The evidential value of underwriting guidelines in minimising indemnity disputes

The Insurance Contracts Act 1984 (ICA) has been in operation in Australia for over three decades, and its application by Australian courts has been varied.

Recent decisions concerning section 28 of the ICA (which section is mirrored in England in the Consumer Insurance (Disclosure and Representations) Act 2012 and the Insurance Act 2015) show that insurers can rely on conservative underwriting practices to deny an insured’s claim where an insured has misrepresented or failed to disclose a matter that would have materially affected the insurer’s decision to enter into the insurance contract, cover loss under the insurance contract once incepted, or avoid the insurance contract.

Insurers’ reliance on conservative underwriting practices

A survey of recent decisions in Australian courts demonstrates that insurers involved in claims litigation regarding section 28 often benefit from evidence of conservative underwriting practices.

An insurer who disputes a claim under the relevant policy will usually do so for one of the following reasons:

• there may be doubt whether the policy responds to the loss claimed; or
• it may be thought that the insured is responsible for the loss because the policy was procured by a misrepresentation, or involved a non-disclosure on the part of the insured.

Where an insurer apprehends a misrepresentation or nondisclosure by the insured, section 28 of the ICA provides two options to remedy the breach by the insured.

Firstly, if the insured’s misrepresentation or non-disclosure is fraudulent, the insurer may avoid the contract, recovering all monies advanced to the insured and retaining the premium paid (the “Fraudulent Limb”).

Secondly, if the insured’s misrepresentation or nondisclosure is innocent, the insurer may only reduce its liability to the extent that it has been prejudiced by the misrepresentation or non-disclosure (the “Innocent Limb”).

Similar provisions in respect of pre-contractual misrepresentation and non-disclosure exist in England under the Consumer Insurance (Disclosure an Representations) Act 2012 for consumer contracts¹ and the Insurance Act 2015 for non-consumer contracts.² Both English acts make the same distinction as the Australian ICA, entitling the insurer to avoid the contract and keep the premium for fraudulent misrepresentation or nondisclosure, and to seek damages proportionate to the insurer’s loss for innocent misrepresentation or nondisclosure.

Misrepresentation or non-disclosure: proving the extent of the insurer’s prejudice

Although insurance fraud is widely thought to be a continuing and major encumbrance on underwriters, the burden of proof for proving fraud is incredibly high, and many Australian decisions show that insurers have difficulty proving the Fraudulent Limb to a court because the concept of fraud suggests a subjective dishonesty which is difficult to demonstrate through circumstantial evidence. For this reason, insurers will often argue the Innocent Limb.

In order to satisfy the Innocent Limb, an insurer must prove that the insured’s misrepresentation or non-disclosure materially prejudiced the insurer, such that if the insurer was aware of the misrepresentation or non-disclosure, it would have either charged a higher premium, imposed different terms, or not issued the policy at all. However, in this respect, Australian courts are aware of the insurer’s benefit of hindsight and tendency to adduce self-serving evidence.

Relevance of underwriting guidelines

Recent cases show that an insurer will be in a better position to prove material prejudice if it can point to internal guidelines that suggest that the insurer holds a conservative attitude towards underwriting risk.

In the 2016 Victorian Supreme Court decision of Bergman -v- CGU Insurance Ltd,³ Mr Bergman (the Insured) was issued landlord’s insurance from CGU Insurance Ltd (the Insurer) whereby the Insured’s property, which he intended to demolish, was insured for a total of $800,000. Approximately three years later, the property became vacant for a period of two days whilst preparations were made for demolishing the buildings on the property, and during these two days, the buildings on the property were substantially damaged by a fire.

The Insured made a claim under the policy which was rejected by the Insurer on the basis that the Insured had specifically answered “no” when asked in the proposal form whether the property was under construction or to be demolished. The court held that the Insured had made a misrepresentation by falsely representing a matter relevant to the Insurer’s decision whether to accept the risk.

The court was ultimately satisfied that if the Insured had disclosed his intention to demolish the insured property, the Insurer would not have issued the policy. On this basis, the Insurer argued it was entitled to reduce its liability to nil. Central to this conclusion were underwriting guidelines tendered by the Insurer that advised its underwriters to deny all insurance proposals that involved property subject to demolition plans. In finding for the Insurer, the court confirmed the guidelines demonstrated that “any demolition plans or statutory orders are blanket unacceptable risks to the defendant”.

Some months later, in the New South Wales Supreme Court case of Beslic -v- MLC Ltd,⁴ the court was required to weigh the evidential value of an internal underwriting policy, this time in the context of MLC’s guideline that its underwriters reject all life insurance proposals involving persons suffering from severe symptoms of mental illness. Similarly to Bergman v CGU Limited, the court placed significance on these guidelines and accepted that they were evidence of the standard practice of MLC’s underwriters. 

The recent decisions show the superior courts in Australia accepting evidence of internal guidelines to determine the individual insurer’s actual underwriting practice, rather than self-serving oral evidence tendered after indemnity has been denied. In theory, underwriting guidelines should provide an objective yardstick for measuring the extent that an insured’s misrepresentation or non-disclosure has prejudiced an insurer.

A lesson for insurers

Australian insurers can capitalise on the courts’ favourable interpretation of underwriting guidelines by adopting conservative and prescriptive underwriting guidelines. In this way, an insurer will be able to put its best foot forward when aiming to prove that an insured’s misrepresentation or non-disclosure materially affected the insurer’s position.

Although underwriting guidelines remain non-binding, the courts’ approach suggests that insurers should be cognisant of the guidelines when writing risk as, in the event of an indemnity dispute, such guidelines may be called upon to determine the application of section 28 of the ICA.

Notes

1.  Consumer Insurance (Disclosure and Representations) Act 2012 s 2, s 5, Schedule 1 Part 1.
2.  Insurance Act 2015 Part 2 s 3, Schedule 1 Part 1. 
3.  Bergman -v- CGU Insurance Ltd [2016] VSC 81.
4.  Beslic -v- MLC Ltd (No 2) [2016] NSWSC 746.

If you would like to view any of the other articles in Global Insurance Focus - May 2017 then please follow the links below: 

A response to consultations on the regulatory framework for a UK market in insurance-linked securities

Contract update 

Draft bill to streamline regulation of Spanish insurance and pension plans

Turning crisis into opportunity: the future of Hong Kong’s insurance sector