Rebecca Sellers says it is past time to change our laws with regard to duty of disclosure to insurers, something our Law Commission recommended in 1996

Rebecca Sellers says it is past time to change our laws with regard to duty of disclosure to insurers, something our Law Commission recommended in 1996

By Rebecca Sellers*

The Government is considering making changes to insurance law that will affect every New Zealander. Our lives are buoyed up by insurance. Warranty and indemnity insurance enables merger and acquisition activity; every building that is built, every container that leaves New Zealand’s shores is kept afloat by an invisible web of insurance. Our lives are held together by that invisible web: the car you drive; your child on the sports field; your home; your teeth; your pet. 

Insurance is an unusual bargain. It should be as light as gossamer until you need it and have a strong flexible embrace when you fall. No customer wants to spend lots of money on insurance – you hope you will never need it. And no customer wants to spend lots of time providing information when insurance is arranged. 

The bargain is unusual for both parties. Insurers know nothing of your life. They risk their shareholder’s money based on trust. In a curious twist of the invisible web, as well as being insured, you may be the shareholder of an insurance company through your KiwiSaver. All of us are effectively shareholders in the EQC and ACC. So, all of us have an interest is making sure the bargain is as effective as it can be.

Insurance companies may no longer have mutual ownership, but there is still an element of mutuality in insurance. Most insurance policies are never claimed on and so the web of insurance will remain invisible. The money you pay in premiums will be used to pay the claims of other policyholders. Each of us as customers depend on insurance companies to charge the right price and to accept the right level of risk. It is in all our interests that insurers only pay valid claims and run their businesses efficiently. If they do not, there is a risk that the web of insurance will not be there to catch us when we fall. Most insurers are covered by reinsurance which will only allow the payment valid claims. The law should offer certainty, but insurance law is ripe for reform. The customer’s duty of disclosure has not changed since Captain James Cook first came to New Zealand.

What the customer must disclose is not certain

In the 18th Century in Mr Lloyd’s coffee house in London, merchants shared the risks of a voyage. The ship’s owner would pay a premium to the other merchants. If the ship was lost, the merchants would share the loss: this is the essence of the insurance bargain.

Three years before Captain Cook sought to observe the transit of Mercury off the Coromandel, the English Courts decided that an insurance customer is under a general duty to disclose all information material to assessment of the risk:  “..the underwriter knows nothing and the man who comes to him to ask him to insure knows everything”.1 The ship owner had the best information about his ship – so the other merchants were entirely dependent on the ship owner to disclose material information, such as the state of the vessel, the drunkenness of the crew or whether the French planned to attack the ship’s destination. 

New Zealand remains one of the last Commonwealth jurisdictions to impose that unrestricted duty of disclosure developed in the 1700s. As a consumer, you are under a duty to disclose all material facts which are or ought to be known by you and which are material to the formation of the insurance contract. A fact is material if it would influence the judgment of a prudent insurer in determining whether to accept the risk or set the premium. 

The law of 1700s England is our current law. But modern business has moved on from Mr Lloyd’s coffee house. Now most insurance cover is commoditised. When a family or small business applies for an insurance policy, in most circumstances there is little active underwriting of the risk. It costs time and resources for an underwriter to consider information, so lack of active underwriting means everyone gets cheaper insurance. This utilitarian approach suits most people as price is a critical factor in buying insurance.

Insurance is often sold at the same time as another product, such as a flight. The sales process usually emphasises how quick and easy it is to get insurance. But this is the moment when the consumer should consider the law of 1700s England. Before clicking “Yes” to the insurance option, the consumer must consider the notional prudent insurer. As the Law Commission identified: “How can the ordinary consumer be expected to know what circumstances would influence the judgement of a prudent insurer?”2.  The insurer may ask the customer specific questions in the proposal form, but the customer is not excused from providing any other information that could be material to a prudent insurer – even if that information is outside the scope of the questions. Ignorance of the law is no excuse, even if the insurer did not warn the consumer about the duty of disclosure. 

Australia effectively abolished the duty of disclosure for consumers in 1984. Australian consumers are only required to disclose answers to express questions. The consumer’s answers must provide material information. But what is “material” will be assessed by reference to a reasonable customer – not a prudent underwriter.  In 2013, the UK abolished the duty of disclosure for consumers. Both jurisdictions have retained disclosure for businesses, but since 2016 in the UK in substantially modified form.

Disproportionately harsh results

The remedy for non-disclosure in New Zealand is that the insurer can decide to void the insurance. It will be as if the insurance never existed. No claims will be covered and the subject matter will be uninsured. The insurer must repay the premium unless fraud is established. This is a draconian remedy. The New Zealand Courts have described the law as leading to “uncertainty and injustice’. 3  The impact is permanent. The unfortunate customer is cursed with the metaphorical “black spot” of bad honour. Every new insurer will ask if a claim has ever been declined or policy cancelled or avoided: it may be impossible to obtain any insurance cover, or cover may only be available on unfavourable terms.

In Australia, an insurer can only avoid the insurance contract where there has been fraud. The general remedy is that the insurer is entitled to be put in the position they would have been in had full disclosure been made. This may mean that the policy is amended or no benefit is payable, but the customer is not left as a pariah with no cover. A UK insurer can avoid a consumer policy only where the consumer has failed to act honestly in making statements to the insurer, and a business policy can be avoided only where there is fraud or where the insurer can show that, had the truth been told, it would not have insured at any price.

How will NZ law change?

The remedies for non-disclosure and misrepresentation need to be updated and the mismatched legislative reforms of the 1970s should be streamlined. There are strong arguments in favour of adopting the UK reforms and abolishing the duty of disclosure for consumers of commoditised insurance products. Insurance law is out of step with other aspects of financial services law. Previous proposals for reform in New Zealand were relatively timid, but those proposals have been overtaken by time and technology.

The insurance industry is going through a process of radical change. Development of peer-to-peer, usage based, and on demand insurance are challenging current insurance models. Insurers are looking at digital methods of distribution and it is likely that insurance will become further embedded in other services or products. Later this month the Financial Markets Authority will be consulting on possible exemption relief to facilitate personalised robo-advice services. 

It is timely for the Government to examine New Zealand’s insurance laws to ensure that the bargain between consumers and insurers is as effective as it can be and is suitable for InsurTech offerings. There is a vital need for New Zealand to move on from an outmoded legal model for this most pervasive and important of financial instruments. Quite clearly, we are no longer in the 1700s.

[1] Carter v Boehm (1766), Rozanes v Bowen(1928)

[2] “Some Insurance Law Problems”, New Zealand Law Commission, 1998

[3] State Insurance v McHale [1992] 2 NZLR 339

Rebecca Sellers is director of Melior Law & Regulation and a contributing editor of Colinvaux’s Law of Insurance in New Zealand. 

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Excellent points. Certainty is long overdue and must reduce costs in the long run. It might even elevate insurers back to somewhere just below car sales people (that might be too much to hope for).

This is part of the researched article:
The unfortunate customer is cursed with the metaphorical “black spot” of bad honour. Every new insurer will ask if a claim has ever been declined or policy cancelled or avoided: it may be impossible to obtain any insurance cover, or cover may only be available on unfavourable terms."
So, two points:
1. What policies now do not ask for claims and policy declinatures? I thought most did. OK, but
2. The answer is quite simple. Open up the specific covers so that a material fact is given a wider definition, as the author suggests, than is written into the legislation now. Simply cover the increased, if any, claims burden on the insurers by waiting for the overall claims cost to rise to a level where higher premiums are essential if normal and equitable profitability is to be maintained. It, the increased claims burden, is spread across all insureds not only the dishonest ones, those with poor memories, or those who don't know or cannot guess what facts the prudent underwriter should take into account.

@bruce. So you'd be happy to pay higher premiums to subsidise the activities of the minority who intentionally deceive insurers with false information and achieves for them cover at a lower price than their risk profile justifies?

What's the difference?The insurers already build the fraud factor into their premiums overall. As you say it is anyway a minority. The insurers are well and truly versed and geared to detect and combat fraud, far more so than the average claimant has the capability to confront deception from the other side. And without any wish to generalise, you would have no difficulty in rounding up a couple of thousand EQ claimants in Canterbury, with genuine claims, who have nevertheless been treated as if they too were fraudsters, by their insurer. So whether we like it or not the good and the bad are all in the same bucket and it all comes out in the same wash.

Yes, general premium rates include the cost of non disclosure and undetected fraud. But if the ability of insurers to decline fraudulent claims is reduced, premiums will rise. Which is the point I made to bruce.

Non disclosure has not been an issue in the CHCH earthquakes. And I'm not aware of any insurers who regard claimants who disputed their settlements as being fraudsters.

You may not be, but I am.

Tiny number. A few prosecutions, mainly EQC.

Effective fraud was widespread ....... of course it wasn't cracked before ....... insurers mostly smiled and nodded.

Somewhat naive one would think. Recent comments on this website do not dispute that, with concern to insurers available, there is a duopoly in play in NZ which is likely to become larger when the Tower situation finally plays out. Therefore the market is completely at their disposal. SImple case of extracting what the market can afford to pay or more accurately what the market can be made to pay. Who exactly is going to stop that. That is a much easier calculation and satisfying process than having to work up, and abide by, a genuine model for formulating premiums.

No, but that is certainly what will happen eventually if the suggested changes cause claims figures to rise, as they surely will, even if it may take time for the insurance companies to realise they are paying some claims where they have been deceived

Here is an extremely well presented case detailing the urgent need for reform. There is the history over the last seven years of the Canterbury earthquakes that reveals deceptive, even unlawful, practices by the insurance industry, supported by, or in support of EQC, that should not be possible in a country with a democratically elected government. Here is a government that provides a government department that can use the laws put in place for protection of its citizens, to instead,persecute them. Here is a government that is self styled as "Corporate New Zealand " and just like minority shareholders, we as tax payers count for little. Here is a government that obviously intends to do nothing as they see that there is nothing wrong. There is the proof of that in the column of Jenee Tibshraeny last 24 May. Here is an appallingly weak parliamentary opposition that fails to hold the government to account and lets all of us down just as much.

Great article. As a former lawyer myself I wonder if my own "that's the way it is" inertia is part of the problem, if a similar 'status quo inertia' is common among policymakers and others. I vaguely knew it was unfair, but I've also never experienced the sharp end of paying premiums for years thinking I'm covered then to be declined for something that reasonable people would never have thought about and which the insurer never asked about. And even when it happens to thousands of people, they're all individuals. It wreaks their lives unfairly but fails to get through the collective consciousness. And insurers then leaven the discussion with a few examples of people actually misleading them, and any public interest spike wanes as we collectively conflate them and the real issue drifts away again.

This article did it for me. It would be too much to hope that policymakers might proactively do likewise. Insurers certainly won't say anything. They have all the power, and this is one area where the average, reasonable consumer has none. Consumer groups, perhaps?

Insurance Lawyers have a vested interest in presenting this issue as a significant one and will imply it impacts on large numbers of people but the IFSO recently indicated only around 10% of the comparatively low numbers of complaints it receives, are related to non disclosure. How many of these were not able to be resolved with insurers, is unknown.

Some reform is needed but implying that if we adopt the UK or Aussie system there will be fewer uninsured 'pariahs', is misleading. The tighter screening process will identify more higher risk proposers at the front end and will likely increase the number who cannot secure insurance, compared with now. It is costly for Insurers to research borderline applications so erring on the side of caution becomes the default response.

Ms Sellers also omits to touch on the significantly more demanding disclosure process and voluminous supporting documentation that anyone taking out insurance in Australia will be familiar with.

The penny drops when you realise the true underlying fundamental of insurance. As with all things mercantile one offers a product or service to entice customers to give you money. You supply that at a reduced cost to yourself and retain the margin. But while you have the money and have not yet paid for the stock you can do with it what you wish. Insurance is not to protect the customer, it is to make money. If it were not so it would not exist. Insurance companies are in the business of attracting funds to invest elsewhere for gain while paying out what minimum is required to placate the policyholders. They use the term "self insured" for those who do not join in, you could do this yourself by putting aside a "premium" investing it and covering any of your own losses from that fund. The only benefit they provide is volume from the beginning.