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Every now and then courts have to self-correct to prevent errant off-shoots of legal reasoning advancing into the law. In the decision, IAG New Zealand Ltd v Degen [2024] NZHC 397, the High Court took its secateurs to two CEIT decisions and set straight just what legal effect the Fair Insurance Code has on insurers.
Context
The February 2011 Canterbury earthquake and the earthquakes that followed significantly damaged Mr Degen’s house. He considered his house to be so badly damaged that it was beyond repair. His insurer, IAG, disagreed on this point and the matter proceeded to the Canterbury Earthquakes Insurance Tribunal (CEIT). The CEIT found that Mr Degen’s house was capable of repair. However, the Tribunal’s decision became controversial because it made a number of subsidiary findings that altered what had previously been considered to be the scope of insurer obligations in relation to manner of payment and assessment of damage:
- Firstly, the CEIT ordered that IAG should pay all of the repair costs in one upfront lump sum, as soon as Mr Degen signed a building contract. Prior practice when an insurer was funding a repair permitted the insurer to make payments when invoices were rendered, and repair costs were actually incurred.
- Secondly, the CEIT decided that IAG should pay for certain professional reports obtained by the insured, beyond those permitted by the policy. The CEIT made this finding on the basis that IAG had breached a duty to adequately assess the damage and scope the repair strategy.
These findings left IAG (and other insurers) wondering where this duty to assess and scope damage adequately came from and whether they now needed to restructure their payment practices to make up-front payments the norm. IAG appealed the CEIT decision, and the resulting High Court decision is the subject of this article.
Do insurers really have to pay for everything upfront?
The CEIT Member reached her conclusion that the insurer should pay the entire repair bill upfront based on the Court of Appeal decision in Medical Assurance Society of New Zealand Ltd v East [2015] NZCA 250, and, in particular, a line in the judgment that says that a “right to settlement [under the insurance policy] … is absolute once they [the insureds] incur a contractual obligation for the purpose of restoring the building.”
However, in the High Court’s opinion, the CEIT Member misinterpreted the East judgment by failing to apply the quoted passage in context. In East, which also concerned the issue of whether repair costs should be paid up-front, the Court of Appeal stated that once the insured incurred a contractual obligation to pay building repair costs, the right to be paid the policy reinstatement benefit became absolute. However, applying this in the context of a building contract to repair, the Court of Appeal considered that the insurer’s obligation was to indemnify the insured “against all costs incurred” as per their approved contractual indemnity and was unpersuaded by arguments to reject the insurer’s approach that liability to cover such costs only arose when those costs were (or were about to be) incurred. The Degen Court agreed, holding that a contractual obligation to pay will normally not arise until an invoice is issued.
Degen concerned a policy where if damage was repairable the insurer had to pay the reasonable repair costs. The insured, however, could choose whether or not to have the repairs carried out. In the event the insured decided against repair, it was entitled only to the present value of its house plus reasonable associated costs. In the context of this policy, the Court expressed concern that where repair costs exceeded the present value of the house, if insurers were required to make up-front lump sum payments, the insured could opt for repair costs so as to get a higher payout than the present value, but then decide to demolish and rebuild. This echoed concerns expressed by the Court of Appeal in East that if the insurer were to pay the insured the reinstatement amount before incurring any liability, it would be powerless to prevent the insured from applying the funds for some other purpose.
Equally, of course, on the other side of the balance, both the Degen and East Courts recognised that an upfront lump sum payment before repair was undertaken would be based on an estimate only and could fall short of the actual repair bill – as we all know, building costs, in practice, frequently exceed the estimate given and the scope of repair itself may need to be varied as works progress. Finally, the Degen Court noted that the current policy of paying invoices when they arise worked efficiently and effectively in practice and did not leave the insured out of pocket.
The Degen decision makes clear that the “contractual obligation” quoted from the East judgment must be read as giving rise to a liability by an insurer to its insured to make payments in response to invoices or payment claims issued pursuant to the construction contract, rather than a liability to pay the full indemnity as a lump sum upon the mere signing of that contract. This makes total sense in context, since even under fixed price (rather than charge-up) construction contracts, payment claims are normally submitted at regular intervals (e.g., monthly) throughout the course of the project, or on successful completion of contractually identified stages. It would be a rare beast of a construction contract that bestowed the entire contract price on the constructor up front and said, run with it!
Is there a duty on insurers to assess damage and scope the repair strategy adequately?
In deciding that the insured’s costs of retaining professionals to assess damage (beyond those permitted under the policy) should be paid, the CEIT Member posited a duty on insurers to assess damage and scope repairs adequately in the first instance. She drew this duty from an earlier (2021) CEIT decision, LS v Medical Insurance Society Ltd, where it was held that insurers had a duty to assess claims accurately by asking correct questions of the relevant experts.
However, on review, the High Court in Degen considered that there was no authority for the CEIT to find such a duty. The LS decision relied on a High Court ruling in Van der Noll v Sovereign Assurance Co Ltd, but that case found a duty arose because the insurers had the contractual discretion to determine if the medical condition suffered by the insured qualified him for one of several benefits under the policy. Under applicable law, the insurer was required to inform itself when deciding how to exercise its discretion. By contrast, in Degen, the insurer had no discretion concerning the availability of cover. The evaluation of whether or not an insured has demonstrated the amount for which they are claiming is of a different nature. Ultimately, it is bedrock law that an insured has an obligation to prove its loss. Imposing a duty on insurers to assess claims accurately risked cutting across this principle and amounted to a substantial departure from existing law.
The Court also rejected the notion that the implied duty of good faith (as established in Young v Tower Insurance Limited) and the Fair Insurance Code were capable of supporting a duty to assess damage accurately and properly scope the repair strategy.
The Young Court had found that the implied duty required an insurer to disclose to the insured all material information, act reasonably and process the claim in a reasonable time, but otherwise left open for another day the full scope and limits of the implied duty of good faith. The Degen Court seized its day to add that an insurer would not be in breach of its good faith obligations if there were reasonable grounds for disputing the claim. The Court observed that while there might be “an opportunity for the courts to consider imposing a duty on an insurer to accurately assess claims”, this was not the day to do so.
What effect does the Fair Insurance Code have on insurers?
The Degen Court also made some clarifying comments on the legal effect of the Fair Insurance Code. The Court stated that the Fair Insurance Code was not incorporated into the terms and conditions of Mr Degen’s policy and was also not an extrinsic tool that could aid in the interpretation of that policy. In this sense, the Fair Insurance Code had no legal bearing at all on IAG’s obligations and, in the High Court’s words, “is designed to sit alongside the law …(with) its own enforcement regime”.
Our Comment
In many respects the Degen decision is a sensible and pragmatic one, correcting what could have been disruptive interpretations of prior case law in relation to insurer obligations. The rejection of a requirement to pay the full remediation costs up-front accords with construction practice and allows the insurer to fund the remediation in a manner that matches its insured’s payment obligations under the relevant construction contract.
In substantially rejecting the view that the duty of utmost good faith requires an insurer to assess a claim accurately, the case balances the insured’s burden to prove its loss against an insurer’s good faith obligation to act reasonably. Young made clear that the full scope of insurer good faith obligations is yet to be developed; Degen leaves open the possibility of some circumstances where a duty to assess a claim accurately might be imposed on an insurer.
With respect to the Fair Insurance Code (FIC), insureds may well begin to ask for insurer obligations under the Code to be incorporated into their policies. Regardless, rejecting the value of the FIC as an extrinsic aid to interpretation of insurers’ obligations is arguably a step too far. For example, professional / industry standards of conduct for architects and engineers can and do assist in demonstrating what constitutes acceptable / best practice in those professions for the purposes of meeting contractual standards of care. By not dissimilar reasoning, FIC requirements that an insurer settle valid claims “quickly and fairly”, could also assist in populating the insurer’s implied contractual obligation of utmost good faith.
While the Degen decision has provided insurers with some reassuring endorsements of existing law and claims adjustment practice, there is much that is still open in this area of insurance and the industry can expect further developments.
If you have any questions, please get in touch with our Insurance Team or your usual contact at Hesketh Henry.
Disclaimer: The information contained in this article is current at the date of publishing and is of a general nature. It should be used as a guide only and not as a substitute for obtaining legal advice. Specific legal advice should be sought where required.
