On 5 April 2013 Justice Asher issued judgment in the case O'Loughlin v Tower Insurance. The decision was eagerly awaited.
It was represented as a David and Goliath struggle and was expected to provide answers to some of the major questions preventing settlement of red zone claims.
In this article we examine whether the case has helped provide the clarity that many were seeking.
The facts of the case were straightforward. The O'Loughlins' Dallington property was damaged in the September, February and June earthquakes. The house was insured under a replacement policy with Tower. The property was subsequently designated in the red zone and the O'Loughlins exercised the option to sell their land to the Crown whilst retaining their rights against Tower.
Tower offered to settle the O'Loughlins' claim by making a cash payment based on an hypothetical repair using low mobility grout (LMG) to re-level the foundations. The O'Loughlins rejected this. They argued for a cash payment of over $1.3milion. Before the earthquakes the house (excluding the land) was worth somewhere in the region of $310,000. Not surprisingly their claim was not settled by Tower. The O'Loughlins then commenced the proceedings.
The Judge identified four broad issues in the case:
- Did the creation of the red zone mean that the O'Loughlins had suffered a total loss obligating Tower to provide full replacement cover?
- Had Tower met its obligations under the policy by offering a payment for the cost of repairing the house adopting the LMG technique?
- If Tower had not honoured its obligations, what sum should it pay and how was that to be calculated?
- Were the O'Loughlins entitled to damages for the distress and hurt feelings associated with Tower's failure to settle their claim?
The red zone
The Judge analysed the history of the red zone and the consequences of the designation. He correctly identified that the red zone designation was only relevant to the claim if it engaged the terms of the O'Loughlins' policy. The issue then was whether the red zone designation caused a loss which Tower had agreed to indemnify the O'Loughlins for under their policy.
The Judge concluded that the O'Loughlins' policy with Tower provided them with cover for physical loss or damage to their home only. The red zone designation did not result in physical loss. It did not cause damage to their house nor did it require the O'Loughlins to do anything to their house. As such any damage arising from the designation must have been purely economic not physical and was not covered by the policy.
It is possible that other insurance policies on different terms might be engaged by the red zone designation but this seems unlikely. As the judge said: "Looking at the wider commercial context, it would be surprising if a public measure that caused no direct physical consequences to a house could be accepted as causing loss or damage to the house in an insurance context...."
The LMG technique
Both Tower and the O'Loughlins called expert evidence as to the appropriateness of the LMG technique. The Judge found, based on what was presented to him, that a building consent would not be issued to do repairs using the LMG technique and that there might be unforeseen problems and costs associated with it. He did not think Tower had acted reasonably in offering settlement on the basis of a cost of repair that was untested and came with risks of failure or potential cost overruns.
Tower had not therefore honoured its obligations to the O'Loughlins by tendering settlement on the basis of the cost of repairs using the LMG technique. There are many earthquake claims that remain unsettled because the insurer is insisting on repair methodologies, such as LMG, which the insured does not accept are appropriate. The LMG technique is being proposed for both residential and commercial buildings; in some cases to our knowledge where our clients' engineers advise that it is not appropriate.
Some insureds will welcome the O'Loughlin decision as it relates to the LMG technique but it may in fact be of little assistance in other cases because the Judge was clear that his decision was "specific to this case and the evidence presented" only. In other cases the insurer may call more evidence to justify the LMG technique.
How was Tower to honour its obligations?
Having found that the LMG technique was not appropriate the Judge concluded that Tower had to make a payment calculated on the basis of the estimated cost of rebuilding with pile foundations, or, the cost of an equivalent replacement house. It is not clear why the Judge considered these were the only options.
Tower could have equally satisfied its obligations by paying a sum to repair based on an alternative but proven repair methodology however this does not seem to have been the way the case was argued. It was agreed by both Tower and the O'Loughlins that the cost to rebuild on their Dallington site was $620,000 and the cost to rebuild on a good site elsewhere was $540,000.
The O'Loughlins argued they were entitled to $620,000 on this basis despite the fact that they were not going to rebuild on the Dallington site and this payment would provide them with a substantial windfall. The Judge rejected their approach. Again everything turned on the terms of the policy. The policy provided that Tower was not required to pay the cost of replacement or repair beyond what was reasonable and was not required to reinstate the house exactly to its previous condition.
The Judge concluded that what Tower was obliged to do was to pay what was reasonably required "to replace [the O'Loughlins' home] with a property of the same general physical condition and size as the O'Loughlins' pre-replacement home was, when new". It could do this by rebuilding or the O'Loughlins could acquire an equivalent home on the market.
Although the cost to rebuild on a good site elsewhere was known at $540,000 the Judge could not determine the O'Loughlins' entitlement on this basis. Tower had the right to choose to settle on the alternative basis of what it would cost the O'Loughlins to acquire a replacement home on the market. The Judge did not have any valuation evidence before him as to the price at which the O'Loughlins might acquire such a property.
Damages for distress
The Judge also could not determine whether the O'Loughlins were entitled to damages for distress as it was not clear that Tower had breached the terms of the policy. This was because the amounts offered and paid to them by Tower might have exceeded Tower's liability under the policy. The Judge noted that both parties had approached settlement of the claim on an incorrect basis but, importantly, the amounts which had been sought by the O'Loughlins were far in excess of their entitlement.
The result was that it is up to Tower to now decide whether to settle with the O'Loughlins on the basis of the cost to either rebuild on good land (which it was agreed was $540,000 less amounts paid to the O'Loughlins by Tower and EQC already) or to buy a comparable replacement home. The parties were given the right to come back to the Court should further orders be required to determine the exact amount Tower had to pay (if anything). The Court also put in place a timetable for resolving whether the O'Loughlins were entitled to any damages for distress.
The case could be regarded as a victory for common sense. Insurers are not required to provide windfalls to their clients regardless of how tragic the circumstances. They are only required to pay for losses arising from events/risks that they agreed to cover.
The red zone issue was resolved in Tower's favour and although this was due to the particular policy wording it is likely that the same result can be expected in most other cases. From an insured's perspective the case shows that insurers can be expected to do more to ensure that the repair methodologies they rely on in formulating settlement proposals are reasonable and tested. This is welcome news.
In this case Tower had clearly not done enough. However, although Tower was held to have approached settlement on an incorrect basis it is yet to be shown that what Tower paid to the O'Loughlins was less than their entitlement. The case reinforces the principle that each insurance claim will be determined on its own facts and policy terms. The Judge was at pains to make clear in his judgment that this was not a case of general application but was confined to its own facts. That said, the case does provide useful guidance as to the likely effect of the red zone designation on insurance claims and the basis upon which insurers may be expected to settle insurance claims in the red zone.
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