Buyer beware: assignment of reinstatement benefits under insurance policies

In Xu v IAG,¹ the Supreme Court upheld the longstanding principle in Bryant v Primary Industries Insurance Co Limited ² that a replacement value benefit that is personal to the insured cannot be assigned without the insurer’s consent.

This case will affect many on-sold insurance claims by purchasers of earthquake-damaged homes. The ability for assignee-purchasers to claim only indemnity value will be of particular significance to owners of buildings in old or poor repair, where the cost of replacement to an ‘as new’ standard is considerably more than the cost of repair to its pre-damage, indemnity, condition.

Facts

The case involved a home owned by Mr and Mrs Barlow, that they insured under a standard replacement policy issued by IAG. The policy entitled the Barlows:

  1. to be paid the actual costs of repairing their home to its condition when new if they reinstated the property, or
  2. if they did not reinstate it, to be paid the lesser of the amount of the indemnity value of the loss or the estimated cost of restoring their home to its pre-loss condition.

The Barlows’ home was damaged in the Canterbury earthquakes. Three years later, in 2014, they entered into an agreement to sell the property. They assigned all their rights in respect of their insurance claim to the purchasers.

The purchasers sued IAG claiming that they were entitled to the actual costs of reinstating the home. IAG accepted that the right to indemnity value was assignable, however the right to reinstate was personal to the Barlows and could not be assigned without IAG’s agreement.

The Court of Appeal’s decision

In agreeing with the High Court, the Court of Appeal held that the right to restore the damaged property and receive the restoration costs from the insurer was personal to the insured and could not be assigned. The Court of Appeal said that ‘moral risk’ associated with the insured party is of critical importance to the insurer’s decision to provide cover. Consequently, “an insurer should not be held liable to a stranger to the insurance contract”,3 whose moral character it had not been able to assess and who may seek to profit from the loss. Therefore, the only permissible assignment without the insurer’s consent is the right to receive an amount to which the insured is entitled  at the time of assignment. At the time of assignment, the insured was entitled to indemnity value only, as they had not taken steps to reinstate the property.

The Supreme Court’s decision

The assignment of reinstatement benefits

Although the Supreme Court expressed some reservations, it declined to overrule or distinguish Bryant and confirmed that Bryant is correct in its statement of legal principle.

One point of interest for legal scholars is that the Court expressed the view that “it may be better to accept that replacement insurance is an exception to the indemnity principle”. This comment was made in the context of the reasons for the rule in Bryant, one of which was that the Court of Appeal considered the indemnity principle (that says the insured should not be put in a better position than it was in before the loss) could be rationalised with replacement insurance (that may result in the insured receiving a new item that is more valuable). The Supreme Court found the principles of moral hazard and the personal nature of the reinstatement entitlement to be more convincing reasons not to overrule Bryant.

The Supreme Court held that the wording of the IAG policy meant that the original insured must carry out the reinstatement to become entitled to the replacement benefit. References to the insured were to the Barlows and could not be interpreted as references to their assignees.

The judgment was a 3:2 decision as two of the Supreme Court judges dissented. They would have held that the assignee-purchasers had received a valid assignment of the replacement benefits under the policy on the basis that the Barlows had an accrued right to those benefits after the earthquakes, and that the assignee-purchasers could fulfil the condition of restoring the home. In their view, there was nothing obviously personal in the reinstatement condition in the policy that only the Barlows could undertake the reinstatement and claim the benefit. They would have overruled Bryant.

Secondary issue – sale and purchase condition

The Supreme Court also addressed a secondary issue – the meaning and effect of Condition 2 of the policy. All five members of the Supreme Court were unanimous on the result.

Condition 2 was headed ‘Insurance during sale and purchase’. It provided that, in some circumstances, the purchaser of a property could bring a claim under the vendor’s insurance policy. The purchasers argued that their claim fell within Condition 2 so they were entitled to claim under it, irrespective of the validity of the purported assignment of the replacement benefit. The Supreme Court held that Condition 2 did not assist the purchasers because it applied only to damage that occurred after a purchaser had entered into an unconditional contract for sale and purchase of a property, and before the settlement of that transaction. In the present case, the purchasers had entered into the sale and purchase agreement years after the damage had occurred. The purpose of Special Condition 2 was to protect the purchaser of a property who entered into an unconditional agreement before the damage was suffered.

Implications

The decision will be well received by insurers, many of whom are dealing with assignees of insurance claims who are claiming a reinstatement entitlement. Many of these claimants will now have to accept that their claims are likely to be worth significantly less, as they are limited to indemnity value.

In a number of these claims, the original insureds were satisfied with the repairs, yet assignees have made claims and issued court proceedings asserting that they were inadequate, sometimes with the support of claims consultants or litigation funders. Insurers view many of these assigned claims as unjustified and opportunistic.

Where repairs have been carried out, the Supreme Court’s decision means that it is likely to be more difficult for assignees to assert that an increased amount ought to be payable where their claim is limited to indemnity value.

The Supreme Court observed that what constitutes indemnity value will sometimes be difficult to determine. This will depend upon the circumstances of each case. The Supreme Court earlier provided guidance in Prattley Enterprises Ltd v Vero Insurance New Zealand Ltd⁴. Where a building is destroyed by an insured event and is not to be reinstated, the most obvious basis for calculating ‘indemnity value’ is its market value. This will normally be less than the cost of reinstatement on a new-for-old basis, particularly where the building was old or in a state of disrepair before the loss. Where a claim is for the cost of repair or reinstatement, the estimated costs, less a betterment allowance or a deduction from the repair cost to represent the depreciated condition of the insured property immediately before the loss, may be the indemnity value. There may also be instances where a repair, or a complete or substantial reinstatement, does not result in betterment. In those cases, indemnity value may be the same as reinstatement costs without deduction.

Purchasers of earthquake damaged buildings will be disappointed if they purchased in the expectation of settling the insurance claim for the property on a reinstatement basis without the insurer’s agreement. While some assignee-purchasers may reflect upon whether they have been properly advised, many sale and purchase agreements were entered into without an assignment  in place and the assignment of insurance claims was recorded as an afterthought, sometimes upon or after settlement, or even after the issuance of legal proceedings.

We anticipate that a number of Canterbury earthquake proceedings by assignees will be settled or discontinued as a result of the Supreme Court’s judgment.

Footnotes

  1. Xu & Anor v IAG [2019] NZSC
  2. Bryant v Primary Industries Insurance Co Limited [1990] 2 NZLR 142 (CA).
  3. At [19].
  4. Prattley Enterprises Ltd v Vero Insurance New Zealand Ltd [2017] 1 NZLR

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