settlement, which were:

1. The full replacement value of Skyward’s house at its current location. That meant the costs actually incurred in rebuilding, replacing or repairing the house to the same condition and extent as and when new and up to the same area as shown in the certificate of insurance;
2. The full replacement value of the house at another site chosen by Skyward, providing the cost was no more than the cost of rebuilding the house on its existing site;
3. The cost of buying another house. This alternative is subject only to the same limitation as the first two alternatives – the cost must not be greater than the cost of rebuilding the house on its existing site;
4. The present day value, which was defined as the cost of repair or replacement, less depreciation, but limited always to the market value of the house when damaged less land value.

It was not disputed that Tower was not bound to pay anything more than "present day value" until Skyward incurred the cost of reinstatement, rebuilding or replacement. Having identified the various alternatives, the Court then recast the primary question as who had the ability to decide which basis of settlement was to be applied. It noted that the High Court had ultimately determined that the provision "in all cases: ... we [Tower] have the option whether to make payment, rebuild, replace or repair your house" was decisive. The High Court had stated at paragraph 68 of its judgment:

"Tower has the choice, therefore, of whether to make a payment, or rebuild, replace or repair. It follows that Tower, in making the payment, can choose the basis of payment. That basis must be on a repair, rebuild or replacement basis, and if repair is not an option, which I have found it is not, Tower can choose between rebuild and replacement."

The Court of Appeal interpreted the different basis of settlement provisions, read together, as containing language which gave the relevant decision to the policyholder, with reference to the following:

1. Tower reserved the right to pay only present day value “if you [the policyholder] choose not to build or repair your house, (the first alternative) or buy another house (the third alternative);
2. Tower reserved the right to disallow Skyward from either building on another site (the second alternative) or buying a house (the third alternative), if the existing house was not damaged beyond economic repair. This right of veto could only be exercised once Skyward had made the underlying choice. In other words, it assumed that Skyward was generally at liberty to make the choice, then restricted the company’s ability to choose options two or three to the case where the existing house is not economically repairable (emphasis added);
3. The second alternative provided for full replacement value of the house “on another site you [the insured] choose” – that is, it is the insured’s right to choose. (underlining added)

The Court of Appeal related these provisions to the parties' respective interests in the property: the policyholder had an ownership interest and the insurer had only a "strictly economic interest." The Court made a number of observations about these respective interests including that  once the insurer must pay the full measure of loss "it should be indifferent to the policyholder’s decision about how to reinstate the property" (paragraph 23). It then stated at paragraph 24:

"In our judgment these provisions must prevail over the statement in the basis of settlement provision that in all cases Tower has the option to make payment, rebuild, replace or repair the house. While accepting that the policy allows Tower to insist on repair in certain situations, we do not accept that it allows Tower to control what happens in every case. If it did, as Mr Campbell observed, Tower might choose to pay on a present value basis, that being one of the settlement options, notwithstanding that the policyholder wished to reinstate or replace the house."

The Court of Appeal said that the policy worked this way:  if the policyholder did not pursue full replacement by repair, rebuilding or replacing, Tower was bound only to pay the "present day value" as defined. If the policyholder wished to repair, rebuild or replace to full replacement value, Tower’s rights depended on whether the house was economically repairable. If it was, Tower would be able to insist on repair or rebuilding on the same site. Further, Tower would be able to commission the work. If the house was not economically repairable, then the policyholder could decide whether to repair or rebuild on the existing site, or rebuild elsewhere, or buy another house. But in every such case Tower needed only pay the cost of rebuilding on the existing site. The Court of Appeal recorded the insurer's submissions the contrary. Counsel for the insurer appears to have made a submission based on the inconsistency between the insurer have the choice between whether to reinstate or pay and for the policyholder to be given the choice between alternative bases for payment. The Court stated that it perceived no inconsistency in allowing the insured party to choose where the measure is effectively the same. It stated at paragraph 29:

"Once it is established as a matter of fact that the house is not economically repairable, Tower has no continuing interest in whether the insured party rebuilds on the existing site, rebuilds on another site or buys a house elsewhere, subject only to the insured actually incurring replacement cost, and further to the agreed financial limits."

So, it framed this submission in the context of the interests analysis referred to earlier. Counsel for the insurer submitted that Tower’s choice of the basis of payment was also confirmed by the limitation on Skyward rebuilding on another site or buying a house only if the existing house is damaged beyond economic repair. No purpose would be served by this clause, he submitted, if the choice between the bases of payment was for the insured. Its true purpose was to give Skyward fair notice of how Tower intended to exercise its choice, and the concept of Tower allowing the insurer to rebuild on another site or buy a house implicitly recognised Tower’s choice whether this will be done. The Court rejected this submission. It stated at paragraph 31:

"This construction of the proviso contradicts its plain language, and we reject it. Its purpose is to impose a limitation on the nature and scope of the insured’s underlying right to choose between alternatives, allowing the insurer to restrict the extent of its liability. It cannot be construed as a notice provision."

The Court of Appeal judgment records Counsel for the insurer as having submitted that in this case, by accepted the policy framed in the way that it was, the parties had effectively agreed that Tower's economic interests should prevail over the insured's interest in being able to rebuild or buy another house in a location where it retains neighbourhood links. This would be mitigated, he submitted, by the insurer acting reasonably to agree an amicable settlement with the policyholder. It would only choose the third alternative as a last resort. The Court of Appeal did not accept this submission. Amongst other things, it said that taken to its extreme, an insurer could require a policyholder to move to another city. The Court stated at paragraph 38:

"The words should not be construed to reach that extreme result and deny an insured party’s legitimate interest unless the words point unequivocally to that result. The insured party’s legitimate interest in remaining in an area is best recognised by the means adopted by the parties of allowing it to choose where to spend the reinstatement moneys."

The ratio for the overall question is contained in paragraph 39 of the judgment where the Court stated:

"Accordingly, the answer to the first question is that, once it has been established that the house is not economically repairable, Tower has no right to choose the basis of settlement. It is then for the insured, not Tower, to decide whether to rebuild (or repair) on site, or to rebuild elsewhere, or to buy another house. Of course it must incur these costs before Tower need pay anything more than the appropriate measure of present day value."

 The measure of settlement where insurer pays the cost of buying another houseAs stated above, one of the questions remitted to the Court was the correct measure of settlement where Tower settled its liability by paying the cost of purchasing another house. The High Court had put it this way at paragraph 58 of its judgment:

"the amount to be  payable by Tower, where it is to pay to Skyward the cost of buying another house, is to be the fair price of a replacement house which is to be a reasonable and practical extent comparable, of the same 270 m² size and construction (as far as may be possible), in the same condition, and of the same style and extent (more or less), as the Kingsford Street house was when new. This could be a new or (more likely) a second-hand house sited outside the red zone. As to whether its size, construction and quality were reasonably comparable, these would all be determined on the facts of this particular case..."

The Court of Appeal disagreed. It stated that the maximum amount payable by Tower as prescribed by all three relevant alternatives was materially the same. The first two alternatives expressly adopted full replacement value at the present site. The third alternative adopted the (necessarily notional) costs of rebuilding on the existing site. The amount payable by Tower if Skyward bought another house was not subject to any other limitation, including any limit on the size, style or quality of the other house. Counsel for the insurer submitted that this was contrary to the indemnity principle (refer: Castellain v Preston (1883) 11 QBD 380). He referred to the valuation evidence to the effect that the cost of rebuilding the house would be up to $770,960.00. Skyward would therefore receive between $860,000.00 and $920,000.00 as the measure of its loss when a comparable house would cost about $365,000.00 and its pre-earthquake market value was $211,000.00. If Skyward was paid the currently estimated rebuilding cost when it did not intend to rebuild, it would be receiving more than three times the market value of the house at the date of loss. The Court of Appeal held that payment at the higher value simply reflected what the parties had agreed - specifically, a measure of loss referable to a replacement value as opposed to the "present day value" (i.e., the indemnity value). Payment using the higher value was therefore justified. The ratio for the overall question is contained in paragraph 49 of the judgment where the Court stated:

"...We are satisfied that if Skyward buys another house Tower is bound to pay the cost of that house up to the cost which Skyward would notionally incur in repairing its existing house to the same condition and extent as and when new and up to the same area as shown in the certificate of insurance."

Did Tower irrevocably elect to make a payment based on full replacement value?The High Court held on the evidence that there was no such election. This was essentially a factual question and it appears that Counsel for the Skyward did not focus a great deal of attention on it in the Court of Appeal hearing. The Court of Appeal concurred that there was no such election, and determined it accordingly but observed that this issue was irrelevant in light of the answer to the two former questions.CommentThe policy in this case offered unlimited replacement value cover. In New Zealand, as is already the case in the United Kingdom and in certain other countries, insurers are ceasing to offer this kind of cover. Instead, they are limiting their liability to a stipulated sum insured that is either linked to an actual valuation (usually commissioned by the policyholder) or in its absence a default valuation. The kind of issues face in this case should, therefore, become increasingly rare as policies under the "old" regime go off risk over the next twelve months, subject to any litigation that is commenced.In this case, the Court of Appeal was prepared to take the fairly robust step of reading down the express term "in all cases: ... we have the option whether to make payment, rebuild, replace or repair your house." The relevant sentence was the proviso to the "second alternative" basis of settlement provision, which was: "we will only allow you to rebuild on another site or buy a house if your house is damaged beyond economic repair." The Court characterised the relevant "allowing" as a "veto", a concept which by its nature required the exercise of an "underlying choice" in the first instance.  By this reasoning, the policyholder had a choice which it was at liberty to exercise. If there is any appeal, this line of reasoning will no doubt be subject to further scrutiny.Giving weight to the parties' respective interests is significant in what was otherwise a non-contextual "black-letter" contract interpretation analysis. The Court of Appeal referred to the policyholder's ownership interest, which included a "legitimate interest" in retaining a neighbourhood link to the existing location of the property, in contrast to the insurer's "strictly economic" interest. The suggestion that, in an insurance policy, language must be unequivocal in order to leave unaddressed a policyholder's legitimate interest in the property, is a unique one as far as this correspondent is aware. This may be the first blip on the radar of a potential incorporation of the United States' approach to contract interpretation which considers the parties "legitimate expectations."(Published on 22 April 2014, updated on 23 April 2014)