Whether and how a sudden price increase can affect the amount of insurance indemnity to be paid by the insurer

In the event of damage of a thing, the insurer generally bases the amount of the insurance indemnity on the time of the occurrence of the insured event and the expenses that are necessary at that time to restore the former situation.

The insurer will find out the exact amount of expenses by comparing the price offers. This means that the insurer will base the cost of the restoration works on a specific and most appropriate quotation and then issue a guarantee letter to the policyholder with the amount of insurance indemnity to be paid out.

However, if we take into account the current and global price rally in the construction sector, when the prices of construction materials sometimes rise within hours, it is clear, that in the case of building restoration, the insurance indemnity determined by the insurer may no longer cover the actual current costs of restoring an equivalent building. In this case, the actual restoration costs of an equivalent building will become clear at the earliest when the real construction is already underway. What legal situation does this put the policyholder in, if due to a sudden and unprecedented increase in construction prices, the paid-out insurance indemnity no longer covers the costs of restoring the building?

The above-described situation was analyzed and explained by the Supreme Court of Estonia in its decision of December 21, 2021. The Supreme Court explained at what point in time the necessary and justified cost of restoration of the building can be assessed and who should bear the risk of rising construction prices.

The policyholder demanded an increase of the insurance indemnity

According to the circumstances stated in the aforenamed court decision, there was a fire on the insured property belonging to the policyholder, during which the building was damaged. The insurer then held tenders to obtain various quotations for the restoration of the building. The insurer, based on the contractor who submitted the lowest price offer, issued a letter of guarantee to the policyholder, with which it decided to reimburse the costs of restoring the building to the extent of a certain amount.

Since during the restoration work it became clear that the amount of the insurance indemnity paid out by the insurer does not cover the total cost of restoring the building to its pre-insured condition, the policyholder demanded an increase of the insurance indemnity. The policyholder found that although the insurer has determined the insurance indemnity based on the builder’s price quote, it cannot be based on it, as it does not take into account the increase in the prices of construction materials.

Of course, the insurer did not agree with the reasons given by the policyholder. The insurer took the position that, according to the contract, the increase in construction prices that occurred after the insured event and the deteriorated construction situation do not automatically increase the insurance indemnity, and therefore the corresponding amount does not have to be compensated by the insurer. Also, according to the insurer’s explanations, neither the law nor the insurance contract contains an express obligation of the insurer to compensate the policyholder for “general price increase” or “increase in the cost of construction works”.

The policyholder then filed a lawsuit against the insurer in the district court and demanded an increase in the insurance indemnity, citing, among other things, the increase in the price of construction.

Disagreements between the lower courts

In the context of rising construction prices, the policyholder and the insurer did not have a common understanding, first of all, whether in the case of the agreed insurance value, the determination of the reasonable costs of repairing the thing must be based on the time of the insured event, or the amount of the cost of repairing the thing after the damage to the thing must also be taken into account when determining the amount of insurance indemnity. The district court and circuit court also lacked a common understanding on this issue.

The district court found that the necessary and justified costs for the restoration of the building can be taken into account even after the occurrence of the insured event, and therefore considered the policyholder’s claim arising from the increase in the price of construction to be justified. However, unlike the district court, the circuit court found that the necessary and justified cost of restoration must be assessed directly at the time of the insured event. In this way, the circuit court annulled the decision of the district court, which satisfied the policyholder’s claim arising from the increase in the construction price.

According to the reasoning of the circuit court, § 479 subsection 1 of the Estonian Law of Obligations Act applies to the time of determining the reasonable cost of repairing the matter. According to this provision, the insurable value is the value of the insurable interest at the time of the insured event. Nor had the policyholder and insurer agreed otherwise in the insurance contract. According to the circuit court’s opinion, in this case it corresponds to the nature of the insurance contract, being aimed only at insuring and indemnifying certain risks, incidents and losses, and not at financing the maintenance of the policyholder’s entire property or the economic activity and costs following the insured event.

The position of the Supreme Court

The Estonian Supreme Court found that the circuit court has, however, mistakenly taken the view that the cost of the necessary and justified restoration of the building must be assessed directly at the time of the insured event and that a possible increase in construction prices will not be compensated. The Civil Chamber explained at this point that although according to Law of Obligations Act § 479 subsection 1 the insurable value is the value of the insurable interest at the time an insured event occurs, when interpreting this provision, among other things, Law of Obligations Act § 476 subsection 1 must also be taken into account, according to which in the case of non-life insurance, upon the occurrence of an insured event, the insurer shall, in accordance with the contract, compensate the insured person for any damage sustained by the insured person due to the insured event. If a thing is insured, the insurer shall, among other things, compensate for damage sustained as a result of eliminating the consequences of the insured event and for damage sustained if insured things are lost in the course of the insured event.

The Civil Chamber also found that the wording of § 479 subsection 1 of the Law of Obligations does not in itself exclude the interpretation that the determination of the insurance indemnity also takes into account reasonable and justified actual costs that become clear after the occurrence of the insured event within a reasonable period of time necessary for the restoration of the building. It should be taken into account that the restoration of the building takes time (including due to preparatory activities). In addition, in the opinion of the Supreme Court, it would not be in line with the compensation principle in insurance law or the purpose of indemnity for damages to leave the risk of the increase in construction prices within this reasonable time to be borne by the policyholder.

In conclusion

The Supreme Court decided that the amount of insurance indemnity does not have to be limited only to the amount of damage that is determined directly at the time of the occurrence of the insured event, but also the necessary and justified costs incurred for the restoration of the building within a reasonable time after the occurrence of the insured event can be taken into account. The Supreme Court satisfied the policyholder’s claim for insurance indemnity related to the increase in the construction prices.

In the case of the agreed insured value, the policyholder can therefore demand an increase in the indemnity even after the occurrence of the insured event and the determination of the amount of the indemnity, if it turns out that the indemnity no longer covers the actual costs of restoring an equivalent building due to the price increase.

However, the policyholder must take into account that as a result of increasing the indemnity, the final indemnity cannot exceed the agreed insurance value and that the basis for increasing the indemnity can only be reasonable and justified costs that are related to and necessary to restore the former situation.

In addition, it is important to pay attention to the fact that the policyholder can only demand an increase in indemnity due to a price increase within a reasonable recovery period, in other words, he has started to restore the damaged thing as soon as possible, and any delays are not his fault.

Article author is attorney Cristen Helendi.

Contributing Advisors