AW091304 Utmost Good Faith in the Context of Insurance – Assignment Help
Question 1
“At the heart of every insurance transaction is a requirement that both parties exercise utmost good faith towards each other….The principle is…sometimes expressed by saying that insurance contracts are contracts uberrimae fidei.”
- Explain what is meant by “utmost good faith” and why it is of particular importance in the context of insurance contracts.
Most legal contracts are subject to the doctrine- Caveat Emptor (Let the buyer beware) putting every entity at their own guard to acquire all the information that they themselves deem to seek important (PBWorks, 2013). Insurance and a few other contracts are subject to a different doctrine. Uberrimae fidei – the Latin expression of “Utmost good faith” is a minimum standard according to the Insurance Contracts Act 1984 (Cth) (Investopedia, 2000). In the simplest terms, this standard implies that both, the insured and the insurer should be completely honest to one another while defining the terms of the transaction. Deliberate concealment of information, critical to the transacting parties, is therefore unlawful.
Although the doctrine of utmost good faith is legally applicable to a number of commercial transactions, its importance in Insurance transactions is amplified. Insurance by its very definition is “a legally binding contract between two or more parties whereby a “risk” is being divided” (Latimer, 2011) and ‘risk’ by its practical definition is “the chance of incurring a loss” (Halton, 2004). While good faith should be important in all the regular everyday transactions; say the selling and buying of a car, the doctrine of utmost good faith will begin to hold significant importance when a potential loss is in perspective. It is then, in this case, that all the transacting parties have to deal in pure honesty. This would mean that all the relevant and concerned information should be declared and not withheld or worse, subverted.
For instance, in the case of life insurance; the risk of someone losing his/her life is absolute; it is only the time that is not exactly certain. The risk will therefore be divided between the insured; the person buying the insurance against a premium, and the insurer; the party selling this insurance against a fee. Dealing in utmost good faith would therefore require for the insured to disclose all the information critical to these transaction that can minimize or maximize the risk for either party. For example, some of the critical information bits in case of life insurance that the insured should disclose are any or all of his/her health conditions. Is there an illness? If yes, is it terminal? Are there any genetic trends in the family that the insured person is likely to develop? The insured must also disclose their lifestyle if it is relevant. For instance, if the insured is a front-line soldier in military, the risks of his/her death are different than that of a school teacher.
Similarly, it is the lawful duty of the insurer to declare any conditions that may apply to the contract. For instance, the insurer is to declare the true expected period by which the insured’s family can claim the insurance or if there are any possible delays under certain circumstances (e.g. in cases when the insured has been suspected to be killed, would there be any prolonged delays or difficulties faced by the insured’s family?)
In light of a precedent; Carter v Boehm (1766), the said doctrine implies that the parties must disclose all material facts, however they are not bound to disclose facts of general knowledge (e.g. the insured is not bound to tell the insurer that the rate of car accidents on average has gone up in the last decade), as well as facts about things they themselves could not know (e.g. that the insured is developing a terminal disease that has shown no symptoms and has not been diagnosed) (Cooper, 2013).
Working around the above given examples, it can be seen that the true purpose of insurance i.e. the reduction of risk, can only be achieved as long as all transacting parties are exactly aware of what they are getting themselves into, otherwise the purpose of insurance fails to fulfil.
- How is this principle reflected in the provisions of the Insurance Contracts Act 1984 (Cth) as amended?
The long awaited Insurance Contracts Amendment Act 2013 came into effect on 28th June 2013. Certain changes were required to be made to the previous Insurance Contracts Act 1984 (Cth) (ICA) for instance, previously in spite of the utmost good faith principle set out at s 13, the insured often found themselves cheated out of their rightful benefits or the insurers often felt that they are being cheated out of information and it took a private legal action to ensure parties into compliance with the duty of utmost good faith (Murray, 2013). In an event of unfair dealing, also known as ‘bad faith’, the insurance company could be sued on a tort claim apart from breaching a contract. But in order to avoid legal battles and also loss to the policyholders in instances when insurance companies refused to defend lawsuits, expanding on the previous provisions became a must. Therefore, the Amendment Act states any failure to meet the demands of the ‘utmost good faith’ principle as a breach of the ICA (Murray, 2013). And although the breach doesn’t cause a penalty under the ICA, however it gives the Australian Securities and Investment Commission (ASIC) the authority to handle and settle such claims related to failure of compliance. The ASIC has in its power to vary, suspend or cancel insurer’s licenses to Australian Financial Services as well as ban individuals from providing any financial services should they find an insurer drifting from the principle (Murray, 2013). Moreover, the ASIC is also capable of intervention in proceedings as well as bring representative(s) in proceedings against the insurers. However, these liberties only apply in situations that arise in relation to a contract of insurance and specifically as a result of mishandling or non-settlement of a potential claim. Such tight control over the payment activities of the insurance companies helps secure and rekindle trust in these very important financial institutions benefitting both the common people and the economy at large.
An extension to the good faith principle is the addition of a third-party beneficiary to the good faith provisions. This requires the insurance benefits to extend to a person not a party to the insurance contract but referred to only for the purpose (McGivern, 2013).
Question 2
Miranda leased a shop as the headquarters for her cosmetics retail business, and took out an insurance policy against fire and theft. The building was later destroyed in a fierce blaze. Damaged equipment and items found on the site after the fire indicated that the premises were used not only as a shop but as a manufacturing plant for Miranda cosmetics. Miranda had not disclosed this intended use in the insurance proposal.
Required:
- Explain to Miranda, using appropriate case law and legislation, whether the insurer can now reject Miranda’s fire claim.
In the case scenario presented here, Miranda’s (the insured) claim can be rejected by the insurer on the basis of “bad faith”.
The issue at hand is that the insured seems to have covered some material facts; hence not abiding by the duty of disclosure.
According to Common Law, duty of disclosure would incorporate the open disclosure of all the facts that could affect the judgement and decision making of a rational insurer as to whether they would like to accept the insurance or not. If yes, then on what premium and on what terms. What Miranda has failed to disclose in the case scenario is exactly such a fact.
Parliamentary Counsel (2013) states that according to the Insurance Contracts act 1984 (Cth) s 21 “an insured has a duty to disclose to the insurer before the relevant contract of insurance is entered into, every matter that is known to the insured, being a matter that:
- The insured knows to be a matter relevant to the decision of the insurer whether to accept the risk and if so on what terms, or
- A reasonable person in the circumstances could be expected to know to be a matter so relevant”
It is apparent even to the laymen, that the dangers and hazards that a regular retail outlet can be subjected to are very different from the kinds of hazards that a manufacturing plant is subjected to. Had Miranda disclosed this material fact by acting in good faith at the time of proposing the insurance, the insurer would have had a different take on what premium to charge or basically just how risky it would be to accept the insurance. It is therefore quite apparent that Miranda has committed a plain sight breach of the contract.
According to Common Law, in the instance of a breach, “the innocent party can avoid (i.e. not pay) the insurance contract from the beginning (ab initio) for non-disclosure of a material fact”.
Having discussed the underlying issue at hand in the given case scenario and the law and legislature referring to it, it can be concluded that the insurer has the right to avoid Miranda’s claim, unless Miranda can prove that the lack of disclosure was innocent and not fraudulent i-e. this usage of the vicinity was not intended at the start of the contract and was intended to be disclosed at the time of renewal.
- Would it make any difference to your answer to Part a. of this question if an insurance investigator finds evidence of a break-in, and concludes that the fire may well have been started by burglars seeking to hide the fact they had stolen goods and equipment?
Yes, it could make a difference to the conclusion in the previous scenario if evidence of a break-in comes into perspective. Since a third party is now involved and the damages occurred have not been caused by the augmented risk due to the existence of the manufacturing facility on site, but because of an intrusion or theft, which the vicinity is insured against; the insured is therefore entitled to a compensation and the whole payment cannot be refused.
According to the Insurance Contracts Act 1984 s54 (Mead, 2010) “the insurer may not refuse to pay the claim by reason only of that act but the insurer’s liability in respect of the claim is reduced by the amount that fairly represents the extent to which the insurer’s interests were prejudiced as a result of that act” meaning thereby that although an insurer is not liable for things that the insurer was not told about but the insurer cannot refuse to pay for an amount that would fairly represent its liability.
Provision 3 of Section 54 of the Insurance Contracts Act 1984 also directs that if the insured succeeds in proving that none of the loss that gave rise to the said claim was caused by whatever information was concealed, the insurer cannot refuse to pay. Therefore, if there is evidence of a burglary and is proven in the court of law, Miranda is entitled to the claim and the insurer cannot reject the same.
Therefore, given the provisions of the Insurance Contract Act 1984, what insurer can do is, refuse to pay any damages or loss incurred at the part of the vicinity which was being used for manufacturing purposes. However, in case of a proved burglary, the insurer is liable to pay any claim that is raised for losses incurred at the part of the vicinity used as the retail outlet, which was the intended and declared use of the property that it was insured against.
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References
Cooper, R. (2013, September 23). Utmost Good Faith. Retrieved September 29th, 2013, from CPR Insurance Services: http://www.professionalrisk.com.au/pages/information/insurance-principles/utmost-good-faith.php
Halton, G. A. (2004). Defining Risk. Financial Analysts Journal, 60(6), 19-25.
Investopedia. (2000, February 29). Doctrine of Utmost Good Faith. Retrieved from Investopedia: http://www.investopedia.com/terms/d/doctrineofutmostgoodfaith.asp
Latimer, P. (2011). Australian Business Law. Sydney: CCH.
McGivern, B. (2013). Utmost Good Faith – Post-Contractual Duty under the ICA. The University of Western Australia Press.
Mead, P. (2010). Professional Indemnity Insurance – Claims Made and Notified Policies – Section 54 and 40(3) of the Insurance Contract Act 1984 (CTH) . Carter Newell Lawyers – Constructive Notes.
Murray, C. (2013). Australia: Insurance Contracts Amendment Act 2013 and Privacy Amendment Act 2012. Market Bulletin.
Parliamentary Counsel, C. (2013). Insurance Contracts Act 1984. ComLaw.
PBWorks. (2013, April 10). Retrieved from Consumer Law: http://stage6.pbworks.com/f/Consumer+Law.pdf
