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How to calculate damages in litigation over property insurance?

In a judgment involving damages under an insurance policy, the Supreme Court of Poland indicates how to calculate the amount of damages, and discusses various possible methods of monetary compensation for property damage in cases involving an insurer’s liability.

Supreme Court judgment of 16 October 2019, case no. II CSK 437/18

In Polish civil law, there is a prevailing general principle concerning methods of redress of injury. The injured party can generally elect whether the injury should be redressed by restoring the prior state, or by payment of an appropriate sum of money. But if restoring the prior state would be impossible or would entail excessive difficulty or costs on the part of the obligor, the injured party’s claim is limited to a payment of money (Civil Code Art. 363 §1).

In its judgment of 19 October 2019 (case no. II CSK 437/18), the Supreme Court held that in the case of damages under an insurance policy, the injured party may as a rule demand only payment of money. In the court’s view, this is dictated by the Civil Code provisions on insurance contracts, which refer to payment of damages (e.g. Art. 822 §1, 8241 §§2–3, 827 §1, and 828 §1).

When there is litigation between the injured party and the insurer (or even earlier, at the stage of the claims adjustment process), the dispute often involves determining which measure should be used to calculate the damages. In this judgment, the Supreme Court addressed particular attention to this issue.

Damages for burned building reduced by wear and tear (depreciation)

The case in which this ruling was issued involved a contract for mandatory insurance of farm buildings against fire and other risks. A fire broke out on the site of the insured farm, burning down some of the insured buildings.

The court of first instance awarded damages against the insurer. The appellate court modified that judgment, reducing the amount of damages. The appellate court upheld the defendant’s argument that the amount of the injury calculated on the basis of a cost estimate should have been reduced by the actual wear and tear on the building as of the date of occurrence of the injury. In the court’s view, if the plaintiff had truly incurred the costs provided for in the expert opinion submitted in the case, as a result of rebuilding of the destroyed structures the injured party would have become the owner of new buildings. But the aim of damages is to restore the buildings to the same condition in which they were found immediately before the fire. The injured party sought review of this issue by the Supreme Court.

The Supreme Court’s ruling is relevant not only for cases involving mandatory insurance of farm buildings, but also for cases where it is necessary to calculate damages under property insurance.

Method of redressing injury

The Supreme Court reviewed four different methods related to insurers’ redress of property damage through money damages:

  • Differential method
  • Cost-estimate method
  • Replacement cost
  • Stipulated value.

The court pointed out that under general rules, money damages are calculated using the differential method, which involves comparing the state of the injured party’s assets resulting from the event causing the loss and the hypothetical state of the assets if the event had not occurred. The court explained that the differential method requires reference to the entirety of the injured party’s assets. Insurance covering only a specific asset is an exception. Then the point of reference is only this asset, and the redress of injury includes only the injury consisting of the loss in value of the insured asset resulting from the injurious event.

The second method discussed, which is commonly approved in the case law of the Supreme Court, is the cost-estimate method (see resolution of seven-judge panel of the Supreme Court of 17 May 2007, case no. III CZP 150/06). It consists of assuming that the damages are equal to the hypothetical repair of the injured item before such repair actually occurs. The court admitted that there are no grounds for applying this method in the Civil Code provisions concerning redress of injury, but in the case of seeking damages from an insurer, application of this method is justified because the nature of the insurer’s liability excludes a demand that the insurer restore the prior state in kind. Significantly, a demand for redress of injury calculated as the hypothetical cost of repair of a thing will not come into play if such repair is not possible or would entail excessive difficulty or cost for the obligor, i.e. when the criteria set forth in the second sentence of Civil Code Art. 363 §1 apply.

Interestingly, in the court’s view, reduction of the hypothetical costs of restoring the prior state by the degree of wear and tear could be a method of calculating damages disadvantageous to the injured party, constituting a hybrid of the differential method and the cost-estimate method.

A third possibility is insurance for the replacement value, meaning that if the insured property (e.g. a building) is destroyed, the insurer will pay damages enabling it to be fully recreated. This method is similar to the cost-estimate method discussed above, but may also be applied in a situation where recreating the destroyed item will entail excessive difficulty or cost. In the case of insurance for replacement value, the newly created thing will generally have a higher value than the thing that was lost, as at the time of the loss it always had some degree of depreciation. This results in enrichment of the insured, but on the other hand the need to recreate a new thing is the only method for restoring the state existing prior to the event, as it would be hard to imagine recreating a used thing.

Fourth, insurance for stipulated value is also possible in practice. This means that the value of the insured item stipulated in the insurance policy is deemed to be the relevant measure for setting the amount of damages, regardless of whether the actual value of the insured item which has been injured was higher or lower than the stipulated value.

The Supreme Court ultimately upheld the cassation appeal, set aside the judgment of the court of second instance, and ruled on the merits of the case, denying the appeal in its entirety. In this case, the court held, the method for setting the amount of the injury was closest to the redress of injury in insurance for the replacement value, and reducing the damages by the degree of wear and tear to the building was inconsistent with the essence of this method of calculating the loss.

It should be stressed that the ruling by the Supreme Court does not exclude the possibility for the parties to specify other methods for redress of injury in the property insurance contract, pursuant to the principle of freedom of contract.

Conclusions from Supreme Court ruling

Following earlier statements by the Supreme Court, there is no longer any doubt in the case law that the amount of injury should be determined on the basis of the specific regulations governing the insurance relationship. It also appears that as far as allowed by the regulations, the amount of the injury should be established on the basis of the insurance contract, if the method for redressing property damage in money is indicated in the contract.

This judgment from the Supreme Court of Poland fits within the assumption that because injury is being redressed with money, the rulings in such cases should depend on the circumstances of the specific case, the established interpretation of the regulations, as well as the wording of the contract, if expressly provided by the parties to the legal relationship.

Dr Marta Kozłowska, adwokat, Dispute Resolution & Arbitration practice, Wardyński & Partners