2010 ALUCA TurksLegal Scholarship
Second Runner Up Marjorie Corvalan
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“Consistency and certainty in the law are not merely an indulgence … they are essential to confident planning by all.1” The introduction of the Insurance Contracts Act (‘IC Act’) resulted in a more predictable and arguably a fairer system to the one which operated prior to its introduction in 19842. This has assisted in the growth of the life insurance industry which currently manages $227.7 billion in assets3. In September 2003 the then Liberal Federal Government commissioned an expert committee to review the IC Act. The expert committee was to have reference to the adequacy of the rights and obligations of insurers and insureds, any ambiguities which may have arisen as a result of the wording of the act or judicial interpretation and any other matter which the reviewers considered necessary4. The committee handed down its recommendations in 2005 which concluded that, by and large, the act had been operating satisfactorily but that amendments were needed to take into consideration judicial interpretation, the time that had lapsed since the most recent amendments to the Act and the changes in the insurance field5. The Insurance Contracts Amendment Bill 2010 (‘IC amendment bill’) was drafted and is currently before the Senate. This paper will examine the issues which the amendment bill seeks to address and how effectively they have been addressed. It will have particular consideration to the duty of non-disclosure under section 21 of the IC Act and the remedies available for the breach of that duty presently available under section 29 of the IC Act. In doing so, this paper will attempt to analyse the current remedies and will seek to examine the implications the amended bill will have on those remedies. This paper will also briefly discuss the benefits for insurers and insureds and will attempt to provide some practical examples of the applications of the remedies as set out in the amendment bill. Section 21 of the IC Act deals with an insured’s duty of disclosure prior to entering into a contract of life insurance with an insurer. This duty has its roots in early maritime insurance law where matters which were relevant to the risk were almost solely within the knowledge of the insured6. This meant that there had to be a strict duty imposed on an insured which required him/her to disclose every material fact to the insurer prior to entering into the contract. This duty was the same for contacts of life insurance. These types of contracts became known as contracts uberrimae fidei in which utmost good faith had to be shown by each party7. Under common law, disclosure was required regardless of whether the insured knew of the fact or believed it to be relevant to the insurer’s
Carter, J. W. & Harland, D.J., 1996, Contract Law in Australia, Butterworths, Sydney.
‘Insurance Contracts Act – Recent Developments and Proposals for Change’, paper presented at the Australian Insurance Law Association National Conference, Sydney, November 2006. 3 Australian Prudential Regulation Authority, ‘Quarterly Life Insurance Performance June 2010’, issued September 2010. 4 ‘Insurance Contracts Act – Recent Developments and Proposals for Change’, paper presented at the Australian Insurance Law Association National Conference, Sydney, November 2006. 5 Explanatory Memorandum, Insurance Contracts Amendment Bill, 2010 (Cth). 6 Australian Law Reform Commission Report, Insurance Contracts, Report Number 20, Australian Government Publishing Service, Canberra, (1982). 7 Cater v Boehm (1766) 3 Burr 1905 in which Lord Mansfield famously made the statement which stipulated why this was necessary. Lord Mansfield argued that there were facts which are only known to the insured which would affect the risk. Lord Mansfield stated that the underwriter had to be able to trust the insured’s representations and rely on them to determine the risk.
assessment of the risk. The only remedy available was to avoid the contract ab initio at the discretion of the insurer for innocent or fraudulent non-disclosure8. The question of whether the non-disclosure was material to the risk was approached differently by different courts. There were namely two tests: the ‘Prudent Insurer Test’ and the ‘Reasonable Insured Test’. The Prudent Insurer test required disclosure of any fact that would influence a prudent insurer in its assessment of the risk9. The Reasonable Insured Test would require disclosure of any fact that a reasonable person in the circumstances of the insured would have considered material to the risk10. Australian Courts adopted different approaches11. This was subsequently settled with the introduction of the IC Act which requires disclosure of “relevant” facts. Relevant facts are those that are material to the risk which is to be insured. Before legislative reform, if the insurer was able to show that it would not have entered into the exact same contract, the insurer was able to avoid the contract regardless of whether the non-disclosure was fraudulent or innocent. The common law protection which evolved was the test of materiality where the insurer needed to establish that the non-disclosure was material to the assessment of the risk. The common law development of remedies for non-disclosure and/or misrepresentation were far more suited to the types of policies for which these remedies were formulated. They were suited to endowment or whole of life policies, and also to policies providing for a payment in the event of the death of the insured. In the current market these remedies would seem inflexible and unworkable as there are many different types of life insurance products offered by life insurers given that the market has become far more sophisticated12. Section 21(1)(b) of the IC Act provides a test which is a mixture of a subjective/objective test. This subsection requires an examination of what a reasonable person in the circumstances of the insured could be expected to know to be a matter that is relevant to the decision of the insurer to accept the risk and on which terms that risk is accepted. The reference to “circumstances” may arguably include not only the circumstances of the individual insured, but also the circumstances of the negotiations between the insurer and insured when entering into the contract. This means that a court would need to take into account the circumstances affecting the insured whilst considering a reasonable person’s state of mind. The Explanatory Memorandum to the amendment bill states that it has been this subjective/objective test which has not been applied consistently13. The IC amendment bill sets out what factors need to be considered when applying this test. The amendment bill repealed s21(1)(b) which is to be substituted with the following: “a reasonable person in the circumstances could be expected to know to be a matter so relevant, having regards to factors including, but not limited to, the nature and extent of the insurance cover to be provided under the relevant contract of insurance”.
Joel v Law Union & Crown Insurance Company  2 KB 863 Marine Insurance Act 1909 s24(2)
Australian Law Reform Commission Report, Insurance Contracts, Report Number 20, Australian Government Publishing Service, Canberra, (1982). 11 See Guardian Assurance v Condogianis (1919) 26 CLR 231; Southern Cross Assurance Co. Ltd v Australian Provincial Assurance Association Ltd (1939) 39 SR (N.S.W.) 174; Mayne Nickless v Pegler  1 NSWLR 228. 12 Explanatory Memorandum, Insurance Contracts Amendment Bill, 2010 (Cth). 13 Explanatory Memorandum, Insurance Contracts Amendment Bill, 2010 (Cth).
In light of this new wording it can be argued that the words “nature and extent of the insurance cover” indicate that the relevant disclosures must be material to the contract and the cover provided under it. Insurers will therefore be required to have regard to the type of cover that was offered and whether the non-disclosure has a direct impact on the particular type of cover. For example, non-disclosure of a prior back injury by a person who is a plumber by trade would be more material to income protection cover as opposed to life cover. This is because a prior back injury is likely to limit a plumber’s ability to work as opposed to affecting his/her life expectancy. It will therefore be expected that a reasonable person in the insured’s circumstances would disclose a prior back injury when applying for income protection cover as this is a fact that is directly material to the nature of the cover provided for under the contract. Section 29(3) of the IC Act allows an insurer to avoid a contract for non-disclosure or misrepresentation if the non-disclosure or the misrepresentation is discovered within 3 years of when the policy was entered into. The section requires the insurer to establish that it would not have been prepared to enter into a contract of life insurance with the insured on any terms. This has been interpreted to mean that the insurer needs to show that it would not have been prepared to enter into any contract of life insurance14. The problem that has plagued the insurance industry is that given the myriad of insurance products available, and the commonly accepted insurer’s philosophy to write contracts, it would be very difficult to establish that it would not have been prepared to enter into any contract.15. This has had the consequence of rendering the remedy limited in its application so that where the insurer is unable to establish a fraudulent intent there is no remedy available other than to vary the sum insured in accordance with s29(4). The IC amendment bill has amended this subsection by deleting the words “a contract” and inserting the words “the contract”. Therefore the insurer will be able to avoid the contract for innocent nondisclosure or misrepresentation if it can show that it would not have entered into the contract. Section 29(3) of the IC Act is now only applicable to contracts with a surrender value and those providing death cover only. Section 28 provides relief for contracts other than those with a surrender value and those which provide death cover only. This section is discussed in detail below. Interestingly, the words “on any terms” were not deleted from section 29(3) and in light of the amendment they would seem not to be required. The application of the remedies for innocent non-disclosure/misrepresentation has been made flexible by the introduction of the ability to ‘unbundle’ contracts which provide multiple cover to the insured. Under the current system, problems have arisen where a retrospective underwriting opinion states that the insurer would have issued some types of cover and not others. Although there has been no case law directly on the issue of bundled policies, His Honour Justice Davis in the decision of Schaffer v Royal & Sun Alliance16 examined section 29(3) of the IC Act in detail. He believed that “the contract” meant “the same contract, the contract in fact entered into, in this case …”. The Financial Industry Complaints Service, now the Financial Ombudsman Service, examined the issue of
See Schaffer v Royal & Sun Alliance (2003) QCA 182 Lawbook Co. Wickens The Law of Life Insurance in Australia, 2008, [p8.1280] 16 (2003) QCA 182 15
bundled policies17. The Financial Ombudsman Service found that if the insurer would have entered into a contract it could not find relief under section 29(3). The Insurer would need to demonstrate that it would not have issued any contract at all had the insured complied with his/her duty of disclosure18. The IC amendment bill introduces a new section 27A to part 1 Schedule 5 (1) which states: “If a contract of life insurance provides 2 or more kinds of insurance cover, this Division applies, in relation to each of those kinds of insurance cover, as if the contract provided only that kind of insurance cover.” The ability to unbundle contracts is a welcomed amendment by insurers. Previously the only remedy that could be applied was be avoid the entire contract, albeit with the requirement to establish fraudulent intent in the non-disclosure/misrepresentation by the insured, this new amendment will allow insurers to maintain one part of the cover whilst having the ability to avoid other part/s of the cover. Section 29(4) of the IC Act currently provides the ability to reduce the sum insured when innocent non-disclosure/misrepresentation has occurred. His Honour McColl JA in Davis v Westpac Life Insurance Ltd19 commented on the history and rationale of section 29(4) of the IC Act. His Honour had regard to the Australian Law Reform Commission Report (ALRC) Number 20 on insurance contracts20. The Report recommended: “That leaves the question of the appropriate method of assessing damages for an innocent misrepresentation or non-disclosure within the contestable period … the choice lies between proportionality and common law damages … Proportionality has already been adopted in the case of mis-statement of age. Its extended application would provide a uniform remedy for innocent misrepresentation and nondisclosure within the contestable period in the whole area of life insurance. Where a misrepresentation or breach of the duty of nondisclosure is discovered within 3 years of the contract being entered into, the insurer should be entitled to reduce the amount payable under the contract in accordance with the principles of proportionality. An exception should be made where the insurer would not have entered into the contract at all. In those cases, the only remedy is avoidance.” Under the current system if the policy is not varied within the 3 years of the inception of the policy and the non-disclosure or misrepresentation is not fraudulent then no further remedy is currently available21. Whilst there is no case law directly examining section 29(4) it can be argued that the words “if the insurer has not avoided the contract” can be interpreted as meaning that 17
See determination number 14395 Schaffer v Royal & Sun Alliance (2003) QCA 182 19  NSWCA 175 20 The Law Reform Commission, Insurance Contracts, Report No. 20, Australian Government Publishing Service, Canberra, 1982. 21 See section 33 of the Insurance Contracts Act 1984 18
the insurer had the right to avoid the contract under s29(2) or s29 (3) but has chosen not to. If the section merely refers to the fact that the insurer has not avoided the contract then the words “if the insurer has not avoided the contract” are, arguably, unnecessary for the working of the section. The Insurance Contracts Regulations 1985 (Cth) shed some light on this issue. In Part 2, the regulations set out the prescribed wording to be used when informing life insured’s of their duty of good faith. The regulations state “An insurer who is entitled to avoid a contract of life insurance may, within 3 years of entering into it, elect not to avoid it but to reduce the sum that you have been insured for in accordance with a formula …”. This would suggest a more narrow interpretation where an insurer who wishes to seek relief under section 29(4) must first be able to establish that it had the right to avoid the contract under section 29(2) or section 29(3). This is somewhat problematic. If an insurer would have been prepared to enter into a different contract, then on its interpretation, section 29(3) would not apply, therefore rendering section 29(4) not applicable. Thus, there is no remedy other than complete avoidance if the insurer is able to prove the insured acted fraudulently in non-disclosing or misrepresenting. In light of the Australian Law Reform Commission Report, Insurance Contracts, Report Number 20 (1982), this is clearly not the intention of the section. The Australian Law Reform Commission (ALRC) argues that the relief should be available under a proportional adjustment of the amount payable under the policy22. This has been addressed by the introduction of s28(1) in the IC amendment bill which allows relief to life insurers under section 28, having previously only been applicable to contracts of general insurance. Section 28(1A) applies to contracts of life insurance where the insured failed to comply with the duty of disclosure or made a misrepresentation. Section 28 provides: “if the insurer is not entitled to avoid the contract or, being entitled to avoid the contract (whether under subsection (223) or otherwise) has not done so, the liability of the insurer in respect of a claim is reduced to the amount that would place the insurer in a position in which the insurer would have been if the failure had not occurred or the misrepresentation had not been made.” Section 28 of the IC amendment bill states that this section applies when “the person who became the insured under the contract” failed to with the duty of disclosure or made a misrepresentation to the insurer. It also states that it does not apply if the insurer would not have entered into the contract “for the same premium and on the same terms and conditions” if the duty of disclosure had been complied with. This requirement is more relaxed than the requirement under the current s29(3) of the IC Act. Under the amendment bill if the insurer can show that it would have charged higher premiums then the remedy under section 28(3) applies. Therefore, if a loading would have applied had the insured made full and frank disclosure then the sum insured would be reduced or higher premiums charged. Similarly, if an exclusion would have been placed on the same part of the body as the one which is the subject of the claim, then the insurer’s liability could be reduced to nil. Section 28(2) allows for the avoidance of the contract on the basis 22
Australian Law Reform Commission Report, Insurance Contracts, Report Number 20, Australian
Government Publishing Service, Canberra, (1982)
Section 28(2) allows the insurer to avoid the contract for fraudulent non-disclosure or misrepresentation.
of fraudulent non-disclosure or misrepresentation. This will possibly result in disputes regarding underwriting opinions and an increased request for copies of similar applications showing the terms under which the contracts were issued. Overall, the IC amendment bill seeks to streamline and clarify the remedies available for insurers when there is a breach of the duty of disclosure or there is a misrepresentation by an insured. Section 21 of the IC Act has been amended, section 29 has been amended and narrowed so that it applies only to contracts that have a surrender value and those that only provide death cover. Section 28 has been expanded to apply to contracts of life insurance as opposed to general insurance contracts only. The amendment bill allows insurers to unbundle contracts where multiple cover was issued so that different remedies can be applied to different types of cover as though they were separate contracts. The changes will have significant impact on the insurers’ claims experience and claims management procedures. The amendments provide a more consistent approach to the remedies available for non-disclosure or misrepresentation and this will allow flexibility in the application for remedies for breaches of the duty of disclosure. It is difficult to predict whether these amendments will fix the problems that have arisen as a result of the current wording of these provisions. It is the writer’s opinion that it will, however, go a long way in untangling the current complexity in the application of the remedies. The amendments will also provide a more consistent and certain environment when dealing with breaches of the duty of disclosure.
1. Australian Law Reform Commission Report, Insurance Contracts, Report Number 20, Australian Government Publishing Service, Canberra, (1982). 2. Australian Prudential Regulation Authority, ‘Quarterly Life Insurance Performance June 2010’, issued September 2010. 3. Carter, J. W. & Harland, D.J., 1996, Contract Law in Australia, Butterworths, Sydney.
4. Cross Assurance Co. Ltd v Australian Provincial Assurance Association Ltd (1939) 39 SR (NSW) 174.
5. Davis v Westpac Life Insurance Ltd  NSWCA 175
6. Explanatory Memorandum, Insurance Contracts Amendment Bill, 2010 (Cth)
7. Financial Ombudsman Service Determination Number 14395
8. Guardian Assurance v Condogianis (1919) 26 CLR 231
9. Insurance Contracts Act 1984 (Cth)
10. Insurance Contracts Amendment Bill 2010 (Cth)
11. Insurance Contracts Regulations 1985 (Cth)
12. Insurance Contracts Act – Recent Developments and Proposals for Change’, paper presented at the Australian Insurance Law Association National Conference, Sydney, November 2006.
13. Joel v Law Union & Crown Insurance Company  2 KB 863
14. Lawbook Co. Wickens The Law of Life Insurance in Australia, 2008, [p8.1280]
15. Mayne Nickless v Pegler  1 NSWLR 228 16. Marine Insurance Act 1909 s24(2) 17. Schaffer v Royal & Sun Alliance (2003) QCA 182