The recent case of ERC Frankona -v- American National Insurance Company (ANICO) illustrates when a moral hazard may entitle underwriters to avoid policy obligations on grounds of non-disclosure or misrepresentation.

The action concerned the quota share reinsurance underwritten by ERC Frankona of ANICO's participation in a personal accident business programme called National Accident Insurance Group, a pool managed by National Accident Insurance Underwriters (NAIU).

Irvine Drobny was NAIU's chairman and chief operating officer.

In 1983 Drobny had been convicted of securities fraud and aiding and abetting, resulting in a four-year prison sentence and a charge for conversion of money held in an escrow account as attorney.

Neither the conviction nor the charge were disclosed to ERC Frankona when the reinsurance was arranged.

The central issue in the case was whether the reinsurers were entitled to avoid the quota share treaty on this basis.

The judge found that ANICO had known or should have known of the convictions.

The judge also found that the conviction and the charge were material and there was appropriate inducement in that, despite criticism made of the underwriting, the underwriter would have assessed afresh whether NAIU was sufficiently reliable had he been aware of the conviction.

The case shows the importance of ensuring that information relating to key company officers and employees is checked and appropriate full disclosure is made.

For insurers, the risk may be twofold in that not only would this affect their exposure in the underlying risk if there was a moral hazard issue, but also their reinsurance protection should the information subsequently come to light.

' Ling Ong is a partner at law firm DLA Piper Rudnick Gray Cary