Moral Risk By John Myatt & Dwana Walsh | November 2006
What is a Moral Risk? In the context of a contract of insurance, under which both parties are obliged by statute to exercise the utmost good faith toward one another, the integrity of the insured would seem to be a matter of fundamental importance to the insurer. The idea that there may be “moral” issues posed by a risk may be reasonably familiar as an underwriting concept but most insurance professionals will never have been obliged to try to deﬁne the moral risk as a concept, much less had to grapple with what rights they may have to receive information from an insured relevant to it . In this paper we aim to examine the concept of moral risk in the context of the insured’s duty of disclosure and to provide some guidance about what the law compels an insured to disclose about themselves from this perspective when they approach an insurer seeking cover. Judges seem to have been content to use the expression “moral risk” without explanation as if it were a term of art.1 Consequently, though the notion frequently ﬁgures in the case law in connection with the duty of disclosure, the occasions when the concept itself has been examined by judges are few and far between. An English judge observed many years ago that from an insurer’s viewpoint, consideration of “moral” issues in connection with the integrity of the proposer of the insurance has a pervading character irrespective of the nature of the risk that is being proposed, noting that: “It is elementary that one of the matters to company in entering into contractual relations with a proposed assured is the moral integrity of the proposer - what has been called the moral hazard.” 2 Taking their cue from how broadly the moral character of the insured impacts on the contractual relationship with the insurer generally, some text writers3 seem to accept that any failure to disclose information, such as a failure to disclose a prior claim for example, is something that has “moral” implications in relation to the risk proposed. To the extent there is an academic argument that the duty of disclosure is an aspect of the duty of utmost good faith, this may be true to a degree. However, this paper does not attempt to address the moral risk in this broad sense, as any kind of departure from the obligation of utmost good faith. Its scope is more speciﬁc. Perhaps the easiest way to approach a working deﬁnition of the concept is to distinguish underwriting information that goes to the physical risk from that which goes to the moral risk.
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Information that goes to the physical risk has a bearing upon the aspects of the particular risk proposed which are relevant to the probability of the insured event occurring during the period of cover. One of the well-respected textbooks on Australian insurance law says “a fact is material to the physical risk if it directly increases the risk of a loss.”4 Examples of facts that are material to the physical risk are easy to ﬁnd. For instance, a history of previous ﬁres will be material to a ﬁre proposal because it may show that the insured conducts his business in such a way as to court the risk of ﬁre. In contrast, information material to the moral risk is described opaquely in the same textbook mentioned earlier as one which “indirectly increases the risk of loss”. Justice Slesser chose a different, though perhaps not inconsistent way to describe it, which may explain the concept more usefully for the purposes of this paper. He said that what is generally intended by the moral risk is: “the risk of dishonesty or lack of integrity” of the insured or (in the case of a corporate insured, any of the insured’s) “executives or key personnel”5. In other words, the moral risk is the risk that the insured will make a dishonest claim on the insurer. The concept was revisited in a recent Federal Court Decision6 in which the Court accepted expert evidence in a similar vein that: “moral risk” is a term in the insurance industry which goes to something in the character of an insured which might lead to the insured deliberately bringing about losses to make a claim or falsifying his claim, say to arson, untrue statements in the making of a claim or making a fraudulent claim.” Information going to the moral risk are facts that might suggest a want of honesty or lack of integrity of the insured and indicate that the insured is a person who an insurer may reasonably think is a person who will make a dishonest claim. Of course, unlike facts that relate to the speciﬁc physical risk, the relevance of information going to the moral risk does not necessarily depend on the type of cover proposed.
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The Duty to Disclose Information that Goes to the Moral Risk THE DUTY OF DISCLOSURE UNDER THE INSURANCE CONTRACTS ACT Under Section 21 of the Insurance Contracts Act 1984 (the “ICA”) there are two categories of information a person seeking insurance must disclose to the insurer to which they are applying for cover. Paraphrased, under the ICA, the insured has a duty to disclose every matter known to them that: 1.
they know to be relevant to the underwriting assessment of the insurer [Section 21 (1) (a)]; and
a reasonable person in the circumstances could be expected to know would be relevant to the underwriting assessment of the insurer [Section 21 (1) (b)].
There are exceptions in Section 21 (2) which may be relevant and which will be discussed speciﬁcally later. However, as most of the decisions examined in this article were handed down prior to the enactment of the ICA it is important to know a little about the former rules.
THE “PRUDENT INSURER” TEST Prior to the enactment of the ICA the settled test of what an insured was bound to disclose was determined exclusively by what a reasonable or prudent insurer would have regarded as material to the assessment of the risk. In terms of its most widely repeated Australian formulation, which appears in the judgment of Justice Samuels in the case of Mayne Nickless Ltd v Pegler. Under this test: “a fact is material if it would have reasonably affected the mind of a prudent insurer in determining whether he will accept the insurance and if so, at what premium and on what conditions.”7
The question of whether a particular piece of information is material within the requirements of the “prudent insurer” test is one of fact and not of law.8 Consequently, a decision that an insured was held duty bound to disclose information in one case does not mean the same result would necessarily apply in another situation. However, the cases decided under the old law show that when determining if information was material to the moral risk, in order to determine what a reasonable or prudent insurer could or could not take into account, the courts generally refer to the same kinds of yardsticks.
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MIGHT THE YARDSTICKS UNDER THE PREVIOUS LAW STILL APPLY? Insurers seldom ask questions in their application documents that directly ask questions about the insured’s moral integrity. As a result, unless there has been a previous course of dealings which would give an insured actual knowledge that the insurer was interested in this kind of information, it is hard to see why the insured would have a duty to disclose it under Section 21 (1) (a) of the ICA. However, the insured must also disclose all those things that a reasonable person in the circumstances could be expected to know would be relevant to the underwriting assessment of the insurer under Section 21 (1) (b). The cases that have been decided since the ICA was enacted tend to show that the courts have generally been liberal in their approach to this requirement in the context of information that goes to the moral risk. What a reasonable insured might properly consider they ought to disclose and what a reasonable insurer could require to be disclosed under the terms of the “prudent insurer” test may not be all that different. After all, under both tests insured and insurer respectively bear an obligation to make a reasonable assessment of the impact the information will have upon the underwriter’s consideration of the risk to be insured. To this extent the yardsticks developed in the context of the “prudent insurer” test may still give a good guide to what information going to the moral risk a court may consider a reasonable insured ought to disclose under Section 21 (1) (b) of the ICA. The use of these yardsticks is demonstrated in the cases which follow that illustrate what a reasonable insurer could require to be disclosed to it relevant to the moral risk under the law prior to the ICA.
Prior Criminal Offences DRIVING OFFENCES In Taylor v Eagle Star Insurance Co. Ltd 9 it was held in the context of a motor vehicle policy that all the plaintiff’s convictions for driving offences were material and should have been disclosed along with his driving licence suspensions and cancellations. None of the offences involved dishonesty on the part of the insured but they formed part of the insured’s driving record. They were therefore relevant to the underwriter’s assessment of whether the loss insured against might occur during the period of cover. In other words, the physical risk. In Itobar Pty Ltd v Mackinnon10 a principal crewmember’s trafﬁc convictions (for driving under the inﬂuence of alcohol) were held to be material in connection with a policy which covered the owners of the vessel for the loss of the vessel by “fortuitous accidents or casualties of the seas”. However, this was only in the context of the crewmember also having been convicted of several offences involving dishonesty.
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The trial judge expressed some hesitation in ﬁnding the failure to disclose the convictions to be material and was signiﬁcantly inﬂuenced by the fact that the plaintiff had failed to call any evidence from an expert underwriter to contradict the defendant’s witnesses in this regard11. Convictions for driving offences are generally only relevant to the insurer’s evaluation of the physical risk and seldom raise questions of dishonesty which would go to the moral risk. Hence, in their text on Australian insurance law authors Kelly and Ball conclude, “a conviction for speeding is almost certainly immaterial to all forms of insurance except motor vehicle insurance.”12 A fraudulent failure to disclose driving offences in connection with a motor policy is unlikely to be forgiven by a court under the power conferred upon it by Section 31 of the ICA13.
OFFENCES INVOLVING DISHONESTY In Regina Fur Co. Ltd v Bossom14 the plaintiff company obtained an all risks policy under which it insured furs owned by it or held by it as bailee. One of the directors of the company, Waxman, had been convicted some years previously of receiving a quantity of fur skins and other items knowing them to be stolen. The insurer sought to avoid the policy on the ground this information was material to the risk and had not been disclosed.
The reasoning of the trial judge, Justice Pearson, in deciding this issue in favour of the insurer was as follows: “Now was the fact of Mr Waxman’ s conviction material for the purposes of the policy? My ﬁrst impression was naturally that an isolated conviction more than twenty years ago must be too ancient and too remote to have any materiality, but there are special facts in this case. At the time of the conviction Mr Waxman was nearly thirty years old and engaged in business and was convicted of receiving a substantial quantity of furs knowing they had been stolen ... Mr Waxman held a predominant position in relation to the company.”15 In this brief passage the trial judge refers in rapid succession to a number of criteria frequently employed as yardsticks of materiality. They include the age of the conviction, whether it is an isolated instance or part of a more extensive criminal record, the maturity of the perpetrator at the time the crime was committed, the nature and severity of the crime and the degree of the connection between the person convicted and the insured. These yardsticks16 are used repeatedly by judges regardless of the particular risk in question and address themselves to whether the circumstances of the conviction provide a guide which could reasonably indicate to a prudent insurer that the insured might make a dishonest claim if it issued a policy. Though the cases have been broken down by category to illustrate the uses to which each of these yardsticks have been put, it can be seen from the examples that follow that they are not used in isolation in practice but are usually interwoven in the judge’s reasoning.
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How Old is the Conviction? The more recent the conviction the more likely it is to be found to be material. For example, in Reynolds v Phoenix Assurance Co. Ltd 17 Forbes J, held that a minor conviction for receiving, which was eleven years old, was too old to be material. Legislation with respect to spent convictions exercised signiﬁcant inﬂuence upon Forbes J, in reaching this conclusion. He was of the view that the period after which an offence would become “spent” (ten years) under the relevant legislation18 provided him with some guidance when a conviction was too old to be material in the face of conﬂicting expert testimony. In Australia, in so far as Federal offences are concerned, the Commonwealth Crimes Act19 deems adult convictions more than ten years old and juvenile convictions more than ﬁve years old to be “lapsed” subject to various exemptions in respect of convictions for violent offences or sexual offences against children. Legislation along similar lines operates in NSW20 and in Queensland.
In a case decided well before the enactment of legislation about “spent” convictions, Roselodge Ltd v Castle21 a twenty year old conviction for a comparatively minor offence (attempting to bribe a police ofﬁcer with ten shillings, resulting in a ﬁne) was held to be not material. However, the trial judge concluded a more serious offence twelve years later ought to have been disclosed to the insurer. The New Zealand Court of Appeal had little difﬁculty in ﬁnding that a conviction for an offence of fraud only four years earlier was material in Misirkakis v New Zealand Insurance Co. Ltd22 The judgment of the Court shows clearly that the currency of the conviction contributed to swaying it toward the ﬁnding that the conviction was material.
Is it an Isolated Offence? A history of offences is more likely to be found material than a single isolated offence. Hence a comparatively minor offence is more likely to be found to be material when it is one of a string of convictions than it would if the same offence was committed in isolation. It is doubtful that the crew member’s conviction for driving under the inﬂuence in Itobar Pty Ltd v Mackinnon 23 would have been found to be material in the absence of a history of subsequent convictions for dishonesty. Similarly, if there is a pattern of convictions a court may be more willing to have regard to an old conviction than it would otherwise do. In Schoolman v Hall 24 a history of convictions beginning at age ﬁfteen and ending when the insured was twenty-ﬁve was held to be material even though the last conviction was ﬁfteen years old at the time of the proposal. The long criminal records of two principals of the insured, comprising offences involving dishonesty and culminating in convictions as recently as two and four years respectively prior to the date of the proposal, lead to a concession that the insurer was entitled to avoid the policy in Fanhaven Pty Ltd v Bain Dawes Northern PtyLtd.25 The only remaining question was whether the broker was liable in respect of its failure to caution the insured to disclose this history.
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The Maturity of the Perpetrator at the Time of the Offence Having reference to the maturity of the perpetrator at the time of the offence is perhaps not as immediately obvious a means of gauging the materiality of a conviction as the other yardsticks that judges have used. The object of this enquiry is clearly to determine whether the character of the perpetrator was formed at the time of the offence and hence whether the circumstances of the conviction provided a reliable guide to whether the perpetrator might again commit a dishonest act in connection with the policy.
The fact Waxman, as a director of the insured was a mature man at the time of the offence, and was already engaged in the type of business engaged in by the insured, was clearly crucial evidence in convincing the trial judge that an insurer might reasonably form that opinion about him in Regina Fur Co. Ltd v Bossom. 26 On the other hand, the circumstances of an eight year old conviction for a minor offence when the plaintiff was eighteen years old and was unmarried did not convince Tompkins J, in the New Zealand High Court that an insurer might reasonably form that view about him in Edwards v A. A. Mutual Insurance Co.27 He found that conviction was not material.
Nature and Seriousness of the Offence Any breach of the law that results in a criminal conviction might possibly be material, for example, the commission of comparatively minor offences not involving dishonesty; such as those for driving under the inﬂuence of alcohol in Itobar Pty Ltdv Mackinnon.28 However, generally, an offence involving dishonesty is much more likely to be regarded as material than one that does not, and a serious offence is much more likely to be material than a trivial one. Consequently, the Court had little difﬁculty deciding that a conviction for robbery was material and ought to have been disclosed in connection with a proposal for a ﬁre policy in Woolcott v Sun Alliance and London Insurance Ltd 29, or that an offence involving dishonesty should have been disclosed when applying for motor vehicle insurance in Cleland v London General Insurance Co. Ltd.30 However, the circumstances in which an offence of stealing occurred lead to it not being found to be material in McLeod v S.I.M.U. Mutual Association31 even though the offence was only three years old at the time of the proposal. The insured was at a boat yard in company with his brother-in-law who siphoned some petrol from a boat. The insured was some distance from him at the time and did not actively assist in the commission of the offence. He nevertheless pleaded guilty to the charge and was ﬁned $100.00. Similarly, the offence that was found not to be material in Edwards v A.A. Mutual Insurance Co.32 was the theft from a motor-cycle tool box of goods worth less than $20.00 for which the insured was ﬁned $150.
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The degree of the Connection between the Person Convicted and the Insured It is not only the insured’s own convictions that may be material to the moral risk. The convictions of other persons who are closely associated with the insured may also be material. Clearly, in the case of an insured that is incorporated the offences of persons who are in a dominant position in relation to the affairs of the company must be disclosed (see Regina Fur Co. Ltd v Bossom, Roselodge Ltd v Castle and Fanhaven Pty Ltd v Bain Dawes Northern Pty Ltd.33) Similarly, the convictions of senior employees may be material if they are in a position of trust, or are in a position in which they can exercise particular inﬂuence over the subject matter of the insurance. For instance, the offences of the skipper of an insured vessel were thought to be material for this reason in Inversions Maniera S.A. v Sphere Drake Insurance Co. PLC & Others: “The Dora”34 as were those of an important crew member in Itobar Pty Ltd v Mackinnon.35 If the insured is aware that a close family member has a criminal record those convictions may also be material where that person is in a position to exercise inﬂuence over the subject matter of insurance. Consequently, the failure to disclose her husband’s convictions lead to the avoidance of a policy insuring the family home against burglary entered into by the wife in Lambert v Cooperative Insurance Society Ltd.36 The High Court of Australia adopted similar reasoning with respect to the criminal activities of a family member in Khourv & Anor v Government Insurance Ofﬁce of NSW37, though in that case the insured merely suspected that his son had taken money from the family business and he had not in fact been convicted of any offence.
Criminal Charges that have not yet Lead to Convictions At issue in March Cabaret Club & Casino Ltd v The London Assurance 38 was whether an offence with which a director of the insured had been charged prior to the renewal of the policy but which had not lead to a conviction at the time of the renewal was material and ought to have been disclosed. The director, Skoulding, with his wife was the effective owner of all the shares in the plaintiff company. The plaintiff in turn owned the freehold of licenced premises in which it conducted a cabaret club, restaurant and casino. It insured them with the defendant against (among other risks) loss or damage by ﬁre. The defendant presented evidence which showed that it had been reluctant to accept the risk because, relevantly, it was wary of the inﬂuence of criminals in the club industry and particularly the operation of protection rackets within it. It said that as a consequence, insurers paid signiﬁcant regard to the good repute and moral standing of the managers of such establishments in agreeing to insure them. The policy was relevantly renewed on 20 April 1970. Some time earlier, in May 1969, a quantity of furs to the value of approximately, £20,000.00 was stolen from a lorry. Skoulding was not implicated in the theft but in June 1969 a friend of Skoulding, at Skoulding’s suggestion, took the furs to a farm belonging to Skoulding’s brother-in-law. Skoulding later went over to the farm and helped to unload the furs, knowing them to be stolen.
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For his trouble, Skoulding received a quantity of the furs which he kept at his own premises. On 14 June 1969 the police visited the brother-in-law’s premises where the main body of the furs were found. As a result of their enquiries they moved on to Skoulding’s premises where the other furs were located. Skoulding at that time admitted the offence. He was committed to trial in November 1969 but despite his plea of not guilty was convicted of the offence of handling stolen goods when he stood trial in June 1970. He was ﬁned £2,000.00. In giving judgment, Justice May concluded: “It is quite clear that the fact that Mr Skoulding had committed the offences is material to the moral hazard. It went to the moral integrity of the proposer and was vital as I have already indicated much earlier in this judgment in respect of this particular insurance.”39 His Honour then went on to address the plaintiff’s argument that considered at the time of the application for the policy the insured was not entitled to know whether Skoulding was in fact guilty or innocent, as he had not yet come to trial. This being so, the plaintiff’s counsel argued, the insurer was entitled at best to disclosure of the charge and committal. This he said could not have been material information to the risk, bearing in mind the general presumption in the criminal law in favor of the innocence of an accused person.
This submission initially caused May J, some concern in determining how he could reconcile the presumption of innocence and the plaintiff’s right to avoid self-incrimination with the insured’s duty of disclosure. His Honour however concluded that this was a false dichotomy in that the duty of disclosure left no room for the operation of either principle. His Honour consequently observed: “One must remember that there is no estoppel by acquittal save as between the Crown and the person acquitted. There is nothing to prevent one party to civil proceedings if the fact be material and relevant, attempting to prove that another party to those proceedings has in turn committed the crime of which that other party has previously been acquitted in the criminal Court.”40 In support of this position his Honour referred to Gray v Barr 41 in which the insurer proved to the appropriate civil standard that an insured had committed a criminal offence of which he had been acquitted. His Honour however proceeded to ﬁnd for the insurer on this issue on a further ground, saying that he would have been prepared to hold that Skoulding ought to have disclosed the fact of his arrest, charge and committal for trial at the date of renewal even if he had in fact been innocent of the offence. This conclusion might be justiﬁable if it is accepted that a prudent insurer would be concerned by the mere possibility of criminal behavior on the part of the insured. However, in a subsequent English case, Reynolds v Phoenix Assurance Co Ltd Ptv, Justice Forbes declined to follow this aspect of Justice May’s judgment observing instead:
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“The object of requiring disclosure of circumstances which affect the moral risk is ... to discover whether the proposer is a person likely to be an additional risk from the point of view of insurance ... It is not only the allegation which must be disclosed but the underlying fact that a crime has been committed.” 42 The fact that a person has been charged with a crime they did not commit cannot objectively be said to reﬂect upon their moral integrity and certainly, from the perspective of an insured who knows they are innocent of the offence could not, it is submitted, be something that they would know would affect the underwriter’s decision. The outcome of the recent English decision in Brotherton v Aseguradora Colesguros 43 does not however sit particularly comfortably with Justice Forbes’ comments in Reynolds. The case concerned a contract of reinsurance issued in connection with a professional liability and banker’s bond program for a Colombian State Bank. Serious allegations of impropriety were made about ofﬁcers of the bank. It was held that they should have been disclosed though they were only rumours which had been circulated in the local media, though the Court clearly thought they were of a serious nature. Curiously, neither Reynolds or March Cabaret Club & Casino appear to have been cited to the Court and the decision turned upon the materiality of the allegations and whether the non-disclosure of them induced the re-insurers to enter into the contract, neither of which would be issues under the ICA. Considering that the insured’s duty of disclosure under Section 21 (1) (b) of the ICA is couched in terms of what a reasonable person in the circumstance of the insured could be expected to know was relevant, it seems unlikely that this would include a duty to disclose a criminal charge of which the insured is innocent. There is limited authority on the subject in Australia, though in GIO General Insurance Ltd v Zeyad Zeidan44. the Court took into account charges relating to driving an uninsured motor vehicle and an unregistered motor vehicle that were pending, and to which the insured was pleading not guilty at the time he applied for the cover. The cover in question was however a comprehensive motor vehicle policy and in the course of the application the insured was speciﬁcally asked “Have you in the last ﬁve years ever had any trafﬁc accidents even if you were not at fault, charges, convictions or infringements, such as speeding ﬁnes and red light cameras? “
Adverse Findings by Royal Commissions & Non-Judicial Bodies The competing views with respect to whether an accusation of criminal conduct was a material matter which ought to be disclosed were considered by Rogers J in the Supreme Court of NSW in Trimboli and Ors. v Royal Insurance Australia Ltd45. Trimboli was a partner in a fruit and vegetable business and obtained insurance cover from the defendant in respect of the business. The business premises, stock and other contents were destroyed by ﬁre and the partners in the business, including Trimboli sought indemnity from the defendant.
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Trimboli had not been convicted of any crime but the Woodward Royal Commission into Drug Trafﬁcking had found prior to the date of Trimboli’s proposal to the defendant that he was linked with illegal drug activities. Rogers J concluded that this ﬁnding was material to the risk and should have been disclosed by Trimboli. The crucial considerations which appeared to have affected his mind in reaching this conclusion were the nature and scope of the Royal Commissioner’s enquiry and the qualiﬁcations of the Royal Commissioner himself as an experienced judge to carry it out. Though his Honour quotes extensively from passages in the judgments of May J and Forbes J, in the two cases mentioned earlier, he does not express a preference for either judge’s views. As a result, it is unclear whether his Honour concluded that the scope of the Commission’s terms of reference and Commissioner’s qualiﬁcations meant that the ﬁndings were more likely to be true and therefore be indicative of the commission of an offence, or merely whether these considerations just gave the ﬁndings added gravity as allegations in the mind of a prudent insurer. It seems that his Honour may have been adopting the latter view as he expressly noted that the ﬁndings of the Royal Commissioner were not evidentiary of the facts found by him.46 The judgment clearly demonstrates that the conclusions of bodies other than judicial bodies may be material facts within the context of the “prudent insurer” test. Though his Honour’s reasoning suggests that the fact that the ﬁndings were made by a judge had some bearing, it is hard to accept that an insured would not have a duty to disclose the adverse ﬁndings made in quasi-judicial proceedings. It is therefore arguable that, for example, there is a duty to disclose adverse ﬁndings as a result of disciplinary proceedings such as those which may be taken against doctors and lawyers under the various regulatory codes that operate around Australia.
As, under Section 21 (2 ) (b) and (c) there is no duty to disclose something that is common knowledge or which the insurer ought to know in the ordinary course of business, if the ﬁndings of a Royal Commission are widely reported an insured may be able to argue that there was no duty to speciﬁcally disclose them to the insurer. The same principle would apply in relation to well-publicised convictions such as those, for example, of Alan Bond or Rodney Adler
The Impact of the Insurance Contracts Act 1984 THE STATE OF KNOWLEDGE & EDUCATIONAL BACKGROUND OF THE INSURED S 21 (1(b) of the ICA requires the court to determine what a reasonable person (objectively) could be expected to know would be relevant to the underwriting assessment of the insurer (subjectively) in the circumstances of the insured.
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The reconciliation of these subjective and objective elements and the determination of the range of subjective “circumstances” that the court should take into account have been sources of controversy since the ICA began operation and these considerations remain an area of interest in the current process of reform of the ICA.47 In Delphin v Lumlev General Insurance Ltd, Keall J, in the District Court of Western Australia concluded that the reference to a reasonable person in the circumstances of the insured in Section 21 (1) (b) of the ICA meant: “a reasonable person with the state of knowledge and having the educational background of the plaintiff.”48 He consequently went on to conclude that having regard to the state of knowledge and the educational background of the plaintiff, her intermittent use of cannabis, use of heroin and a criminal charge in relation to drug offences prior to her proposal to the defendant for household contents insurance were not matters she would know would be relevant to the insurer. However, he concluded on the same basis that a later conviction relating to the insured’s cultivation of cannabis at the house ought to have been disclosed by her in view of its connection with the insured premises. This may be seen as a somewhat capricious distinction. Some doubt was in fact cast upon this reasoning when the matter went on appeal,49 though the appeal was substantially concerned with other issues. If the conclusions of Keall J are correct and the court is required to look into the subjective state of knowledge to the insured, it is questionable how often a criminal offence, particularly one not involving dishonesty, might have to be disclosed. On the other hand, In Twenty-ﬁrst Maylux Pty Ltd v Mercantile Mutual Insurance (Australia’) Ltd 50 Brooking J, in the Supreme Court of Victoria, expressed the view that Section 21(1) (b): “did not take into account the personal and individual idiosyncrasies of the insured such as imperfect understanding of English, cultural background or unfamiliarity with business or insurance practice.”51 His Honour considered that the matters to be taken into account were conﬁned to the circumstances of the negotiations leading up to the insurance, the type of cover in question and the insurer’s marketing material. The cases involving criminal convictions that have been decided in the context of the ICA have tended to be more consistent with the approach of Brooking J in Twenty-ﬁrst Maylux than that of Keall J in Delphin.
CASES INVOLVING THE DUTY TO DISCLOSE CRIMINAL CONVICTIONS AFTER THE ICA The courts have approached the question of the disclosure of criminal offences under the ICA pragmatically and certainly the recent decisions dealing with the duty to disclose criminal convictions do not enquire into the subjective characteristics of the insured. The judges seem to have been generally willing to assume that any reasonable applicant for insurance would be expected to know that a history of criminal activity would be relevant to the insurer’s assessment of their proposal.
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In Thompson v Government Insurance Ofﬁce of NSW 52 the plaintiff insured with the defendant the premises in which he and his wife were then living and from which he also carried on the business of selling billiard tables and ancillary equipment under separate domestic and small business policies. The premises were destroyed by ﬁre resulting in a claim on both policies in circumstances that gave rise to a strong suspicion in the defendant of arson. In addition to other grounds of defence, the defendant relied upon the plaintiff’s failure to disclose his numerous convictions for trafﬁc offences, including offences described as “offences of dishonesty” such as driving whilst disqualiﬁed, giving false information to the police and convictions for stealing and assault occasioning actual bodily harm. In relation to his business policy, the defendant also relied upon the failure to disclose charges relating to certain drug offences. Rolfe J concluded that the plaintiff was an unreliable witness and, as a result of cross examination by the defendant’s counsel, did not believe the plaintiff when he asserted that he did not know that these matters would be relevant to the defendant’s assessment of the risk of insuring him. His Honour was consequently willing to hold that the relevant matters ought to have been disclosed to the defendant on the basis that the plaintiff in fact knew they were matters relevant to the defendant’s assessment of the risk within the meaning of the test in Section 21 (1)(a) of the ICA. His Honour’s comments with respect to Section 21(1)(b) are however of more general interest. His Honour was of the view that as a general rule any reasonable applicant for insurance would be expected to know that convictions for offences of dishonesty would be relevant to the insurer’s assessment of their proposal, observing: “Alternatively, I am satisﬁed that a reasonable person in the plaintiff’s circumstances could have been expected to know the matters to be “so relevant”. I do not accept that a reasonable person seeking insurance cover would not regard the various convictions for anti-social offences and offences involving dishonesty (furnishing false information and stealing) and violence as not relevant to an insurer.”Consequently, in another unreported decision, Macquarie Bank Ltd v National Mutual Life Association of Australasia Ltd,53 Cole J concluded that a solicitor who had committed substantial frauds against his trust account was bound to disclose this information to the life insurer to whom he applied for loan protection insurance. The solicitor had never been charged with any offence in relation to the fraudulent transactions prior to his suicide, which resulted in a claim under the policy by the ﬁnance provider. The policy was declared to be void. His Honour’s conclusion that the insured was under a duty to disclose the criminal activity, which must have arisen under Section 2 1(1) (b) but which was not expressly considered in the judgment, was not subsequently contested on appeal.
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The issue was considered in greater detail, but to similar effect, by Sheperdson J, in yet another unreported decision, this time in the Supreme Court of Queensland, Naomi Marble & Granite Pty Ltd v FAI General Insurance Co. His Honour observed that the ICA: “strikes a new balance between the underwriter’s need for information and the insured’s need for security in relying upon insurance. However the adjustment lies in specifying that the duty of disclosure, instead of being measured in terms of the needs of the prudent insurer should be measured by what facts the insured knew or which a reasonable person in the insured’s circumstances would have known to be relevant to the insured’s assessment of the risk.”54 Perhaps somewhat surprisingly, his Honour concluded that the knowledge of a reasonable person in the circumstances within the meaning of Section 21(1) (b) was capable of being informed by the position at common law. In particular, his Honour referred to the judgment of Justice May in March Cabaret Club and Casino Ltd v The London Assurance as interpreted in Reynolds v Phoenix Assurance Co Ltd and “The Dora” (all mentioned earlier) as setting out the relevant tests in this regard. His Honour then proceeded to the conclusion that various charges relating to offences of dishonesty made against the plaintiff ought to have been disclosed by him in accordance with his duty under Section 21(1)(b). While it is now clear that the previous common law tests which were concerned with what was material to a prudent insurer’s assessment of the risk are not part of the law under Section 21,55 the approach taken in Naomi Marble & Granite Pty Ltd supports the view that the yardsticks that evolved in those cases may continue to have relevance, particularly when assessing what is “reasonable” in applying Section 21(1) (b).
SECTION 21A – ELIGIBLE CONTRACTS OF INSURANCE Section 21A of the ICA, which came into operation in 1998, modiﬁes the insured’s disclosure obligations in relation to some common personal lines described in the ICA as “eligible contracts of insurance’’56. These “eligible contracts” currently include motor vehicle insurance, home buildings and contents insurance, sickness and accident insurance, consumer credit insurance and travel insurance. The section deems an insurer to have waived compliance with the duty of disclosure in connection with such a contract unless before the contract was entered into it either: (a)
requests the insured to answer one or more speciﬁc questions relevant to its decision whether
it asks speciﬁc questions (as in (a)) and expressly requests the insured to disclose each
or not to accept the risk; or exceptional circumstance that is known to the insured or a reasonable person in the circumstances could be expected to know that is a matter relevant to the insurer’s decision whether or not to accept the risk which is not a matter the insurer could reasonably be expected to make the subject of a question under (a) or a matter that reduces the risk.
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The onus for proving compliance with the section rests upon the insurer. 57 Hence an insurer under an eligible contract would either have to ask speciﬁc questions about the matter or be able to establish that the matter they sought to rely upon was not something that “could reasonably be expected” to make the subject of a question. This suggests that if an insurer considers a past history of convictions to be relevant to underwriting an eligible contract it would be prudent to ask speciﬁc questions about them. What an insurer could “reasonably be expected” to make the subject of a question is difﬁcult to identify with precision, so it remains feasible that an insured may still be required to disclose some matters that touch on the moral where the insurer has elected to require disclosure of “exceptional circumstances”. However as speciﬁc questions about prior criminal convictions or charges could be asked with little difﬁculty it seems likely that an insurer under an eligible contract who did not ask speciﬁcally about them will be deemed to have waived compliance with the duty of disclosure in this respect.
Matters Relevant to “the Risk” Section 21 (1) (a) requires the insured to disclose those things which they know are “relevant to the decision of the insurer whether to accept the risk and, if so, on what terms”. Section 21(1) (b) requires a reasonable person in the insured’s circumstances to disclose the same matters. In its decision in Permanent Trustee Australia Limited v FAI General Insurance Company Limited (In Liq),58 the High Court reversed the decision of the NSW Court of Appeal and determined that matters relating to “the risk” which must be disclosed under s 21 do not include commercial or “emotional” issues between the insurer and insured. However, the narrow view which the Court adopted toward “the risk” raises some doubts about the status of “moral” issues. The facts of the case were fairly complex. Permanent Trustee Australia Limited had a multi-layered professional indemnity insurance cover of $70 million with a number of insurers. FAI was one of the insurers that provided excess of loss cover. Permanent’s broker, Sedgwick, sent letters to the other insurers involved in the program inviting them to participate in a renewal. However, Sedgwick had made a provisional decision not to offer any opportunity of annual renewal to FAI subject to a satisfactory quotation from another underwriter. It became necessary for Permanent to seek an extension of the existing program before the new program could be put in place. The lead underwriter agreed to an extension of 30 days. FAI was prepared to follow the lead underwriter’s decision to grant the extension and considered Permanent to be one of its “good accounts”. However, Sedgwick was concerned about FAI’s attitude to the extension if it became aware that Permanent would not be approaching it for renewal.As a result,Sedgwick made a considered decision not to inform FAI of Permanent’s intentions regarding the commercial relationship in the course of negotiations with respect to the extension. Sedgwick subsequently sent placing slips for the extension to FAI, which in signing them believed that it would be invited to quote for participation in the renewal.
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FAI presented evidence that it would not have granted the extension had it been informed of the commercial intentions of Permanent. During the period of the 30 day extension, Permanent became aware of circumstances that ultimately gave rise to a claim arising out of their trusteeship of the Aust-Wide Property Trusts in relation to a development at 1 O’Connell Street, Sydney. Permanent sought indemnity from their insurers, including FAI, whose contribution was some $38 million. FAI refused to pay. At ﬁrst instance, the trial judge found that the failure of Sedgwick to inform FAI of Permanent’s intentions not to renew was a breach of Permanent’s duty of disclosure under Section 21(1). The trial judge also concluded that had FAI been informed of Permanent’s intention not to renew it would not have granted the extension. Under Section 28(3) of the Act, FAI was therefore entitled to have its liability reduced to the amount that would place it in the same position in which it would have been in if the breach had not occurred. The Court therefore ordered that all Permanent was entitled to was the return of its premium. FAI also alleged that there was a misrepresentation on the part of Permanent because, according to FAI, Sedgwick was obliged to correct FAI’s false impression that it would be invited to renew. The trial judge found there had been no misleading statements made by Sedgwick and that as FAI had said nothing on the subject either, Sedgwick’s silence was not sufﬁcient to amount to a misrepresentation. In the NSW Court of Appeal, Justice Handley (with whom the other members of the Court of Appeal agreed) also concluded that Permanent’s commercial intentions had to be disclosed to FAI under Section 21(1)(a) of the Act as Permanent knew it to be relevant to FAI’s decision “whether to accept the risk and, if so, on what terms”. The Court of Appeal took the view that the word “statement” in Section 26(2) of the Act, which deals with misrepresentations, could include silence on a matter and that Sedgwick, in making a statement to FAI which was literally true, but incomplete, made a “statement” which was a misrepresentation for the purposes of Section 26(2) of the Act. The Court of Appeal said that the knowledge of Sedgwick regarding Permanent’s intentions was knowledge for the purposes of deciding whether Permanent had acted in breach of its duty of disclosure under Section 21(1)(a) of the Act and Permanent had therefore also made a misrepresentation under Section 26(2) of the Act by virtue of Sedgwick’s silence. Thus, the knowledge of Sedgwick could be imputed to Permanent, and Permanent was bound by the knowledge of Sedgwick, who negotiated the extension on its behalf. The High Court decided by a narrow majority to overturn the decision of the NSW Court of Appeal and found that there was no relevant non-disclosure or misrepresentation on the part of Permanent. The majority comprised of Justices McHugh, Kirby and Callinan in a joint judgment reasoned by reference to the terms of the Law Reform Commission Report which preceded the introduction of the Act and by reference to Hansard, that the key words to be understood in Section 21 were “accept the risk”. These words had been deliberately chosen instead of alternatives such as “enter into the contract of insurance”.The use of the word “risk “ indicated that the duty of disclosure was focused on the particular hazard to be insured and upon matters of relevance to that hazard, not upon the broader question of the commercial willingness of
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the insurer to contract with the insured and, “still less emotional or individual reactions to that question.” Assessment of the insurance hazard was, said the majority, more susceptible to objective ascertainment than commercial and emotional responses. Seeming to address the argument from the perspective of public policy as well, the majority said that to extend the duty of disclosure to include matters of commercial relevance to the insurer would, “be to impose an extraordinarily high burden… indeed a burden that few insureds could ever fully discharge” and “opens a Pandora’s box involving a large range of other considerations, such as are illustrated by the facts of the present case”. The minority, consisting of Justices Gummow and Hayne, thought the case was very much conﬁned to the unusual circumstances surrounding the ﬁnancial down grading of FAI on the road toward its eventual collapse as part of the HIH group of companies. Like the majority, they took the view that there was no room for the previous common law rules in interpreting Section 21 but, contrary to the majority, considered there was no line worth drawing between accepting a risk and entering into a contract. Both Sedgwick and FAI knew, in the unusual circumstances peculiar to their commercial relationship at that time, that the fact that FAI would probably not be approached to participate in the renewal of Permanent’s programme was relevant to whether FAI would have been prepared to offer the extension. The section therefore required disclosure of what Sedgwick knew to be relevant to FAI’s decision as Sedgwick’s knowledge was deemed to reside also with its principal, Permanent.
The Implications for the Future of Moral Risk In Permanent Trustee Australia Limited v FAI, FAI had sought to show that the common law had developed a broad concept of what was relevant to the risk. One branch of its submissions directed the Court to several cases in which it had been established that “moral” factors connected with the insured themselves and not just the risk proposed by them had been held to fall within the duty of disclosure. These were generally matters such as previous criminal offences or convictions. While it is clear that neither the majority or minority felt that the common law offered much assistance in the task of interpreting Section 21, the majority at least declined the opportunity to conﬁrm that “moral” factors fell within the boundaries of the duty of disclosure concluding: “It is unnecessary to decide in this case whether the words “acceptance of the risk of the particular peril or perils intended to be insured against” extend to a “moral hazard” or “moral risk” recognized as relevant by the common law.”
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The High Court’s decision in Permanent Trustee Australia Limited v FAI shows there are instances when there is no duty to disclose a fact which both insurer and insured would both acknowledge to be relevant to the insurer. The decision creates a new basis for technical argument that a matter does not have to be disclosed so long as the insured can demonstrate it does not relate to “the risk”. The majority judgment leaves unexplored what the signiﬁcant aspects of “the risk” are. Is it just the physical aspects of the risk, or are “moral” issues in relation to the insured also included? If so, why did the majority fail to take the opportunity to conﬁrm this? It seems inevitable that insurers can at least expect plaintiff’s lawyers to eventually cite the judgment in support of the conclusion that such matters do not form part of the risk and insurers may need to be more pro-active in seeking this kind of information about their customers in the course of the application process. It seems likely that insurers will also be called upon in future cases to be able to articulate in evidence (presumably through their underwriters) the part that moral risk issues play as a dimension of the overall risk they are agreeing to insure. Prior to Permanent Trustee Australia Limited v FAI there was a reasonable body of case law concerning the ICA which demonstrates that the courts have been happy to accept that a reasonable person seeking insurance ought to know that the commission of an offence involving dishonesty would have an impact on the insurer’s assessment of their proposal. Courts have generally arrived at the conclusion that there was consequently a duty to disclose this kind of information under Sections 21(1) (a) and (b). The decisions which have relied up on Section 21 (1) (b) have perhaps surprisingly spent little time considering the subjective state of knowledge to the insured or educational background. While this outcome may be questionable in terms of the original objects of the ICA the result has been that the decided cases up until Permanent Trustee Australia Limited v FAI followed the common law. However, there is some reason to believe that because the insured’s obligation under Section 21 (1) (b) is couched in terms of what a reasonable person ought to know is relevant, courts must, and in practice have, continued to make an assessment of the probative value of the information in question in deciding whether it ought to be disclosed to an insurer under the ICA. To this extent the yardsticks which judges have used in earlier cases before the enactment of the legislation as a means of gauging the probative value of information that goes to the moral risk may well remain relevant. Insureds have been held to be obliged to disclose both convictions and criminal charges under the ICA. Though no cases have been decided under the ICA there is probably also a duty to disclose adverse ﬁndings made by quasi-judicial tribunals.
The position under the “prudent insurer” test as espoused by Justice May in March Cabaret Club v Casino Ltd59 was that the existence of charges had to be disclosed irrespective of whether the offence had been committed or not.
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While this might be justiﬁed if the insurer’s suspicions are relevant to the test, it is unlikely that a person who knew themselves to be guiltless of such an offence could reasonably be expected to disclose a groundless charge. Consequently, it is hard to imagine any circumstance in which there would be a duty to disclose an allegation made against an insured (simply because it exists as an allegation) under Section 21 of the ICA, if the allegation were false. It remains to be seen what impact the High Court’s decision in Permanent Trustee Australia Limited v FAI will have on the future of moral risk issues and in particular what use will be made of the Court’s refusal to endorse outcomes based on the equivalent position under the common law and its narrow interpretation of what constitutes “the risk”. As recently as October this year the NSW Court of Appeal considered a similar species of contract of utmost good faith, a ﬁnancial guarantee which was provided by an insurer and expressed to be subject to the duty of disclosure set out in Section 21 of the ICA. The majority of the Court had little difﬁculty in concluding that a senior employee’s previous conviction for fraud was a matter which should have been disclosed to the insurer and the insured company’s failure to do so entitled the insurer to avoid the contract60. The issues determined in this case demonstrate that the concept of moral risk continue to be of vital interest to insurers. As the 21st century begins to pose more complex questions about the “moral” character of insureds it is clear that moral risk will remain so.
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References 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47 . 48. 45. 49.
See for example Sanders v Oueensland Insurance Co. Ltd (1931) 45 CLR 557 at 571 (EvattJ) and Kazacos v. Fire and all Risks Insurance Co.Ltd (1970) 92 WN (NSW) 397 at 403. Per Slesser LJ in Locker & Woolf Ltd v. Western Australian Insurance Co.  1 KB. 408 at p 4l4. For instance, see Ivamy E., General Principles of Insurance Law 4th Ed. 1979. David St L. Kelly and Michael Ball, Principles of Insurance Law in Australia and New Zealand 1991 at par 3.144. Locker & Woolf Ltd v. Western Australian Insurance Co. Ltd (supra) at 414. A & D Douglas Pty Ltd ACN 008 404 180 v Lawyers Private Mortgages Pty Ltd ACN 010 556 751  FCA 520 (12 May 2006). The expert witness was Frank Hoffman (1974) NSWLR 228 at p239. See Mutual Life Insurance Co. of New York v Ontario Metal Products Ltd (1925) AC 344. (1940) 67 L1.L.R. 136. (1985) 3 ANZ Insurance Cases 60-610. Supra at p 78,724 Kelly and Ball (supra) at par 3.150 GIO General Insurance Ltd v Zeyad Zeidan (2005) 13 ANZ Insurance Cases 61-633 (1957) 2 Lloyd’s Rep 466. Supra at p 483. Similar criteria, or yardsticks as I have described them, are mentioned at various places in Philip Clarke’s article “The Disclosure of Criminal Information to Insurers” 1984 LMCLQ 100., though mainly see p 103. (1978) 2 Lloyd’s Rep 440. In this case it was the Rehabilitation of Offenders Act 1974. (UK) See Section 85ZV, Pt VII C The Criminal Records Act 1991  2 Ll R 113 (1985) 2 ANZ Insurance Cases 60-633. Supra (1951) 1 Lloyd’s Rep 139. (1982) 2 NSWLR 57. Supra (1985) 2 ANZ Insurance Cases 60-668. Supra  1WLR 493. (1935) 51 Ll L. Rep 156. (1987) 4 ANZ Insurance Cases 60-784. Supra. Supra. (1989) 1 Lloyd’s Rep 69. Supra  2 Ll R 485. (1984) 3 ANZ Insurance Cases 60-581.  1 Ll R 169. Supra at pp 176 to 177 Supra at p177  2 QB 554. Supra at p 460  2 All ER 298. (2005) 13 ANZ Insurance Cases 61-633 (1983) 2 ANZ Insurance Cases 60-500. Supra at p 77,845. GIO General Insurance Ltd V Zeyad Zeidan ( supra) (1989) 5 ANZ Insurance Cases 60-941. Lumley General Insurance Ltd v Delphin (1990) 6 ANZ Insurance Cases 60-986. (1990) 6 ANZ Insurance Cases 60-954
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50. 51. 52. 53. 54.
56 . 57.
Supra at p 76,304 Unreported judgment of Rolfe J in the Supreme Court of NSW delivered 15 June 1994. Unreported judgment of Cole J in the Supreme Court of NSW delivered 15 June 1994. Unreported judgment of Shephardson J in the Supreme Court of Queensland delivered 4 April 1997 See for instance Handley J in Permanent Trustee Australia Co Ltd v FAI General Insurance Co Ltd (2001) 11 ANZ Insurance Cases 61-491 at p 75,674, where he observed “In my judgment s 21(1)(a) leaves no room for the continued operation of the previous test of materiality. The changes are too many and too substantial to allow this, and they must have been deliberate. The section appears in a code and it is not possible to construe it as codifying the previous law.” Regulation 2B of the Insurance Contracts Regulations deﬁnes what are “eligible contracts of insurance’’ for the purpose of the section. The section applies to new business entered into after 30 April 1998. S 21A (8)  HCA 25.
Teoh v QBE Insurance (Australia) Ltd  NSWCA 281 (19 October 2006)
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