When is a property owner entitled to the cost of replacing their damaged insured property with a new one, rather than the actual cost of the insured property?
In Carter v. Intact Insurance Co., the Ontario Court of Appeal dealt with a dispute between the insured and the insurance company on whether the insured was entitled, under the insurance policy, to the cost of replacing their damaged property with one that was not of like kind and quality.
The plaintiffs’ income producing property was damaged in a fire. They wished to build a condominium development on property to replace the damaged buildings. The proposed condominium was significantly different from the insured property. The insured property had been 51,930 square feet, mix of one and two storey buildings, containing 15 residential units, and 42 above ground parking spaces. The proposed condominium was 193,694 square feet, eight and a half stories, contained 129 residential units, and 165 underground parking spaces.
The insurance policy defined “replacement” as follows:
“Replacement” includes repair, construction re-construction with a new property of like kind and quality…
The plaintiffs claimed the actual replacement cost of the insured property, amounting to $6.24 million. The insurer refused to pay replacement cost on the ground that the proposed condominium was not a “replacement”, because it was not a “new property of like kind and quality.” Instead, the insurer paid the plaintiffs only the actual cash value of the damaged property, amounting to $3.9 million.
On a Rule 21 motion to determine an issue before trial, the motion judge interpreted the insurance policy to mean that replacement cost is only available if the insured’s property is of like kind and quality and also found that the proposed condominium was not of like kind and quality. In particular, the motion judge concluded that to recover replacement cost, the “construction must be effected with new property of like quality to what was there before."
The plaintiffs appealed this decision to the Ontario Court of Appeal. The plaintiffs argued, among other things, that the motion judge erred because he did not give effect to the work “includes” in the definition of “replacement”. The word “includes”, they argued, contemplated that the insured could choose to replace their damaged buildings by means other than repair, construction or reconstruction. The phrase “of like kind and quality”, under this interpretation, only modifies the enumerated methods of replacement: repair, construction or reconstruction, but it did not modify the unenumerated replacement, such as their condominium.
The Hon. Mr. Justice John Laskin, writing for the Ontario Court of Appeal, provided a useful overview of the principles and objective of two kinds of coverage - actual cash value coverage and replacement cost coverage:
20 The insurance industry has marketed two types of protection for residential and commercial properties: actual cash value coverage and replacement cost coverage. Under actual cash value coverage, property is insured to the extent of its actual cash value. This coverage recognizes that the insurer is entitled to deduct reasonable depreciation from the value of the loss. Under replacement cost coverage, the insured is entitled to the full cost of repair or replacement without any deduction for depreciation.
21 A main objective of property insurance is indemnity, and a policy providing for actual cash value coverage is a pure indemnity contract. Actual cash value recovery puts insureds in the position they were in before the loss. Since most property depreciates over time, actual cash value is equivalent to replacement cost less depreciation. So actual cash value recovery prevents insureds from profiting or benefiting from their loss.
22 But actual cash value recovery poses a problem for insureds who want to build a similar structure to replace the insured property that was damaged or destroyed. Because of depreciation, these insureds will incur a cash shortfall, which they may not be able to afford, and which will thus prevent them from reconstructing their damaged structure.
23 Replacement cost insurance solves this problem. It goes beyond the notion of indemnity. It recognizes that depreciation, or the deterioration of a property over time, is an insurable risk. Replacement cost insurance, in effect, insures depreciation: the difference between replacement cost and actual cash value. So, under replacement cost insurance, if insureds do indeed repair or replace their damaged property, they are entitled to recover from their insurer the full cost of the repairs or the replacement. They can replace "old" with "new". In that sense, even though replacement cost insurance makes insureds better off and violates the indemnity principle, it is justifiable, because without it, many property owners would be unable to cover the shortfall caused by the depreciation of their damaged or destroyed property.
24 But, allowing insureds to replace old with new raises a concern for the insurance industry. The concern is moral hazard: the possibility that insureds will intentionally destroy their property in order to profit from their insurance; or the possibility that insureds will be careless about preventing insured losses because they will be better off financially after a loss.
25 To put a brake on moral hazard, insurers will typically only offer replacement cost coverage if insureds actually repair or replace their damaged or destroyed property. If they do not, they will receive only the actual cash value of their insured property. Insurers also limit replacement cost coverage to an amount defined in the insurance policy. These two conditions — insistence on actual repair or replacement and limiting replacement cost to a defined amount — are found in the appellants' policy with Intact.
The Court of Appeal did not accept the plaintiffs’ arguments, holding that, although the word “includes” in the definition of “replacement” means that the replacement could be effected by a method other than repair, construction or reconstruction (for example, by purchasing an existing building to replace the one that was lost), these unenumerated method of replacement must be of like kind and quality.
Justice Laskin found that to give effect to the plaintiffs’ interpretation of the definition of “replacement” in the contract would be either illogical, or would render the phrase “of like kind and quality” meaningless.
In reaching its decision, the court reiterated the principles of interpretation when it comes to insurance contracts, particularly when it comes to ambiguous provisions:
28 An insurance policy is a contract, and the primary goal of contract interpretation is to give effect to the intention of the parties. If the policy provision in question is unambiguous, the court gives effect to the parties' intention by giving effect to the provision's plain and ordinary meaning. In doing so, and as interpretive aids, the court should take into account the provisions of the policy as a whole, the surrounding circumstances and the "commercial atmosphere" in which the insurance policy was contracted for, and the general purpose of insurance: see Consolidated Bathurst Export Ltd. v. Mutual Boiler & Machinery Insurance Co.,  1 S.C.R. 888, at para. 26.
29 If the provision is ambiguous — that is, it is reasonably capable of more than one meaning — then the court applies the following rules: it should prefer an interpretation that is consistent with the reasonable expectations of the parties, as long as that interpretation can be supported by the text of the policy; it should avoid an interpretation that would give rise to an unrealistic result or that would not have been contemplated by the parties at the time the policy was contracted for; and it should strive for an interpretation that is consistent with similar provisions in other insurance policies.
30 If the rules for resolving ambiguity are inadequate, then the court should interpret the provision contra proferentem, "against the offeror" — that is against the party who drafted the policy, the insurer. In applying the rule of contra proferentem, courts should construe coverage provisions broadly and exclusion provisions narrowly.
This case highlights the fact that the insured's entitlement is subject to the provisions of the insurance policy, and that these provisions must be interpreted using the principles established by case law.
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 Carter v. Intact Insurance Co., 2016 ONCA 917, 2016 CarswellOnt 19060