At the time of the Christchurch earthquakes it was common for commercial buildings to have replacement insurance for loss or damage up to a maximum liability limit or 'fixed sum'. Often these policies provided that the fixed sum would apply to each loss causing event during the period of insurance. Whilst fixed sum policies were also in place for residential properties this was much less common, most of them had full replacement insurance.
During the period September 2010 to June 2011 Christchurch suffered hundreds of earthquakes and at least four caused significant damage to buildings. Many policyholders with fixed sum policies made claims for successive earthquakes. It was possible for such claims in aggregate to exceed the fixed sum and even the full replacement cost of the building. Such claims were often resisted by insurers and one such case was recently considered in the Supreme Court in Ridgecrest NZ Limited v IAG New Zealand Limited.
Ridgecrest was the owner of a commercial building that suffered damage in four earthquakes. The building was damaged beyond repair in either the third or the fourth of the earthquakes. Its policy contained a maximum liability limit of $1,984,000 for each event. What was 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 subsumed in the loss caused by the final earthquake under a legal principle known as "merger".
In some insurance contexts, notably marine insurance, where a series of partial losses are followed by a total loss the principle of merger limits the insured's right of recovery to the final total loss only. When applied the principle can significantly reduce the amount an insured can recover under their policy. In Ridgecrest the insurer argued that merger should be applied to fire and general policies of insurance.
To demonstrate how merger might work let us assume that a building owner, ABC Limited, has earthquake insurance with a fixed sum limit of $2,000,000 per event and the building would cost $4,000,000 to replace if totally destroyed. The building suffers damage in three earthquakes which to repair would cost $200,000, $300,000 and $500,000 respectively. It then suffers damage in a fourth earthquake and is totally destroyed and cannot be repaired. If merger does not apply ABC Limited can recover for losses suffered in each earthquake. For the first three earthquakes it will recover the sum of the repair costs of $1,000,000 and for the fourth earthquake the fixed sum limit of $2,000,000, a total of $3,000,000. If merger applies however it will make no recovery for the first three earthquakes as the losses suffered in those earthquakes will be regarded as having been subsumed in the final loss. It will only recover one payment of the fixed sum limit being $2,000,000.
The Ridgecrest case had reached the Supreme Court as a result of controversial decisions of the High Court and Court of Appeal which had both held against Ridgecrest but for different reasons. The High Court had arrived at its conclusion by the plainly incorrect view that Ridgecrest's policy could not be enforced against the insurer as it had been frustrated by the earthquakes; a conclusion the Supreme Court noted was not plausible. The Court of Appeal held the policy was not frustrated but took a technical approach to the way the case had been presented by Ridgecrest's lawyers to deprive Ridgecrest of recovery for more than one payment of the liability cap.
The Supreme Court has now held that the doctrine of merger did not apply here and that the policy wording provided Ridgecrest with an independent right to recover both its partial unrepaired losses and its subsequent total loss. The Court found that the merger principle was inconsistent with the terms of the insurance policy and in particular its term that provided for the resetting of the liability limit after each event that caused loss.
However, in a very important qualification to its judgment the Court also held that an insured could never recover more than what it had lost which would preclude an insured from ever recovering more than the replacement cost of its building.
To demonstrate how that qualification might work, if in the example earlier ABC Limited's building suffers damage in three earthquakes that will cost $3,000,000 to repair and is then totally destroyed in a fourth earthquake ABC Limited will never be able to recover more than the cost to replace the building of $4,000,000. This is so even though the aggregate of its claims for the four earthquakes might well exceed that figure.
The decision is a victory for common sense and should be welcomed by insurers and insureds alike. For insureds the certainty that had been taken away by the early decisions in the High Court and Court of Appeal as to the ability to make successive claims in appropriate cases has been removed. For insurers it is now clear that whilst it is possible in some cases for an insured to make more than one claim for successive losses which exceed the fixed sum, the insured can never recover more than its actual loss.
As with most insurance cases the result in Ridgecrest was determined by the terms of the policy. The Supreme Court noted that the merger principle was not a free standing legal rule operating independently of the agreed contractual relationship between the parties. In this case the application of the merger principle would be inconsistent with the terms of the policy.
The lesson for policy holders is to carefully read and understand the terms of your policy before loss occurs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.