Currently, an insurer is entitled to avoid a contract of insurance and refuse to meet any claim if it was induced to enter into the contract by reason of a material nondisclosure or misrepresentation.

This year marks the centenary of the Marine Insurance Act 1906 which has formed the bedrock of English insurance contract law on material non-disclosure and misrepresentation. It also coincides with the Law Commission's ongoing review of this area of law.

One of the specific areas of insurance contract law being reviewed by the Law Commission concerns the “all-or-nothing” remedy of avoidance.

The current law:
Currently, an insurer is entitled to avoid a contract of insurance and refuse to meet any claim if it was induced to enter into the contract by reason of a material non-disclosure or misrepresentation. Generally speaking, it matters not that the non-disclosure was entirely innocent (subject to minimum terms or special conditions) or that the underwriter concerned with writing the risk never thought to ask about the undisclosed fact or that there was no causal link between the undisclosed matter and the actual loss - the insurers remedy remains the same, ie. a right to avoid.

It is for these reasons that substantial injustice can arise. It certainly has not gone unnoticed by the judiciary and some very senior judges have described the “all-or-nothing” remedy as “draconian” (Longmore LJ in North Star Shipping Ltd -vs- Sphere Drake Insurance plc [2006] EWCA Civ 378) and a “drastic remedy” (Staughton LJ in Kauser -vs- Eagle Star [1997] CLC 129).

Although these areas have been considered by the Law Commission previously and by BILA, the current interest shown by some members of the judiciary in this area, such as Lord Lloyd in the North Star Shipping case in which he said that the law in this area needed to be changed, might mean that there is a sufficient catalyst to create a change. So what alternatives are available?

It is convenient to address this question by looking at how jurisdictions in France and Australia approach the remedies for non-disclosure.

Australian approach:
In the North Star Shipping case, Longmore LJ perceived the Australian system, with its Insurance Contracts Act 1984, to be well ahead of the UK. Under Section 28, an insurer may only avoid a contract where the non-disclosure was fraudulent.

In all other cases, the liability of the insurer will be reduced to the amount that would place the insurer in the position in which it would have been had the non-disclosure not occurred. The insurer may therefore reduce its liability to nil by proving that the risk would have been refused, or that the contract would have been drafted on terms carving-out that type of loss. (This "decisive influence" test was rejected by the majority in the English case of Pan Atlantic -vs- Pine Top [1995] 1 AC 501).

However, if this is not shown, the insurer will only be entitled to set-off against the claim the additional premium which it would have demanded to write the risk had full disclosure been made.

French approach:
 In France, the law relating to non-disclosure in non-marine insurance contracts is codified in Article L.113-9 of the Code des Assurances.

Again, an insurer will only be entitled to avoid a policy where the non-disclosure was fraudulent. However, whilst an insurer remains liable in all other cases, it will only be liable for the risk in proportion to the premium actually charged as against the premium that would have been charged had the material fact been disclosed. For example, if the non-disclosure led to the premium being set at 50 percent of the correct premium, then the insurer will only be liable to pay 50 percent of the claim.

This is known as the “proportionality” principle, and is thought by some to be a more sensible approach than the Australian set-off of premium (and more favourable to insurers). Indeed, the Australian Law Reform Commission itself has recommended the proportionality approach (Review of the Marine Insurance Act 1909, Report No 91, 2001).

An insurer is only able to avoid a contract of marine insurance where there has been a fraudulent non-disclosure or where it can be shown that an insurer would not have written the risk but for the non-disclosure (Article L.172-2).

Analysis:
The French proportionality principle is particularly interesting. This concept is not new to the Law Commission. In its report “Insurance Law: Non-Disclosure and Breach of Warranty” published in 1980, the Law Commission acknowledged the merits of the proportionality principle adopted in France in that it would eliminate the “all-or-nothing” approach in the UK. However, the Law Commission recognised (amongst other problems) that an increase in premium is not always the reaction an insurer might have to an undisclosed fact. For example, the insurer might choose to insert further warranties into the policy instead or decide not to write the policy. It becomes less easy to apply the proportionality principle where there is no comparative premium. The Australian Law Reform Commission has also commented that a significant problem with the proportionality approach is that there is nothing to deter the insured from providing incomplete or inaccurate information; making it more difficult to assess risks, which may in turn result in higher premiums (see Report No 91). For these reasons (and in anticipation of a proposed EEC Directive on the issue, which never materialised), the proportionality principle was not recommended.

The Law Commission has since acknowledged in its issues paper on non-disclosure and materiality (published in September 2006) that its previous conclusion that the French proportionality principle is unworkable needs to be reconsidered in light of the experience of the Financial Services Ombudsman, who has successfully applied proportionality in many cases over the last 25 years. The Law Commission has clearly stated that it does not intend to restrict an insurer's right to avoid an insurance contract where a business insured has behaved fraudulently. However, where an insured has behaved innocently and not negligently the Law Commission has tentatively proposed that the insurer should have no right at all to avoid an insurance contract or to refuse to pay a claim under it on that ground.

A proportionality remedy is also being considered in respect of cases where the insured has behaved negligently but not fraudulently. The Law Commission is canvassing views on whether the court should have a discretion to apply a proportionality solution where an insurer would otherwise have declined a risk but where the insured's fault is minor and other insurers would have accepted the risk at a higher premium.

It is also being tentatively proposed that an insurer may prospectively terminate an insurance contract on reasonable notice following a negligent non-disclosure. This would be without prejudice to claims that have arisen or which arise within the notice period.

Summary:
Although hints are given in the issues paper, it is impossible at this stage to predict the Law Commission's final recommendations in relation to the remedies for non-disclosure. It is probable that some element of proportionality will be introduced, certainly in relation to consumer contracts. Most importantly, it is possible to influence the outcome of the recommendations by responding to the consultation process in the summer of 2007. It is understood that any draft Bill will not be put before Parliament before 2010.

Although the current regime seemingly appears to favour insurers, judges more recently have sought to apply the judicial mechanism of waiver to address the apparent imbalance in favour of the insurer, with the result that the insurer is left without a remedy to which it would otherwise be technically entitled. The introduction of a proportionate remedy would enable the courts to do justice between the parties more satisfactorily.

This Special item appeared in issue 110 of JTW News - November 2006

Author: Paul Cha | Tom Filby - Mills & Reeve