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January 12, 2012

RETENTIONS – Legal Authority

The function of a Material Damage Policy is to pay a sum of money to the Insured so that he is placed in the same financial position after the loss as was enjoyed before.

The Insured must be, subject to contract conditions, restored to the previous financial position he was in.

Marine Insurance Act 1906 is continuously referred to in the context of fire and pecuniary insurances when dealing with the principle of indemnity.

The Act defines a “Valued Policy” as follows:

27 (1) A Policy may be either valued or unvalued.
(2) A “Valued Policy” is a Policy which specifies the agreed value of the subject matter insured.

“Unvalued Policies” are defined as:

28 An “Unvalued Policy” is a Policy which does not specify the value of the subject matter insured but subject to the limit or sum insured leaves the insurable value to be subsequently ascertained.

The “Measure of Indemnity” is defined as :

67 (1) The sum which the Insured can recover in respect of a loss on a Policy by which he is insured, in the case of an “Unvalued Policy”, to the full extent of the insurable value, or in the case of a “Valued Policy”, to the full extent of the value fixed by the Policy, is called the “Measure of indemnity”.

A “Valued Policy” defines the basis of value for indemnity as does the Business Interruption wording under a “Fire Policy”.

Individual Policies can be modified to contain a definition of the mode to be adopted in ascertaining the loss [Henry Booth & Sons –v- Commercial Union Insurance Company Limited (1923)].

Castellain –v- Preston (1883) sets out the basic concept and purpose of a Policy of insurance.

“The Contract of Insurance contained in a Marine or Fire Policy is a contract of indemnity and of indemnity only and this contract means that the Assured shall be fully indemnified but shall never be more than fully indemnified. This is a fundamental principle of insurance”.

Lonsdale & Thompson Ltd. –v- Black Arrow Group Plc and another (1993) confirm that insurance contracts are contracts of indemnity but parties to the contract may make specific provision for a assessing the loss on an agreed basis. Aside from this the measure of indemnity is the diminution in value of the property insured. This case is seen as an authority for deductions for wear and tear to be made.

Four important English cases which have considered the amount payable as indemnity in respect of building losses:

(1) Elcock and others –v- Thomson (1949)
The sum insured applied to losses which were partial. Again reference to Marine Insurance Act 1906 (This act is repeatedly referred to in cases about indemnity calculations thus demonstrating its relevance) reference is to Section 69 (3) of the Act. If a ship was not repaired, recovery under the Policy would be limited to sum representing the actual depreciation caused by the casualty. In Elcock case, property was not reinstated. In Elcock case it was decided that the agreed loss was reduced proportionately in the context of the agreed value (VAR) thus underpinning the fundamental of proportional deduction for under-insurance (in this case the sum insured was an agreed value).

(2) Reynolds & Anderson –v- Phoenix Assurance Company Ltd. & Others (1978)
In this case Insurers argued that reinstatement less wear and tear was inappropriate (in this case) and that either market value or “alternative modern construction” should be the method used.

The Court suggested three possible ways of evaluating the loss, (1) market value, (2) equivalent modern replacement and (3) reinstatement.

Market value is only appropriate in certain circumstances in that buildings are not like tonnes of coffee and unless the Insured is a Property Dealer, unlikely that market value is correct basis for calculating indemnity.

The Insured intended to use property as a grain store and to mill grain to produce feed for livestock (also intervention store).

Agreed by Insurers that the sum insured before the loss represented replacement value with a building of similar massive construction although in the event of a substantial loss it was unlikely that the building would be reinstated in such manner.

There was a fire and a claim presented for £346,476 for repair and reinstatement. The cost of reinstatement was agreed at £280,000 to £240,000 with a deduction agreed for “betterment producing the figure of £243,000 but this would not cover the cost of reinstatement”.

Reference to Castellain –v- Preston “You are not to enrich or impoverish”.

In this case the Judge was satisfied the Policyholder intended to reinstate in which case the true measure of indemnity was the cost of reinstatement less measurable betterment.

Loss Adjusters had agreed (subject to Insurer’s approval) the following:

(a) The appropriate way of calculating the loss was reference to reinstatement costs
(b) The amount of the indemnity payment should be £243,000.
(c) That the whole sum should be paid within four weeks irrespective of whether re-building had started by then or not.
The judgement supported this view but in view of the delays since that agreement and the finalisation of the case the Judge allowed additional sums for inflationary factors together with Architect’s fees etc. so that the sum for unliquidated damages was £343,320 which the Judge was satisfied was sufficient to put the Plaintiffs in the position they would have been had Insurers not refused to pay under the contract.

(3) Pleasurama Ltd. –v- Sun Alliance (1979)
Relating to market value –v- reinstatement less wear and tear

The Policy did not incorporate Reinstatement Memorandum. The property was a bingo hall and the Policy agreed to “pay to the Insured the value of the property” at the time of the damage etc.

It was stated that it was generally accepted that the mode of calculating an indemnity was reinstatement less wear and tear and that payment on account was made on this basis. In Pleadings Insurers contended that they overpaid and that the correct measure was loss of market value. Reference was made to an Insured suffering damage to a room as a result of fire which has to be replastered and redecorated and fitted with new doors and windows, it is the cost of carrying out these operations which is the measure of damage – “it must however be subject to one proviso, and that is that if the Insured is paid the whole cost, he may be given a profit for which he will be getting something new for what was previously to a greater or lesser extent worn or old. This however can be dealt with and is in practice dealt with by a deduction for depreciation”.

It was held that reinstatement must be adopted as the measure of indemnity and there was not “sufficient evidence of market value for establishing bingo halls to enable any kind of reliable estimate to be made”.

The Policy did cover professional fees and Public Authorities costs but reference to “incurred” meant that these had to be incurred by the Insured.

Legal text commentary on this case is important as it repeats and gives authority to the general understanding of indemnity for buildings being on the basis of “reinstatement less wear and tear”.

(4) Leppard –v- Excess Insurance Company Ltd. (1979)

This is relevant for market value in that the Policyholder had decided before the loss to sell the property in which case market value was relevant on the basis of calculating an indemnity.

Keystone Properties Ltd. –v- Sun Alliance (1992)

Stated that “value” as referred to in the Policy wording is not market value.

Above cases reinstate the principle of reinstatement less wear and tear, such deductions always on a component basis, never on an “arbitrary” basis. This principle is also enforced by a number of third party legal cases which are referred to in my dissertation as published by the Chartered Insurance Institute Journal 2003 “Damages for Third Party Property Losses” (see for dissertation).

Ref: breach of duty of utmost good faith by Insurers – Manor Park Homebuilders Ltd. v AIG (2008)

In that case reference was made to the Australian decision of AMP Financial Planning Ltd. –v- CGU Insurance Ltd. (2005). “Whilst dishonest conduct will constitute a breach of the duty of utmost good faith, so will capricious or unreasonable conduct”….”failure to make a timely decision to accept or reject a claim by an Insured for indemnity under a Policy can amount to a failure to act towards the Insured with utmost good faith”.

It follows that an Insured who has had a sum retained by an Insurer may sue for specific performance and/or for damages for breach of utmost good faith and may seek interest on the sum not paid (this has been supported by an Opinion we have from Senior Counsel).

Refer also to Austin Buckley in “Insurance Law in Ireland” [Chapter 4] (pages 7 to 9 to 85). Mr. Buckley makes reference to the cases already cited together with reference to Irish Case Law such as St. Albans Investment Company –v- Sun Alliance in London (1983) and in that case market value was the appropriate basis but reference to partial loss in that the Insured is entitled to an indemnity “based on the cost of reinstatement of the damage portion less an allowance for betterment”.

This allowance for “betterment” or depreciation has always been calculated on a “scientific” basis i.e. less wear and tear deductions on a component basis as clearly there is no other approach or option available (“measurable betterment” is a different matter for example improved scope or capability). The imposition of arbitrary deductions for wear and tear which are presented as “retentions” is clearly wrong and disregards proper well established (as is acknowledged by the Courts) procedure in these matters.

Otherwise where particulars and proof of the loss have been provided, an Insurer who delays payment after the amount of the loss has been ascertained is in breach of the contract. This is in the absence of an express condition precedent stating otherwise. Furthermore in the absence of such condition precedent the retention of any monies after the sum settlement has been ascertained is in breach of the contract.

Reference to Policy wordings – clearly the Insurers option to reinstate is completely different and irrelevant in the context of this argument. Once an Insurer has elected to reinstate, the contract is no longer one to pay a sum of money but to reinstate the property.

If Policy wordings are examined they are all fairly standard (FOC/ABI format), for example

the RSA “Safe Home” Policy states that deductions will be made for wear and tear if the property is not in a good state of repair or the sum insured is inadequate or if reinstatement of the building cannot be carried economically then Insurers will pay a reduction in market value (see my previous reference to partial loss vis-a-vis market value). However there is no reference to retention and clearly deductions for wear and tear should be made in accordance with recognised procedure and precedent. If the sum insured is adequate and the property in a good state of repair then the implication is that no deductions at all should be made. The implication therefore is that retaining any money is in breach of the contract.

AVIVA Household Policy

Again reference to “normal wear and tear” in event that the buildings are not kept in a good state of repair or the sum insured is inadequate. Again the implication is that no deductions should be made if these criteria are met and again the retention of any monies suggests breach of contract. However there is a further condition that deductions for wear and tear will not be made if the buildings have been reinstated and in this situation Insurers should apply an indemnity settlement i.e. wear and tear deductions on a component basis with the balance to be paid on completion of the works. Again the balance is the “reinstatement” difference which in the majority of cases will be “Nil” or nominal.

Zurich Commercial Policy –

“we will pay full cost of repair or reinstatement provided the work is done without delay….. we will not pay for repair or reinstatement to a condition better or more extensive” etc.

This is the Reinstatement Memorandum wording and again there should be no difficulty here in calculating the reinstatement difference (same considerations as above apply).

Zurich Home Policy –

There is reference to work not being carried out as follows

“if repair or reinstatement is not carried out we will pay the reduction in market value resulting from the loss or damage but only up to what it would have cost to rebuild or repair if such work had been carried out without delay”. In terms of a partial loss, loss of market value is the cost of repair. In other words the market value has been diminished by the damage and reinstating the pre-loss value represents the cost of repairing or reinstating the damage. In the event of a total loss, different considerations apply (see Leppard –v- Excess Insurance Company 1979) and in terms of a total loss where the Insured does not intend to reinstate, the Insured’s intention prior to the loss is paramount as well as “evidence of market value” (Pleasurama Ltd. –v- Sun Alliance 1979).

AXA (Homeguard) –

If repair or reinstatement is carried out there will be no deduction for wear and tear provided the sum insured represents the full “reinstatement value of the building and you have maintained the building in good repair”. Again subject to these criteria, if works are carried out the Insured is entitled to the full repair, reinstatement cost. Again no reference to retaining any part of the payment or indemnity. AXA more so than other Insurers in the market exercise their option to reinstate and in the “operative” clause state that they “will, at our option pay the cash value of the loss or damage or we may repair, reinstate or replace lost or damaged property”. Reference to cash value again is in line with Marine Insurance Act 1906 i.e. put the Insured in the same financial position, again no provision for retaining an arbitrary amount and the second part of the clause refers to Insurers option to reinstate or replace which is a more recent development in the context of “managed repair networks” etc.

FBD Insurance Vintners Policy –

again in the “basis of settlement” wording reference to wear and tear deductions for under-insurance or where the buildings have not been maintained in good repair but a further condition that no payment shall be made until reinstatement has taken place is unusual which in essence can be interpreted that no payment will be made until reinstatement has been carried out. This can be interpreted in two ways. Firstly that no payment will be made at all until works are done or secondly that payment will be made on an indemnity i.e. deductions for wear and tear basis until work is carried out. In essence the wording is somewhat contradictory and will no doubt be subject to a contra proferentum interpretation/ruling.

Allianz Home Insurance Policy –

Again reference to no deductions for wear and tear provided the premises has been maintained in good repair and repairs are carried out without delay. Otherwise the claim will be settled on an “indemnity basis with appropriate deductions for wear and tear and depreciation”.

This wording clearly sets out Insurers obligation to indemnify by payment less wear and tear deductions or payment without those deductions provided the premises is in a good state of repair and works were carried out without delay. Again no reference to retentions and clearly Insurers initially should make an indemnity payment i.e. deductions for wear and tear with the balance (retention difference) being paid on completion of works and submission of relevant details and proof.

The above on Policy wordings has been paraphrased from a Legal Opinion obtained from Senior Counsel.

Alan FitzGerald, FCII., FCILA.,

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