Lessons from Christchurch: Insurance policies and significant events

Repairs to earthquake damaged shops on New Regent Street after the Christchurch earthquakes. If a loss in profit was because of damage to a business's property, it was likely to be covered by insurance. If, however, the loss was due to fewer customers visiting the affected area, it may be excluded under another circumstances clause. Photo / File

Over the past 2½ years, Christchurch's business environment has challenged many assumptions and contracts. In this six-part series, lawyers from Christchurch legal firm Malley & Co look at some of the lessons all businesses can learn. In this article Michael McKay looks at some of the insurance issues.

Insurance is one of the biggest business issues to emerge from the Christchurch earthquakes.

It's led several businesses to consider whether they can claim under their existing policy and whether that policy is still appropriate.

After the earthquakes, it became apparent that many insured and insurers held different views about the scope of their policies. Policy provisions were often untested, and interpretations differed.

The courts have responded by allocating extra resources to Christchurch and setting up a fast-track process for precedent-setting cases. The decisions have clarified some legal issues. For example, one insurer that had to repair a building "as new" was allowed to use modern building methods, meaning some hidden features (such as covered rimu floors) did not have to be replaced like-for-like.

Under another building replacement policy, even if the insured elected reinstatement, the insurer had to pay the indemnity value of the property upon proof of loss. The insured did not have to wait until reinstatement was under way for a payout.

Policies differ and business may need specific advice about the meaning of a particular provision. Existing decisions, however, may guide businesses on how the courts are likely to interpret their case.

Business interruption insurance

Another important insurance lesson relates to business interruption (BI) insurance.

An English insurance expert says the point of BI insurance is to ensure a business promptly returns to comparative health and is "still in the game" after an insured event.

Many BI policies insure for reduced gross profit arising from damage to insured property. Some have an extension that covers loss of gross profit arising from damage to property other than that of the insured business.

Nearly all BI policies, however, contain an "adjustments" or "other circumstances" clause, which tries to refine which types of loss trigger recovery of reduced gross profit.

The clauses all aim to distinguish a reduction in gross profit that would not have occurred but for damage to the insured property (covered) from reductions that are likely to have occurred even if the property had not been damaged (not covered).

Gross profit fell for many Canterbury businesses after the earthquakes. If this was because of damage to a business's property, it was likely to be covered. If, however, the loss was due to fewer customers visiting the affected area, it may be excluded under another circumstances clause.

This has been described as the "depopulation" effect, but the principle has broader application. Insurers might question what caused the reduction of profit if, for example, a key person had left the business shortly before the February 2011 earthquake. So, too, for an orchard that had an infected crop shortly before the earthquake.

If part of a claim is rejected because it was caused by an uninsured event, there needs to be evidence to support the claimed causation. Businesses with several outlets can compare the performance of a similar store in another location with the damaged outlet. The Canterbury earthquakes did show, however, that in other cases determining the cause(s) of a reduction in gross profit can be difficult and time-consuming.

Is there a way forward?

Businesses should review their circumstances and determine what type of cover is appropriate and affordable. Some businesses have reduced the gross profit sum insured or abandoned that part of the insurance altogether because of the causation issues, and increased the sum insured for stock and other operating assets.

This is not without its issues but for those businesses replacing those assets is particularly important to trading again.

What will your business need to still be in the game?

Michael McKay is a lawyer with Malley & Co. He is acting for several insured in relation to issues arising from the Canterbury earthquakes.