A majority of the Supreme Court has ruled that it is not possible to assign replacement benefits in an insurance policy:  Xu v IAG New Zealand Limited [2019] NZSC 68 (3 July 2019). In the view of your humble correspondent, the minority view is to be preferred. The case presents an opportunity to review some of the underlying principles. This review is useful because these ideas may resurface if a later Court picks up the minority opinion. You can read a summary of the case prepared by the Court/ its staff here. In this article, editorial views are put forward.

The principal issue in Xu was whether the entitlement to replacement was capable of being assigned where the customer, as assignor, had not incurred the cost of replacement at the time of the assignment. The assignment occurred at the time of a sale and purchase of the property between the assignor and assignee.

The subject was considered in Bryant v Primary Industries Insurance Co Ltd [1990] 2 NZLR 142 (CA) which held that a right to replacement benefits was conditional on the insured incurring the cost of repair could not be assigned where the insured party has not incurred that cost.

Under an classical insurance policy the insurer indemnifies the insured in respect of the loss or damage. The insured is put in the position it would have been in if the loss or damage had not occurred. Where property is involved, generally, this form of cover requires the insurer to indemnify the insured for the indemnity value of the property. Often that will be less than the cost of purchasing the property new at the time of the loss.

Commentators have said previously, as has your humble correspondent, that replacement type insurance is a different beast altogether. In the event of an accepted claim, it represents a boon to the customer, who receives something new for something old. If this involves a one-hundred year old mansion being rebuilt as-new then the difference is significant by an order of magnitude.  A premium of $600 may result in building costs in the millions.

This is not betterment because betterment by its nature is not covered. Betterment is an uplift on an indemnity where doing what is necessary under the policy necessarily results in an increase of value of the property. It sits to the account of the insured.

By contrast, replacement as-new may involve the insured receiving from the insurer something significantly more valuable than it otherwise would have obtained under a traditional indemnity policy. It is not an indemnity at all. From the insurer’s point of view, it is closer to a gamble. In individual cases the insurer writes the risk without having specific information about the total replacement costs for a building if it is destroyed. (The market value is not a point of reference.) Put differently, the amount required for replacement is not solely an incident of the loss. It is the function of a contractual commitment to be liable for certain costs, whatever they happen to be, if a certain thing happens and other criteria are met.

There is a principle of insurance law that an insurance policy is not capable of being assigned by the insured without the consent of the insurer. The reason for this rule is that an insurance policy is personal to the insured. The insurer has had the opportunity to assess the risk of the individual being insured. It cannot make this assessment of the new person who takes its interest under an assignment. That person might have a bad claims history. It might be a customer the insured does not wish to deal with. (Insurers may transfer policies to other insurers under a legislative scheme which required Court approval.)

So much for insurance law principles. Then there are the classical laws of property, including rules of law regulating assignments. A chose in action may be assigned. On the face of it, a claim under an insurance policy–certainly an outstanding claim for an indemnity only–is a chose in action, like a debt. It is a thing capable of being assigned, as a matter of law.

How then to treat an assignment of a replacement type policy? This question draws together rules of insurance law and rules of property law. It is also useful to understand the economics of the situation.

Until the time of the Canterbury earthquakes, competition in the retail insurance sector led to insurers offering unlimited replacement cover for property. This risk was passed on to reinsurers. Insurers made money on the margin between the reinsurance premium and the premium charged to the customer, less their costs. These margins have always been, and remain, tight.

Since the time of the earthquakes, market practices in New Zealand have changed. Generally, cover of this nature is not offered. This change is linked to the cost of reinsurance. The cost of reinsurance for full replacement cover means that the insurer could not make an adequate margin. This means they could not operate prudentially: they would not have enough premium income to pay claims and make a surplus.

So, opposition by insurers to moving away from the Bryant approach is understandable. There will also be a more immediate issue about a cohort of similarly affected people wishing to advance assigned claims on the same basis. Even if there are only about one hundred claimants, complete replacement in every case could presumably add up to tens of millions across the sector.

The present case will not have been one that invoked a great deal of sympathy for the claimant. The Courts will have proceeded on the reasonable assumption that the claimant-purchaser-assignee received legal advice on the possibility that he would not receive the replacement benefit he received under the assignment, on the basis of Bryant. Presumably the claimant was not counting on a change of law by an appellate Court.

Replacement  is often expressed in the insurance policy to be dependent on the customer having already paid for the reinstatement. In reality, this is generally not what happens because almost no one has sufficient surplus funds to pay for those works and then wait to be reimbursed. The actual concept in play is a little different. This requirement represents a commitment to pay for replacement works that are planned and then implemented. Generally, that process is coordinated by the insurer and its representatives. This way, it is in control of the cost. All of this is subject to the specific terms of the insurance policy.

These are reasons to read down this requirement. This kind of reading-down occurs where a provision in an insurance policy conflict with its basic purpose. I say that this occurs because an insurance contract is not an ordinary commercial agreement, it is one that is intended to effect the transfer of a particular risk.

For example, Courts have read down a requirement on an insured to take reasonable care and stipulations about “alteration of the risk” during the currency of the policy. You cannot agree to deliver 10 widgets and then say you have a discretion to deliver 8. The Court will require you to deliver 10. So, you cannot insure someone against their own negligence and then except cover when they are negligent. The minority approached this issue on the basis that by the time of the agreement for sale and purchase of the property, the right to claim replacement under the policy had accrued. This analysis is preferable because regarding the right as having accrued reflects the reality that building works are not generally carried out and then reimbursed. The right to require performance of a contractual commitment arises in accordance with the terms of the contract–in this case, upon the occurrence of loss or damage covered by the policy. The identity of the claimant should not matter because by that stage, the subject-matter is not personal.

Reinstatement of this kind cannot be described as personal. While there are many decisions to be made, they are capable of being resolved objectively and so are not dependent on the whims of the person requiring the works to be carried out or paid for. Neither the person nor the property need to be assessed for risk. The damage has already occurred.

In summary, I consider that the better approach is to regard the right to obtain reinstatement as purely contractual in nature. It is not an indemnity. All talk of the indemnity principle should be jettisoned. As a contractual right, it is capable of being assigned on ordinary principles. The minority achieved this outcome by regarding the rights as having accrued at the relevant time. For the issue to resurface, market practices must change once again. That is likely to be a while away. By then, a differently composed Court may take the opportunity to revisit Bryant.

Steve Keall
Barrister
4 July 2019