Repair vs Replace - O’Loughlin v Tower

On Friday 5 March 2013, Justice Asher handed down his decision in the widely publicised case of O’Loughlin v Tower Insurance Ltd [2013] NZHC 670. This decision was eagerly anticipated by policy holders affected by residential red zoning in Christchurch and insurers alike.

If you reside in Auckland, you may query why you should be concerned with this decision given that it relates to a property in the residential red zone in Christchurch. This decision is relevant as it may potentially affect the way in which your insurer assesses your property (on a repair vs replace basis) following a future event (such as an earthquake in Auckland or elsewhere in the country) which causes damage in relation to which your insurance policy responds.

It is also a timely reminder to property owners (given that insurers are changing cover to a sum insured) to ensure that insurance premiums are up-to-date and that the sum for which you elect to insure your property will be adequate to cover any potential cost to repair, rebuild or replace your house in a future event to which your insurance policy responds.

Facts

Briefly: the O’Loughlins’ property in Gayhurst Road, Darlington, Christchurch was damaged by earthquakes on 4 September 2010 and 22 February 2011 and a significant aftershock on 13 June 2011. The property is situated in the residential red zone and the Government (via CERA) made two alternate offers to purchase the property. The O’Loughlins accepted the second option, under which the Government purchased the land for $110,000 leaving the O’Loughlins to pursue the remaining compensation from their insurer, Tower.

The Dispute

A dispute then arose between the O’Loughlins and Tower over what compensation is properly payable under the terms of their house insurance policy (“the Policy”). The Policy is typical in its wording in that Tower had the option to make payment for replacement by repair, rebuild, buying another house, or present day value.

Tower elected to assess the cost on a repair basis using injections of low mobility grout (LMG) to re-level the concrete slab foundation. Tower offered to settle by making a payment, rather than having actual work done. On the basis of the assessed cost of repairs, Tower claimed it was only obliged to pay the O’Loughlins $197,179.15.

The O’Loughlins claimed that Tower, in assessing the cost on a repair basis, had not met their obligations under the Policy, and instead claimed they were entitled to a higher amount assessed on the cost of rebuilding a new house on the same site.

The O’Loughlins commenced proceedings in the Christchurch High Court seeking a declaration or alternatively judgment that Tower is liable to pay the net sum of $416,113.50. If successful, this meant that the O’Loughlins would receive a total of $620,000 being the equivalent cost to rebuild on the existing site in the red zone, although the equivalent cost of rebuild on a sound site outside the red zone was $540,000. The O’Loughlins also sought general damages in the sum of $50,000.

The Issues

Four significant issues were canvassed over the course of the lengthy judgment:

1. Did the creation of the red zone itself cause physical loss or damage to the house so that, irrespective of the level of damage, the O’Loughlins were entitled to full replacement cover? In other words, did the creation of the red zone render the property a total loss?

2. Did Tower meet its obligations under the policy by offering a payment to the O’Loughlins in a sum equivalent to the cost of repair, adopting the LMG technique?

3. If Tower has not fulfilled its obligations, what sum should it now pay?

4. Should the O’Loughlins receive general damages of $50,000?

The Decision

While Justice Asher stopped short of entering judgment for either party, he indicated that he would be able to make the following declarations:

(a) Creation of red zone- did not constitute or cause physical loss or damage to the O’Loughlins’ house

Justice Asher (at paras 55 to 86) discussed whether the creation or designation of the red zone rendered the property a total loss. He held that the designation of the red zone did not give rise to a claim by the O’Loughlins under the primary insurance clause (which required physical loss or damage). The red zone did not require physical alteration or repair to the house and did not prohibit habitation, repair or rebuilding, or the grant of building consent.

He also held that the creation of the red zone did not give rise to a claim under the natural disaster special benefit clause in the Policy. This clause extended cover to direct losses arising from measures taken by proper authorities after earthquakes to reduce their consequences and did not include the word “physical”. However, the wording of the Policy and wider commercial context indicated that claims are limited to physical loss or damage to the house and not economic loss. In any event, he held that there was no economic loss suffered, as the creation of the red zone was accompanied by a CERA offer to buy the house at the 2007 valuation, which has not been shown to be less than the market value at the time of the earthquakes.

(b) Tower’s repair calculation - did not meet obligations under the Policy

Tower had not met its obligations under the Policy by offering a payment equivalent to the cost of repair using the LMG method. On the evidence presented, it was conceivable that the LMG method could encounter serious problems and would not secure a building consent. The LMG method had also never been carried out by Tower’s experts and there was a risk that the concrete slab could crack on re-levelling. Accordingly, Justice Asher (at para 154) held that “no reasonable insured or insurer would commit to carry out actual repairs in this way” and Tower, in making payment on the repair methodology using the LMG method, did not meet its obligations under the Policy.

Further, the amount offered by Tower was not shown to be the replacement value (which the O’Loughlins are entitled to) and does not equate to the actual cost of bringing the house back to “the same condition and extent as when new” under the Policy (at paras 87 to 158).

(c) Tower needs to pay replacement value on another site

Under the Policy wording, it is expressly Tower’s election on how to indemnify the O’Loughlins. Justice Asher (at para 177) said that Tower is obliged to replace the property to “the same general physical condition and size as the O’Loughlins’ preearthquake home was, when new.” It does not need to be an exact replica but comparable to the original house as when it was new.

As Justice Asher found that repair was not an option (given that the LMG method is not an actual repair), Tower’s only remaining options were to elect between payment for full replacement value of the O’Loughlins’ house on another site, calculated at its option on a rebuild or replacement basis. It is now up to Tower as to which of these options it chooses. Justice Asher also held (at para 181) that in calculating the cost of rebuilding, the O’Loughlins are only entitled to claim the cost of building on another site i.e. on sound land outside the red zone.

(d) Further submissions required on compensation payable and general damages

Justice Asher indicated that the parties should now make submissions as to Tower’s election and the appropriate amount of compensation payable and general damages.

Wider implications

The decision has wider implications on other insurance claims not yet settled in the red zone and on those cases currently before the Christchurch High Court.

The fact that Justice Asher indicated that the creation of the red zone did not constitute physical loss or damage avoids a potential flood of claims by red zone residents seeking to unwind their settlements and provides certainty to insurers in relation to claims which have already been settled.

The Judgment on repair methodology is specific to the facts of this case but emphasises that if a repair methodology is used, insurers need to ensure that the scope and assessments on the cost of repairs are accurate, realistically achievable and will secure a building consent.

However, as Justice Asher indicated that the repair methodology (in the circumstances of this case) did not meet Tower’s obligations under the Policy and that the claim should be settled on the repair or replacement cost on another site. This potentially leaves the door open for red zone residents whose claims are not yet settled to be assessed in the same way.

What is now clear is the way in which rebuilds should be assessed. Any such assessments should be made as if the house was to be built on another site on sound land outside the red zone. This avoids policy holders receiving a windfall in claiming additional foundation costs which they would not actually incur when rebuilding on another site opposed to the existing site.

This also means that insurers, in obtaining assessments on this basis, will be deemed to be fulfilling their obligations under their respective policies.

Conclusion

The overall result of the decision is a win for the O’Loughlins in that they will be entitled to an amount that is greater than that which would have been paid out on a repair assessment basis.

This decision however, is also a win for Tower as the amount of compensation payable is limited to the equivalent amount it will cost to rebuild the house on another site, assuming the land is sound.

The end result remains to be seen, but it is likely that the interim decision of Justice Asher will have a bearing on how other similar claims are assessed in future.

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