The New Zealand High Court has ruled that red-zone designation in Christchurch does not in itself trigger an insurance claim.

In one of the first major insurance decisions following the Canterbury earthquakes, the court’s interim judgement clarifies treatment of properties in the severely damaged area, but also signals that insurers paying out claims based on repair cost must show a notional repair is achievable and would gain building consent.

The court has rejected a repair method proposed by Tower Insurance, which the company used in paying out a claim for an earthquake-damaged house that will be demolished.

Justice Raynor Asher ruled Tower must make a payment based on a rebuild or replacement for a comparable house.

However, the court says homeowners Matthew and Valerie O’Loughlin, who sued Tower, have failed in their argument that creation of the red zone caused loss so, irrespective of physical damage, the insurer was obliged to provide full replacement cover.

It has also rejected their argument that the payout for a new house elsewhere should be based on the more expensive cost of rebuilding on the red zone site. The court says this would give them a windfall.

Following the interim judgement, Tower and the O’Loughlins must return to court to make further submissions on the payout and how it is calculated.

The O’Loughlins sued Tower after it paid them $NZ197,179 ($160,200) for their severely damaged home, on top of $NZ203,886 ($165,600) paid by the Earthquake Commission.

They claimed Tower should have paid $NZ416,113 ($338,000), meaning they would receive $NZ620,000 ($503,000) in total.

It would cost $NZ620,000 to rebuild on their red zone site and $NZ540,000 ($438,600) to do so outside the area. Justice Asher has ruled the $NZ80,000 ($65,000) difference would give a windfall profit.

The O’Loughlins have sold their land to the Crown for $NZ110,000 ($89,000) and will move.

Their property suffered liquefaction and a warped concrete slab.

Justice Asher says Tower had the option of making a payment based on rebuilding, replacing or repairing, and elected to pay based on a notional repair using technology that would level the slab.

The O’Loughlins argued such a repair would not work and their payout should be based on a rebuild.

Justice Asher has ruled the notional repair technology “is too uncertain, and a payment based on it cannot be regarded as representing the actual costs of repair”.

Tower’s offer did not meet its obligations under the policy, because the repair method might not get building consent and did not return the house to as-new condition.

But Justice Asher says a payment for rebuilding must be based on doing so at a good site. 

“This is because the O’Loughlins have chosen not to rebuild on the existing damaged site and both parties have proceeded on the basis of a cash payment that will enable them to purchase elsewhere in Christchurch out of the red zone,” he said.

In ruling that creation of the red zone did not trigger an insurance claim, he says the policy covers physical loss or damage to the house. The red-zone designation did not require physical alteration or repair and did not stop people living there, repairing or rebuilding or receiving building consent.

The decision has been keenly awaited in insurance and legal circles.

Insurance Council of New Zealand CEO Tim Grafton says the judgement provides clarity that red zoning does not require insurers to rebuild a repairable property and that claims are limited to physical loss or damage, not economic loss from the red-zone designation.

Tower told the New Zealand Stock Exchange it will decide between offering the O’Loughlins the costs of rebuilding elsewhere or buying out of the red zone.

Legal firm Wynn Williams says although the decision has been dubbed a victory for the O’Loughlins, the judgement on Tower’s repair methodology “is relatively narrow and fact-specific” to their claim.

It says the judgement does emphasise the need for both parties to the claim to ensure the scope and costing of repairs is accurate and realistically achievable.