There are two main areas of litigation when it comes to insurance disputes. On one hand, disputes take the form of liability disagreements and on the other, liability otherwise agreed, the amount to be paid would be the disputed matter. It is the latter that can be proactively avoided through appropriate valuations and adequate sums insured.
Traditionally, a contract of property insurance is a contract of indemnity which means that the insurer will seek to place the claimant in the same financial position enjoyed prior to the loss. The manner by which such indemnity is provided is governed by the provision of the policy document itself which states that “the insurer will pay to the insured, the value at the time of loss or the amount of damage, or at the insurer’s option reinstate or replace such property or part of it”.
This effectively means that it is the insurer who will decide whether the subject matter insured should be repaired or compensated in cash. This of course will be dependent on the cost effectiveness of the loss compensation ensuring that the claimant is placed in the same financial position. In fact, Indemnity ensures that it is the financial equivalent that is paid out excluding any sentimental or consequential value in the settlement equation.
Moreover, the insurers have to be careful to ensure that they actually fulfil their indemnity obligations since any under-indemnity provided to the claimant may be construed to mean that no indemnity was provided at all. The case of Scottish Union and National v. Davies in 1970 is testament to this, wherein the judge presiding the case, dismissed that indemnity had been provided due to inadequate repairs and is quoted as saying “so far as the claimant is concerned, the insurers could well have thrown the indemnity money into the Thames” stressing how futile their indemnity payment was.
Once indemnity is provided to the claimant, then the insurer is relived from further obligations under the policy for that event. In this respect, it is not uncommon for the claimant to be asked to sign a discharge from which will confirm that the case is closed and not subject to further claims. Such will ensure that the claimant was indeed indemnified declaring the loss was paid in “full and final settlement”.
Since an indemnity payment satisfies the obligations under the policy to put the claimant in the same financial position, the claimant, now in possession of the financial equivalence of the loss, is not obliged to replace or repair the lost, damaged or destructed subject matter. The indemnity money may be used for any other purpose as what matters is that the claimant was given an equivalent sum of money to reflect the amount of the loss. In practice the most common way of paying the claimant is by way of cash via a cheque or bank transfer as this is the most efficient.
Nowadays, it is very common to find that modern underwriting of property policies is being offered on a reinstatement basis rather than on an indemnity basis. This effectively means that whereas indemnity deducts an element for wear and tear in the final settlement calculation, reinstatement on the other hand, will do away with this deduction and will settle as new – hence the derivative of the word “new for old”.
Reinstatement cover provides a better basis of settlement reflective of the loss and does away with the disputes that revolve round how much depreciation should be deducted, notorious in indemnity settlement calculations. In this way, reinstatement has an overall effect of decreasing areas of disputes under property-related insurance contracts.
The reinstatement basis of settlement may be offered as a standard or as an optional clause under an indemnity policy which the policyholder can buy at an additional premium. However, it is imperative to note that the application of this reinstatement clause in practice, assumes the adequacy of the sum insured which has to reflect the repair/rebuilding cost, as new, throughout the currency of the policy and at the time of reinstatement, otherwise “Average” will apply.
Average in insurance explained
Average is a way of how insurers control mismatch of sums insured and has an effect of paying a claim in proportion to the amount of underinsurance. By way of a simplistic example, a property with a sum insured of €100,000 and an actual value of €200,000 will have a claim for €5,000 proportionality reduced to €2,500 after the application of the average clause. In this case, average has been applied on the basis that the sum insured is 50% less than it should be, hence to penalise the policyholder who is paying less premium by virtue of this shortfall, the insurer will proportionally reduce any ensuing claims.
Application of reinstatement
Therefore, at inception and renewal, the policyholder, ideally assisted by an architect, will provide a figure to stand as the sum insured of the property and which will be adequate to repair/rebuild the property in the same state as new without considering the age and wear. The sum insured has to reflect an amount adequate enough to reinstate the property as new in a 100% total loss scenario.
However, if a reinstatement policy has a sum insured which is found to be well under the real reinstatement value, then such reinstatement will not apply. To this effect, a reinstatement average clause is thus inserted under reinstatement policies which will dictate that if the sum insured is less than 85% of the cost of reinstating the property at the time of reinstatement than the principle of “average” will become applicable. On the other hand, if the sum insured is more than 85% of the cost of reinstatement at the time of loss than the full repair claim becomes payable as the sum insured is considered to be adequate.
Delays in settlement
It is important to note that a reinstatement calculation may be adversely affected by delays. For example, should the cost of reinstatement be delayed and expenses augment, then a previously acceptable ratio of say 89% may suddenly become subject to average at 81%. We can demonstrate this by means of an example.
Say the following are the amounts:
On a reinstatement basis of settlement, one needs to establish whether the 85% reinstatement memorandum is applicable. Therefore, if the sum insured divided by the value at the time of loss would be €85,000 / €95,000 = 89%, then the cost of repairs without delay would be paid in full that is, €40,000, as this exceeds the 85% threshold.
However, the position would be different if the repairs had been delayed with a consequent increase in both the cost of repairs and the full reinstatement value at the time when the repairs are finally commissioned. Therefore, taking the above fictitious figures as an example, the ratio of underinsurance would be €85,000 / €104,500 = 81%. As the sum insured is now less than 85% of the rebuilding cost at the time of the delayed reinstatement, then full average applies and therefore the following will become payable: €85,000/ €104,500 X €44,000 = €35,790.
In conclusion, equity and fairness is achieved if the requirements under a property insurance policy are respected particularly the requirement that the sum insured is adequate both for indemnity and reinstatement purposes. This will in turn satisfy the expectations of the contracting parties whereby the insurer receives commensurate premium and the claimant receives adequate compensation. Moreover, the overall benefit is that less property insurance disputes reach the doorstep of our courts.
Mr. Andre Farrugia commenced his professional career working in the insurance industry before moving to the Malta International Training Centre where he occupied the post of Director of Studies. He is currently part of the academic staff within the Insurance department at the University of Malta. He has achieved the Fellowship of the Chartered Insurance Institute (FCII-UK) and the Fellowship of the Institute of Risk Management (CFIRM-UK). Lately, Andre has completed an MSc in Risk Management with the Glasgow-based University of Caledonian and is currently reading for a PhD with the University of Malta. During his professional career, Andre has contributed to the industry through the publication of articles and conducted training overseas, specifically to associations and colleges in Kosovo, Dubai and Ghana. He is currently a Board member of the Malta Education Consultative Council, outgoing President of the Malta Insurance Institute and Honorary member of the Malta Association of Risk Management.
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