Can An Insurance Claim Provide a Profit?
The Principle of Indemnity As Applicable to Insurance Contracts Means That the Insurance Coverage Is Intended to Put a Person Back Into the Same Financial Position As Existed Before the Incident Leading to a Claim. Over-Indemnification Via Replacement Cost Coverage May Actually Provide a Gain.
Understanding the Principle of Indemnification Within Insurance Coverage Including the Various Exceptions
A fundamental principle of the law applicable to insurance matters is the requirement that insurance coverage comply with the concept of indemnification, which means that, subject to an adequate amount of available insurance, an insured person should be put back into the same financial position as the person was in before the incident resulting in the loss of the insured object.
The principle of indemnity was confirmed by the Court of Appeal in the matter of Gore Mutual Insurance Company v. Carlin, 2018 ONCA 628 at paragraph 21 where it was said, " ... a contract of insurance is a contract of indemnity; it is not a vehicle for turning misadventure into profit. ... ". Expanding further, the Court of Appeal in Gore said:
 Contracts of insurance are to be interpreted in a manner that results in neither a windfall to the insurer nor an unanticipated recovery to the insured: Brissette Estate v. Westbury Life Insurance Co., 1992 CanLII 32 (SCC),  3 S.C.R. 87, at pp. 92-93. In the present case, the motion judge’s decision goes beyond an unanticipated recovery to grant a windfall that is wholly unconnected to the recovery of any loss. The policy provides only for indemnification for a loss suffered.
Simply stated, if an object, such as a bicycle, was worth $1,000 a split second before the bicycle was stolen or lost due to another peril covered by an active and applicable insurance policy, then the person who suffered the loss of the bicycle should receive $1,000 in compensation for the bicycle whereas receiving $1,000 as exactly the amount that the bicycle was worth "indemnifies" the person by putting the person back into the exact same financial position as existed at the time the bicycle was stolen resulting in the $1,000 loss.
Historically, insurance law principles mandated that the quantum of payout on coverage of an insured loss be strictly limited to the amount required to provide indemnification. The purpose of restricting coverage payouts to an amount equivalent to the indemnification amount was intended to discourage fraudulent claims whereas, with dollar-for-dollar indemnification and therefore without opportunity for profit or gain, an insured person would be without any advantage to suffer an insured loss. Simply said, if a person were to lose the $1,000 bicycle mentioned in the example above, and was stood only to receive indemnification in the $1,000 amount, then the loss of the bicycle would be without any potential benefit; and accordingly, the person carrying insurance on the bicycle would be without any motive, being a profit, should a loss of the bicycle occur.
The principle of indemnity is such a basic fundamental to the concept of insurance that such is stated within the definition to the very word of "insurance" per section 1 of the Insurance Act, R.S.O. 1990, c. I.8 which reads:
“insurance” means the undertaking by one person to indemnify another person against loss or liability for loss in respect of a certain risk or peril to which the object of the insurance may be exposed, or to pay a sum of money or other thing of value upon the happening of a certain event, and includes life insurance; (“assurance”)
Exceptions to Principle of Indemnity
Rebuilding Cost Guarantee
When a building, usually a residential house that is owner occupied is destroyed or severely damaged and the actual value of the structure is less than the cost of repair or the cost of rebuilding, insurance coverage that is strictly based upon the principle of indemnity may present as a significant financial challenge for the owner who would thereby need to incur an out-of-pocket expense to make up the financial shortfall between the indemnity received from insurance coverage and the full cost of repairing or rebuilding the structure. Accordingly, and despite being contrary to principles of indemnity, insurers developed the Rebuilding Cost Guarantee coverage as a means to fill the potential gap.
Generally, insurers will offer the Rebuilding Cost Guarantee only to qualifying insureds. To qualify, among other things, the insured is required to provide various construction details to the insurer who will then perform a rebuilding cost evaluation. If the insured agrees to purchase, meaning pay premiums, per the rebuilding cost evaluation, then the insurer will provide the Rebuilding Cost Guarantee coverage; and accordingly, if at a later date the insured suffers a serious loss, for which the amount of coverage is insufficient to actually perform rebuilding, subject to a few conditions, the insurer becomes obligated to make up for the shortfall.
Coverage A - Dwelling Building And Coverage B - Additional Buildings
If you repair or replace the damaged or destroyed building(s), on the same site, with a building of the same occupancy, constructed with materials of similar quality, within a reasonable time after the damage, we will pay the cost of repairs or replacement (whichever is less) without deduction for depreciation.
We provide Guaranteed Replacement Cost on Coverage A - Dwelling Building which means:
we will pay the cost of repairs or replacement, on the same site, even if it is more than the principal dwelling replacement cost amount shown on the Coverage Summary page, provided:
- the principal dwelling replacement cost amount, shown on the Coverage Summary page on the inception date of the policy, or the most recent renewal date, or the increased amount under the inflation protection coverage on the date the increase took effect, was not less than 100% of the cost to replace the dwelling building, as determined by a valuation guide acceptable to us;
- the principal dwelling replacement cost amount has not been reduced below the amount determined by the valuation guide; and
- you notified us, within 90 days of the start of the work, if any improvement, extension or addition has been made to your dwelling that will increase the replacement value by more than $10,000.
When this guarantee is applied on any principal dwelling claim, the total amount of insurance available for other insured coverages is the single amount minus the principal dwelling replacement cost amount shown on the Coverage Summary page.
If you decide not to repair or replace the damaged or destroyed building, we will pay the actual cash value of the damage at the date of the occurrence.
Source of Example:
Intact Insurance - Homeowner's Policy
Replacement Cost Endorsement, new for old
Many modern insurance policies provide exceptions to the principle of indemnity. These insurance policies include various forms of first-party property insurance, such as the contents replacement coverage within the insurance policy commonly purchased by a homeowner. With replacement cost coverage, the insured may receive a new-for-old betterment when an insured object suffers an insured peril. As an example, a homeowner may own, and insure, contents consisting of outdated furniture from the 1970's that is virtually worthless to sell; however, following a total loss by fire (or another cause as an insured peril), the replacement cost coverage permits the homeowner to purchase new furniture to replace the old (financially worthless) furniture and thereby to receive a gain that presents as an over-indemnification and therefore as a form of betterment.
Depreciation Waiver Endorsement, your money back
Another example of an over-indemnification would be the depreciation waiver that is commonly offered by automobile insurers via the endorsement known as the OPCF#43 - Depreciation Waiver whereas a buyer of an automobile may purchase the depreciation waiver and be protected, financially, against a reduction for depreciation for a period of time (commonly two years) should the purchased automobile suffer a total loss. Whereas an automobile initially purchased for $50,000 may suffer a total loss, and being after a period of time and usage may be worth considerably less than the $50,000 initial purchase price, applying the principle of indemnity would result in compensation equivalent to the value of the automobile at the time of the loss; however, with the depreciation waiver, the purchaser of the automobile would receive the initial $50,000 purchase price; and accordingly, be placed into a financial position that is improved from the financial position that actually existed moments before the automobile became a total loss.
Building Bylaw Coverage
When an older building, structure, or dwelling, is damaged or destroyed, laws governing rebuilding or repairing may mandate certain improvements be installed so to comply with current building codes. To accommodate and protect against the possibility that a business may be required to improve a facility, or that a person may be required to improve a dwelling, insurers may offer coverage that would cover this increased cost of complying. Similar to the replacement cost endorsement as an over-indemnification coverage, with the building bylaw coverage (or as marketed by insurers using any other name), the improvements as required by law are paid for by the insurer of the person or business that suffered the loss. As the improvements are paid for by insurance, such is another possible example of an over-indemnification or gain to the favour of the insured person.
Betterment, liable third-party
The exceptions to the principle of indemnity as outlined above are available as a first-party coverage only. By first-party coverage, what is meant is that the availability of a replacement cost endorsement or the depreciation waiver endorsement, among any other coverage benefits that may be available under a policy of insurance, are provided by an insurance company only to the client of the insurance company rather than in favour of a third-party should the client of the insurance company cause damage to the property of a third-party person who is a stranger to the insurance policy. Essentially, the over-indemnification coverage is sold by insurers as a benefit for the client of the insurer rather than as a benefit for a stanger who may have property damaged by the client of the insurer. This goes in keeping with the indemnification principle in law that where a person becomes liable for causing harm to the property of another person, the harmed person is entitled to indemnification for the financial loss suffered and that the indemnification should be, as indemnification is, the dollar-for-dollar compensation of the actual loss suffered.
While rare, it does happen that the legal liability for compensation owed to a third-party will involve a betterment and therefore an over-indemnification. This generally happens where the innocent party who has suffered damage to property due to negligent, or other conduct, or a wrongdoer and where it would be unfair to compensate the innocent party merely for the value of an old object. This situation tends to arise where a business suffers harm to a structure or chattels and must provide betterments or improvements when rebuilding or replacing the damaged property. Generally, courts have held that where a business must incur a rebuilding or replacing expense greater than the value of the damaged property, and must do so to expedite a return to normal operations, therefore mitigating downtime losses and the risk of losing labour force, among other things, the party that caused the damage may be legally liable for the over-indemnification. This exception was stated by the Court of Appeal in the case of James Street Hardware and Furniture Co. v. Spizziri (C.A.), 1987 CanLII 4172, while relying on doctrine articulated in the Court of Appeal of England in Harbutt's "Plasticine" Ltd. v. Wayne Tank & Pump Co. Ltd.,  1 Q.B. 447 where it was said:
In support of its argument that the trial judge erred in deducting $34,000 from the award, the appellant relies upon the judgment of the Court of Appeal in England in Harbutt's "Plasticine" Ltd. v. Wayne Tank & Pump Co. Ltd.,  1 Q.B. 447. In this case the plaintiff's factory was destroyed by fire. Under the applicable planning law the plaintiff was not allowed to rebuild according to the same structure and design as the destroyed building. The replacement building had two storeys. The old factory had five storeys. The cost of replacement was (STERLING)146,581. The difference in value of the factory before and after the fire was (STERLING)116,785. Each of the three judges addressed the damages issue succinctly.
At p. 468 Lord Denning M.R. said:
The defendants said it should be the difference in value before and after the fire, relying on Philips v. Ward,  1 W.L.R. 471. The plaintiffs said it should be the cost of replacement, relying on Hollebone v. Midhurst & Fernhurst Builders Ltd.  1 Lloyd's Rep. 38.
The destruction of a building is different from the destruction of a chattel. If a second-hand car is destroyed, the owner only gets its value; because he can go into the market and get another second-hand car to replace it. He cannot charge the other party with the cost of replacing it with a new car. But when this mill was destroyed, the plasticine company had no choice. They were bound to replace it as soon as they could, not only to keep their business going, but also to mitigate the loss of profit (for which they would be able to charge the defendants). They replaced it in the only possible way, without adding any extras. I think they should be allowed the cost of replacement. True it is that they got new for old; but I do not think the wrongdoer can diminish the claim on that account. If they had added extra accommodation or made extra improvements, they would have to give credit. But that is not this case. I think the judge was right on this point.
Widgery L.J. said at pp. 472-3:
I must now turn to the issues raised as to the measure of damage. The distinction between those cases in which the measure of damage is the cost of repair of the damaged article, and those in which it is the diminution in value of the article, is not clearly defined. In my opinion each case depends on its own facts, it being remembered, first, that the purpose of the award of damages is to restore the plaintiff to his position before the loss occurred, and secondly, that the plaintiff must act reasonably to mitigate his loss. If the article damaged is a motor car of popular make, the plaintiff cannot charge the defendant with the cost of repair when it is cheaper to buy a similar car on the market. On the other hand, if no substitute for the damaged article is available and no reasonable alternative can be provided, the plaintiff should be entitled to the cost of repair. It was clear in the present case that it was reasonable for the plaintiffs to rebuild their factory, because there was no other way in which they could carry on their business and retain their labour force. The plaintiffs rebuilt their factory to a substantially different design, and if this had involved expenditure beyond the cost of replacing the old, the difference might not have been recoverable, but there is no suggestion of this here. Nor do I accept that the plaintiffs must give credit under the heading of "betterment" for the fact that their new factory is modern in design and materials. To do so would be the equivalent of forcing the plaintiffs to invest their money in the modernising of their plant which might be highly inconvenient for them. Accordingly I agree with the sum allowed by the trial judge as the cost of replacement.
Finally, Cross L.J. said at pp. 475-6:
... but in my judgment the value of the building and of the plant and machinery before the fire throws no light on the true measure of damage in a case like this where it was obviously right for the plaintiffs to rebuild and re-equip their factory and start business again as soon as possible. Further, I do not think that the defendants are entitled to claim any deduction from the actual cost of rebuilding and re-equipping simply on the ground that the plaintiffs have got new for old. It is not in practice possible to rebuild and re-equip a factory with old and worn materials and plant corresponding to what was there before, and such benefit as the plaintiffs may get by having a new building and new plant in place of an old building and old plant is something in respect of which the defendants are not, as I see it, entitled to any allowance. I can well understand that if the plaintiffs in rebuilding the factory with a different and more convenient lay-out had spent more money than they would have spent had they rebuilt it according to the old plan, the defendants would have been entitled to claim that the excess should be deducted in calculating the damages. But the defendants did not call any evidence to make out a case of betterment on these lines and we were told that in fact the planning authorities would not have allowed the factory to be rebuilt on the old lines. Accordingly, in my judgment, the capital sum awarded by the judge was right.
As stated above, generally a person who causes damage is liable only for the sum required to indemnify the person whose property is damaged; and as per the Lords of the Court of Appeal of England as quoted in James Street Hardware, a person rarely becomes liable to provide an over-indemnification; however, it does remain possible.
The principle of indemnity is a concept intended to minimize insurance fraud for profit whereas, when insurance coverage provides only for indemnification, the loss of an insured object is financially compensated with the exact sum (as best as the exact sum can be calculated) that the object was worth a moment before the loss occurred.