Written by Riley Gay and Tiah Mepani
An insurer’s position on a claim can be compromised by a policyholder’s acts or omissions before and after a general insurance policy has been entered.
The insurance contract may set out what an insurer can do in the event of a breach of the insurance contract or a pre-contractual non-disclosure, such as refuse to pay a claim. However, the Insurance Contracts Act 1984 (Cth) (the Act) limits the options available to insurers in these circumstances.
Here we discuss what those limits are and how insurers can navigate them.
Pre-Contractual Acts or Omissions
An insured has a duty of disclosure before entering a general insurance contract and on each occasion it is renewed, extended or varied.
Section 21A of the Act relates to new business insurance for eligible contracts such as motor and home policies. An insurer will be regarded as having waived compliance with the duty of disclosure unless the questions in the insurance proposal conform with the requirements of s.21A, including asking specific questions relevant to its decision whether to accept the risk and if so, on what terms. Particular attention should be paid to following up any unanswered questions.
Section 21 of the Act applies to insurance contracts other than those covered by s.21A and requires broader disclosure from an insured. The disclosure required relates to every matter known to the insured relevant to the insurer’s decision to accept the risk and what a reasonable person in the circumstances could be expected to know.
Section 22 requires the insurer to give written notice to the insured of the duty of disclosure, before the contract is entered.
Remedies under the Act
Section 28(1) of the Act provides that an insurer has no remedy for an insured’s pre-contractual non-disclosure if it would have entered the contract on the same terms if the non-disclosure had not been made.
Section 28(2) provides that if the insured made a fraudulent non-disclosure or misrepresentation, the insurer may avoid the contract. This article does not intend to touch on fraud.
Section 28(3) of the Act provides that, where there has been a misrepresentation or non-disclosure with respect to an insurance contract, an insurer is entitled to reduce their liability to the amount that would place them in the position they would have been in had the failure not occurred.
If the insured failed to disclose relevant information prior to entering the policy, and the insurer would not have entered the contract if the disclosure had been made, under s.28(3) the insurer is entitled to reduce their liability to nil. Alternatively, if the insurer would have charged a higher premium or imposed some other condition on the policy if the disclosure had been made, then the insurer’s liability to pay the claim is reduced by that amount.
If an insurer wishes to rely on s.28(3), it will need to clearly refer to underwriting guidelines or evidence which demonstrate what it would have done differently if proper disclosure was made by the insured before entering the policy. For example, guidelines which require the underwriter to refuse cover if the prospective insured discloses past criminal offences.
Breach of the Policy
Acts and omissions by the insured during the policy period can also prejudice an insurer’s position. For example, failing to inform an insurer of an alteration of the use of an insured property.
Many insurance policies contain conditions that if the insured does or omits to do something after a policy has commenced, the insurer is entitled to reduce or refuse to pay a claim. However, section 54 of the Act limits insurers’ rights in this regard.
Instead, the insurer is entitled to reduce its liability by the amount that fairly represents the extent to which the insurer’s interests were prejudiced because of the act or omission. The extent of the prejudice is determined by reference to the actual financial damage which the insurer has suffered.
The onus is on the insurer to prove that the act or omission prejudiced its interests and to prove the financial damage it suffered as a result.
However, section 54(2) provides that an insurer is entitled to refuse to pay the claim where the act caused or contributed to the loss which the insurance contract covers. For example, where an insured’s vehicle is damaged by the insured colliding with another vehicle while the brakes were faulty, the insurer may refuse to pay the claim if:
- the insurance contract requires the vehicle to be in a roadworthy condition; and
- the faulty brakes caused or contributed to the damage.
Section 54(3) provides that where the insured proves that no part of the loss that gave rise to the claim was caused by the act, the insurer may not refuse to pay the claim by reason only of the act. Expanding on the previous example, the collision was the other party’s fault and the faulty brakes had nothing to do with the cause of the collision.
Importantly, section 54 does not apply to circumstances where the insurer can rely on an exclusion in the policy. The insurer bears the onus of proving that it can rely on the exclusion.
Section 54 provides a clear path for insurers to reduce their liability for claims where the insured has breached the terms of the policy. However, caution should be exercised when determining what prejudice has been suffered and what steps the insurer is entitled to take.
Summary
Where there has been a breach of the policy or failure to disclose relevant information, an insurer can only completely reduce their liability in narrow circumstances:
- in the case of pre-contractual non-disclosure, where the insurer can prove it would not have entered the contract if the relevant disclosure was made;
- in the case of a breach of policy after it commenced, where the insured’s act or omission caused or contributed to the loss covered and where the insurer can prove its interests have been prejudiced to the full extent.
Prior to entering the contract, it is important that general insurers provide written notice to the insured of the duty of disclosure and ask questions relevant to the risk to protect their position.
When considering its options regarding a breach of the policy, it is important for an insurer to consider how their interests have been prejudiced and what loss the breach caused.
Should you wish to discuss any of the above, please contact Riley Gay on 03 9947 4514 or one of the Ligeti Partners team members on 03 9947 4500.
