One of the fundamental principles of insurance is the principle of utmost good faith. Applying this to an insurance contract raises the question of duty, which does not arise in a sale of goods contract. A buyer of goods normally has the opportunity to inspect them before purchase and, as long as the seller does not mislead the buyer and answers any questions truthfully, the contract cannot be avoided by the buyer simply because he feels he has made a poor bargain.
The person selling the goods is under no ‘positive’ duty to disclose information which is not requested by the buyer.
Therefore, if Audrey buys a second hand car from Adam, who is a former racing car mechanic, and does not ask any questions about the car’s performance and Adam omits to tell her that the car’s engine has been modified to improve performance, Adam would not be guilty of misrepresentation.
Although some protection is given to the buyer under statute law, contracts for the sale of goods are basically subject to the doctrine of ‘let the buyer beware’ or caveat emptor.
Audrey is now about to apply for motor insurance cover on her new car. Should she disclose the information about the higher than normal performance of the car to the insurer at the time of making the contract, or can she say nothing because the onus is on the insurer to discover this information when it inspects the car?
Under the doctrine of utmost good faith Audrey must declare this information.
The insurer cannot inspect every risk proposed for insurance and, even if it could, it would not necessarily reveal any underlying ‘moral hazard’, such as a poor driving record.
Therefore it relies on the proposer to make a full disclosure, under the doctrine of utmost good faith, of any material or relevant facts that might affect its acceptance of the risk, the underwriting terms imposed and, if the risk is accepted, the premium charged.
Here, in our example, a modified engine would be a relevant or material fact.
The doctrine of utmost good faith imposes two duties on both parties to the contract:
• A duty not to misrepresent any matter relating to the insurance, that is, a duty to tell the truth
• A duty to disclose all material facts, that is, a duty not to conceal anything that is relevant.
A misrepresentation in general law is a false statement of fact that induces the other party to enter into the contract. It is worth noting that a false statement does not have to be fraudulent. A negligent, or even innocent misrepresentation can affect the validity of the contract.
The rules regarding misrepresentation apply to both parties to an insurance contract, but it is normally the proposer who breaks these rules. For example, where someone says he has, say, a burglar alarm when in reality he does not.
In practice, there is little difference between misrepresentation (making false statements) and non-disclosure (failing to disclose the whole truth).
Because insurance is an intangible product, there is a positive duty of disclosure on both parties. This duty, as it applies to the proposer, was summed up in the case of Rozanes v. Bowen (1928):
“As the underwriter knows nothing and the man who comes to him to ask him to insure knows everything, it is the duty of the assured… to make a full disclosure to the underwriter without being asked of all the material circumstances. This is expressed by saying it is a contract of the utmost good faith.”
The positive duty of disclosure also applies to the insurer, although there are few examples of material facts which an insurer would need to disclose. The main requirement will be to provide full and accurate information about the cover which is being offered and, in this area, the FSA has introduced a considerable number of regulations and requirements as to the provision of information and documentation.
So what type of fact is a material fact that needs to be disclosed?
The legal definition of a material fact is contained in the Marine Insurance Act 1906: “Every circumstance is material which would influence the judgment of a prudent insurer in fixing the premium or determining whether he will take the risk.”
Consider some of the words and phrases in more detail.
Influence the judgment: the words are taken to mean any fact which an underwriter would have wanted to know about when making their decision. It need not be a fact which would have caused him to act differently had he known about it.
Prudent insurer: although ‘prudent’ suggest a cautious individual, the courts have held that this term has the same meaning as a ‘reasonable insurer’.
In the UK, the right to avoid the contract arises whenever a non-disclosure (or misrepresentation) is discovered. This often happens at the time of a loss, but there is no legal requirement for any connection between the non-disclosure and the cause of the loss.
Under FSA rules, however, an insurer must not, except where there is evidence of fraud, refuse to meet a claim made by a retail customer on the grounds of:
• Non-disclosure of a material fact that the retail customer could not reasonably be expected to have disclosed;
• Misrepresentation of a material fact, unless the misrepresentation is negligent.
The proposal form used for most types of insurance is designed to obtain all the material facts that the underwriter needs to properly assess the risk. However, if the proposer knows about something that is material, he must disclose it, even if he is not specifically asked to do so on the form.
Material facts that require disclosure can be divided between two classes: those which relate to the physical hazard, such as an adequate description of the subject matter of insurance and details of any unusual features that may increase the level of risk; and those which relate to the moral hazard – those aspects of the risk which depend on the character and behaviour of the insured.
Typical examples of physical hazards would be:
• Fire insurance – for example, the construction of the building, the nature of its use, any fire detection equipment
• Theft insurance – nature and value of the stock, any security precautions
• Motor insurance – type of car, any modifications, driver details
• Life assurance – age, medical history.
Examples of moral hazards would be:
• Identity of the insured – discrimination on race and sex grounds is now prohibited, although insurers are still able to vary premium rates for men and women and for different occupations
• Criminal acts – even if it is unconnected to the risk, a previous criminal history indicates a high degree of moral hazard
• Previous claims history – may provide evidence of physical and moral hazard, as may any adverse insurance history. An example is an earlier premium loading or refusal of cover
• Other non-indemnity policies in force –. high amounts of life insurance with several different insurers.
Facts that do not need to be disclosed, even if they are material will normally fall under one of the following headings:
• Matters of law. Everyone is deemed to know the law , for example, as an owner of a building, the proposer has an insurable interest
• Matters of common knowledge – an insurer should know about normal trade processes or, say, wars in various parts of the world
• Factors which lessen the risk – a factory which has installed a sprinkler system
• Factors which could have been discovered – the proposer puts 'see your records' on the proposal form instead of detailing his previous claims history. Similarly, if the insurer carries out a survey there is no need to disclose facts which are clearly visible and which the surveyor should have spotted
• Facts covered by the policy terms – if a dangerous pastime is excluded from cover under a policy, there is no need to declare it
• Facts which the proposer does not know – a proposer for life assurance does not know that they are seriously ill
• Spent convictions – under the Rehabilitation of Offenders Act 1974 many convictions become ‘spent’ after a defined period and no longer need to be disclosed.
The duty of disclosure also continues during the term of the contract where:
• There are agreed changes to the contract – a change of car, or drivers, during the policy term brings with it a duty to disclose material facts about the change
• The policy contains an ‘increase of risk’ clause. This imposes a continuing duty on the insured to notify any (permanent) alteration which increases the risk of damage. Cover will cease unless the alteration is notified to and accepted by the insurer (commercial property insurance policies invariably contain such a clause and some insurers have introduced them into their home insurance policies.
The duty of utmost good faith also applies when it is time to renew an insurance policy and at that time the insured is required to declare any changes in the risk.
The duty of disclosure at renewal does not, however, apply to long term insurance such as life assurance and permanent health insurance. This is because these are not annual contracts, even though the premium may be paid annually, or more frequently. IT
This article is taken from broker ASSESS the CII’s online learning programme. For further information email: brokerASSESS@biba.org.uk, or call 0844 7700 266