How NZ courts interpret insurance policies

By Crossley Gates, Partner, Keegan Alexander

Contract law is central to the world of commerce.

Traders rely on contract law to keep parties to their promises. Contract law forms part of what is generally referred to as the rule of law. Without contract law, the world of commerce as we know it, would not exist.

Insurance policies are contracts governed by the same contract law but with a few variations to allow for some unique features of insurance, such as the imbalance of knowledge between the parties. That leads to the duty of disclosure, which only applies to insurance contracts.

Insurers sell contracts that transfer defined risks faced by the insured to the insurer. The transfer of risk is intangible and only exists as words in the contract. In that sense, the insurance policy is everything. A drafting error could be potentially serious for an insurer. Contract law will keep the insurer to its promise.

At claim time, disputes may arise about the drafting of the contract. This is usually in the context of whether the background facts come within the transfer of risk in the contract or not. Drafting an insurance policy is perilous as it is difficult to foresee every factual eventuality under the sun.

When a dispute becomes serious, well-meaning claims handlers often go back to the underwriter and ask what their underwriting intention was. They use this as a way of determining the dispute.

Contractual interpretation

Is this how a court will determine the dispute? The answer is a very firm no. This article explains why.

How will a court determine a contract interpretation dispute? The legal answer to this in New Zealand is a quote from an insurance case that went all the way to the Supreme Court of New Zealand (New Zealand’s highest court).

The Supreme Court of New Zealand summarised the proper approach in Firm PI 1 Ltd v Zurich Australian Insurance Ltd [2015] NZLR 432 as follows:

“It is sufficient to say that the proper approach is an objective one, the aim being to ascertain ‘the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract’. This objective meaning is taken to be that which the parties intended. While there is no conceptual limit on what can be regarded as ‘background’, it has to be background that a reasonable person would regard as relevant. Accordingly, the context provided by the contract as a whole and any relevant background informs meaning.

“While context is a necessary element of the interpretive process and the focus is on interpreting the document rather than particular words, the text remains centrally important. If the language at issue, construed in the context of the contract as a whole, has an ordinary and natural meaning, that will be a powerful, albeit not conclusive, indicator of what the parties meant. But the wider context may point to some interpretation other than the most obvious one and may also assist in determining the meaning intended in cases of ambiguity or uncertainty.”

Objective exercise

In summary, the exercise is an objective one based primarily on the words used in the contract and their context. What one or more of the parties to the contract subjectively intended is largely irrelevant. That is why the claims handler’s inquiry to the underwriter referred to above misses the mark.

The reason why a subjective approach is undesirable and would lead to great uncertainty in the law is because once a dispute has arisen, each party to the dispute is likely to frame their intention in a way that suits the outcome that each party desires from the dispute.

It would be fruitless for a court to base its decision-making on this subjective approach. How would the court determine which intention to believe?

Seeking the underwriter’s intention does have a useful business purpose, however. If after applying the proper approach to interpretation, the outcome is not what the underwriter intended, then something has gone wrong with the drafting and the insurer needs to amend its policy wording quickly to ensure that, for the future, the subjective intention is reflected in an objective interpretation of the words used.