Earthquake insurance appeal cases deal with problems of successive events and allocation of loss
Published October 2015
In the International Law Office newsletter – New Zealand
In 2010 and 2011, the Canterbury region of New Zealand suffered several major earthquakes, resulting in huge destruction. The most devastating one in February 2011 caused tragic loss of 185 lives, as the country’s second-largest city Christchurch was torn apart. Unsurprisingly, the insurance industry has spent the following years dealing with the aftermath of unprecedented property claims. The volume of claims was on a scale not before seen in New Zealand and, in many cases, raised novel or complex issues requiring litigation to resolve.
Over recent months, senior appellate judges of the Supreme Court and the Court of Appeal have decided a number of important cases regarding earthquake insurance. These rulings will shape New Zealand insurance law for decades to come, and more cases remain in the pipeline for resolution yet.
Successive quakes and causes of damage/loss
The first earthquake in September 2010, of magnitude 7.1, struck about 40km west of Christchurch. It triggered a series of aftershocks over many months, including 4 others that were major earthquakes in their own right. The February 2011 quake was a magnitude 6.3 at shallow depth directly below the city, in the middle of the working day. One-third of the Christchurch CBD’s buildings were destroyed in that quake, and many more later suffered additional damage or required demolition due to aftershock quakes, which occurred in relatively quick succession and continued (with diminishing force) into 2012. Often, building damage from an earlier earthquake was unrepaired and still being assessed by the time the next quake hit.
This article examines a trio of insurance cases grappling with the difficulties created by the successive, separate, physical events.
Insurer liability issues in multiple events
Insurance policies covering material damage of premises usually allow automatic reinstatement of full cover after one event, unless contrary notice is given. But if a later event causes fresh damage while the building was still awaiting repairs, or turns a damaged building into one that is destroyed (i.e. a total loss), are successive payments due to the insured because of the automatic reinstatement?
In attempts to limit their liability under such policy clauses, some insurers argued that if partial loss is suffered in an earlier earthquake, followed by total loss in a later quake, insureds should only be entitled to the total loss payment in respect of the cumulative damage suffered across all events. These arguments typically took two forms:
(a) that the doctrine of merger, commonplace in marine insurance cases, should apply to general insurance cases, meaning that an insured’s partial loss claim would merge into any later total loss claim; or
(b) that the indemnity principle should apply to prevent an insured from also recovering for earlier partial losses, where recovery is made for a later total loss.
The doctrine of merger
In Ridgecrest NZ Limited v IAG New Zealand Limited, the Supreme Court considered whether the doctrine of merger could apply to insurance policies outside of the marine insurance context. Earlier High Court decisions had diverged on this issue. The Court noted several important differences between marine policies and general insurance policies, notably that under marine insurance policies a cause of action for unrepaired damage generally only arose when the risk expired (i.e. at end of the policy year).
In the Ridgecrest policy, maximum liability in respect of any single “happening” to the commercial building was NZ$1,984m. Ridgecrest’s building was damaged by each of the September and December 2010 earthquakes. Repairs were underway, but incomplete, before it was then damaged beyond repair in later 2011 quakes. The true replacement cost exceeded the amount of the liability cap, leading the insured to argue that losses were assessed happening-by-happening, with a cause of action accruing immediately after each event. IAG’s policy wording provided that the liability cap was reset after each happening, another factor the Court considered important in its assessment of whether the doctrine of merger applied.
The Supreme Court concluded that the doctrine of merger could not apply, and the insured should be paid for damage for each earthquake event. The Court was careful to frame its conclusion on this point with particular reference to the policy that it was interpreting. However, the broad comments made about the differences between marine and general (i.e. non-marine) insurance policies may make it difficult for an insurer to now limit the scope of the Supreme Court’s Ridgecrest reasoning and argue for the doctrine of merger in liability policies that rely upon “event” or “happening” wordings.
In a later case, QBE Insurance (International) Limited v Wild South Holdings Limited, the Court of Appeal noted that, although the Supreme Court did not go so far as to strictly confine the doctrine of merger to marine insurance, it did hold that the doctrine is a correlative of contractual practice there, where a cause of action arises only when the risk expires. Accordingly, if any scope remains to argue that the doctrine of merger can still apply outside the marine insurance context, it is likely only to be where the policy provides that the insured’s right of action arises only when the risk expires – which may be an unlikely scenario in many general insurance contracts.
The indemnity principle
Notwithstanding the difficulties in now arguing that an insured’s successive property damage claims should be merged, Ridgecrest did allow more scope for an insurer to argue that the principle of indemnity is a method of limiting its liability under insurance policies. The principle is that where an insurer has an obligation to indemnify for loss, the insured shall be fully indemnified and made whole, but never more than indemnified or in receipt of a windfall from the contract.
In Ridgecrest, the Supreme Court noted the availability of the indemnity principle in general, notwithstanding its rejection of the doctrine of merger, and that the principle would preclude recovery of more than the replacement value of the property insured. However, in this particular case, IAG’s policy wording prevented the indemnity principle from applying as a limit on the insurer’s liability. The policy contemplated full replacement cover, and the liability cap under the policy was less than the replacement value of the building. Moreover, the policy provided that the liability cap reset after each event. To apply the indemnity principle to prevent the insured from claiming for more than one event would “involve a substantial rewriting of the liability cap provision” in favour of the insurer.
The indemnity principle was further considered by the Court of Appeal in QBE v Wild South, which determined that if an insured suffered damage from an earlier event, unrepaired at the time of a later event, the insurer is liable to indemnify only for the cumulative damage of both events. The cost of reinstating the property after the later quake represents the insured’s actual loss, although it may also claim for any expenses actually incurred in relation to the earlier damage.
The Court of Appeal rejected arguments that such an application of the principle denies the insured its right to be indemnified for the unrepaired damage from earlier events. In most cases the insured will never actually incur the expense of remedying damage from the first event. To allow separate recovery for unrepaired earlier damage would allow insureds to profit from the policy.
The Wild South decision involved 3 appeals heard together, raising similar issues of interpretation. One of the insurers sought leave to appeal the case further, but was refused by the Supreme Court. New Zealand’s highest court said there was no obvious error by the Court of Appeal, which had applied orthodox interpretation to the specific wording of the automatic reinstatement and average clauses, and did not conflict with its earlier Ridgecrest principles.
Use of computer modelling to allocate losses
In a subsequent case, Vero Insurance v Morrison, the Court of Appeal had to evaluate ways in which insurers and policyholders might try to quantify and apportion damage between multiple quakes, in particular, the evidential value of expert computer modelling techniques.
The insured parties owned an industrial-commercial building in Christchurch that was severely damaged across several quakes. Their experts said it suffered separate cumulative damage in each of the 5 major quakes. The insurance policy provided indemnity cover for the building on an event-by-event basis, with automatic reinstatement for each “event or series of events arising from the same cause” in any 72-hour period. Vero said it was only liable for damage arising from two of the quakes.
Actual witness evidence or building test data was sparse in this case. Vero’s experts had not visited the site. To advance its claim, the insured’s structural engineering expert employed modelling that measured the ground shaking intensity of each quake, to assist in identifying the events of loss and quantifying the extent of the damage caused by each event. The expert used it to identify the likely percentage damage resulting from each event, along with a photographic essay of the building at different times.
The High Court judge had found the modelling reliable and substantially helpful as an input for assessment of a reasonable allocation of damage and repair costs per event. Vero challenged this on appeal. The Court of Appeal rejected Vero’s argument that the evidence was inadmissible, finding it plainly relevant, meeting the reliability threshold, and “of some probative value”. Due to the deficiencies in documentation or building testing of damage, this was an appropriate case to use modelling to supplement the evidence. The Court referred with some approval to an approach taken in UK cases involving LMX-spiral reinsurance, which used actuarial models as a pragmatic solution to proving losses with less than “scientific exactitude”, although it did not formally decide whether such approach extended to other types of insurance.
However, the Court of Appeal was more sceptical of the value of the modelling evidence than the High Court. It agreed with Vero that the model had flaws and limitations, such that less weight should have been accorded to the evidence. Direct evidence on the extent of the damage would usually be preferable. Together with the photographs, the insured could prove there was some additional physical damage attributable to later quakes, but the limitations of the model meant that the extent of it, and cost of repairing it, was relatively minor and perhaps only nominal.
When is a building not just damaged, but “destroyed”?
In both the Wild South and Morrison cases, a separate issue was when the building should be treated as “destroyed” for the purposes of the insurance policy, particularly where it may have still had some physical utility or functionality but has become uneconomic to repair.
While this is closely a question of fact in every situation, the principles applicable to the meaning of “destroyed” usually include an objective assessment by the court, but informed by considerations which may include any special features of the building, the insured’s intentions for it (so long as they are not eccentric or unreasonable), and the respective costs of reinstatement and replacement. The test was not simply what the insured would do if it were spending its own money, and is not defined only by the economics of repair.
In Wild South, it was important that the policy distinguished between destroyed and damaged buildings. In particular, different measures of indemnity were applied to each – the cost of rebuilding was the measure where the property is destroyed. That situation differed in two respects from the Morrison policy, which first specifically defined “destroyed” and, further, contained a constructive total loss provision. In both cases the building was still functional to some extent, and the insured wanted to preserve and use what they could. In Morrison, there was conflicting evidence about the practicalities and economic viability of repair of repair. More weight was seemingly given to the owner’s subjective intentions, and contra-proferentum to the insurers’ specific wording, which could have chosen to include “economic destruction” language but did not.
These cases demonstrate the significant influence that appellate courts are having in shaping the insurance sector’s response to the Canterbury earthquakes. The decisions clarified the principles of liability of insurers and entitlements of insured property owners, in both residential and commercial sector, and should assist towards settlement of other similar unresolved cases.
However, the decisions also show how outcomes depend on the specific policy wording used, and that allocation of specific damage across several events of loss is an extremely complicated evidential problem. While general principles have been established relating to the application of the indemnity principle, and “destroyed” buildings, cases often turn on the particular policy wording. Even so, these rulings may have far-reaching consequences and, in particular, the Supreme Court’s rejection of the doctrine of merger makes it difficult to argue the doctrine can apply to general insurance cases in New Zealand.
Published while at Wilson Harle: Gary Hughes, 2015
 Ridgecrest NZ Limited v IAG New Zealand Limited  NZSC 129.
 QBE Insurance (International) Limited v Wild South Holdings Limited  NZCA 447.
 Certain Underwriters at Lloyds of London v Crystal Imports Limited  NZSC 186.
 Vero Insurance New Zealand Limited v Morrison  NZCA 246.
 Equitas Ltd v R & Q Reinsurance Company (UK) Ltd  EWHC 2787 (Comm)