Inconsistent language in an indemnity policy affects method of settlement

Insurance Update

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The Court of Appeal recently considered the correct way of cash settling a claim for destruction of a building covered under an indemnity policy (Prattley Enterprises Ltd v Vero Insurance NZ Ltd [2016] NZCA 67). It found that the language used in the policy precluded the insurer from paying the building's lost market value. Instead, the Court of Appeal found the building's depreciated replacement cost was the more appropriate measure. Why was this so?

The parties agreed that the Material Damage Policy had been arranged on an indemnity only basis. It contained the usual insuring clause, which referred to indemnifying the insured. The reinstatement extension did not apply. 

The Court of Appeal accepted that the principle of betterment applies to an indemnity only policy and that depreciation should be allowed for. However, the question arose as to whether this allowance should be calculated by assessing the lost market value of the building, or by assessing the building's depreciated replacement cost. These two calculations do not always result in the same figure. 

When a building is destroyed, the insurance industry practice is to assess the insured's loss under an indemnity policy by way of loss of market value. Depreciated replacement cost is usually only used where a building has no market value because of the nature of it (eg a church). Consistent with market practice, the insurer in this case argued that market value was the correct measure of the indemnity payable. However, the starting point is always what the insured contracted for under the policy. 

The Court of Appeal noted that although the policy was an indemnity one, the insuring clause said: 

You will be indemnified by payment, or at our option, by repair or by replacement of the lost or damaged property. 

Further, the insurer had added a special note to the policy, which said: 

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

The Court of Appeal was influenced by the references to 'replacement' in the insuring clause and by the language used in the special note. It said: 

As noted at [22] above, the special notes confirm the cover reflected the building's original appearance, capacity and design. That is notwithstanding that Prattley chose not to purchase full reinstatement cover. In our opinion "reinstatement" in this policy was not merely a method by which the insurer might discharge its obligations. It was also a primary measure of the material damage indemnity; primary because it reflected the parties' agreement that cover would reflect the special character of the building. 

As a consequence of this, the Court of Appeal found that the insurer was required to settle the claim by paying the depreciated replacement cost of the building, not its lost market value. This was because the policy language foresaw reinstating the building. 

The lesson here for insurers is clear. If you wish to settle claims for the destruction of buildings under indemnity policies by paying their market value: 

  • Ideally, say so in the policy, and 
  • In any event, do not use language elsewhere in the policy that implies the policy will reinstate or replace the building. In addition, do not refer to reasonably equivalent appearance, capacity, design and materials. This is the language of a replacement policy, not an indemnity policy. 
If you have any questions, or require further information regarding any aspect of this publication, please contact us.

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