Contracts of insurance attract a unique set of principles of interpretation, and are subject to a comprehensive regulatory regime.
Characterising a contract as one of insurance has significant consequences. Among other things, the contract will be subject to a comprehensive regulatory regime, its operation and effect may be altered by legislation such as the Insurance Contracts Act 1984 (Cth), the insurer under the contract must be authorised to enter into it and, in the event of a dispute over the terms of the contract, it will be interpreted in accordance with a set of principles which may not apply to other contracts.
Despite these consequences, the difference between a contract of insurance and other contracts of indemnity is not always apparent on the face of the document itself. Sometimes you need to consider the circumstances in which the contract is formed. Even then, there may still be some uncertainty as to the proper characterisation of the contract.
In Todd v Alterra at Lloyds Ltd (on behalf of the underwriting members of Syndicate 1400)  FCAFC 15, the Full Court of the Federal Court of Australia considered these issues in the context of an insurer arguing that, in the case of any doubt as to the proper construction of an insuring clause of a policy of indemnity insurance, the doubt should be resolved in favour of the insurers. This principle was said to rest on various High Court authorities in the context of contracts of indemnity. The insurer argued that it similarly ought to apply to a contract of indemnity insurance.
The Court held that the principle did not apply to contracts of insurance. In doing so, the Court restated some of the factors which help to distinguish contracts of insurance from similar types of contracts. They also made clear the reasons why contracts of insurance attract a unique set of principles of interpretation.
What is a contract of insurance?
Many contracts of insurance are, in essence, promises by the insurer to indemnify the insured against specified types of loss, damage or liability. Similarly, many commercial contracts will include a promise by one party to indemnify the other against specified types of loss, damage or liability. What distinguishes a contract of insurance from others is a combination of factors. The relevance and weight to be given to each factor depends upon the nature of the contract and the particular circumstances in which it is entered.
The starting point in characterising a contract of insurance is typically the century-old definition given by Justice Channell in Prudential Insurance Company v Commissioners of Inland Revenue  2 KB 658 at 663-664. That definition requires that for monetary consideration (the premium), a person (the insurer) agrees to pay to the other (the insured) a sum of money or some benefit upon the occurrence of one or more specified events. As a general rule, there are very few contracts of insurance that fall outside of that definition. However, that definition also captures a number of other types of contracts which are not properly characterised as insurance.
In Todd, Chief Justice Allsop and Justice Gleeson said that it is then necessary to elaborate upon each of the elements in this definition, being the premium, promise to pay, sum of money or other benefit, upon a specified event. However, this should not be done by way of further definition. It should be done by reference to the purpose and character of the arrangement to share the risk of, or spread the loss from, unhoped-for, but possible, contingencies that may or may not happen. This inquiry helps distinguish between:
- a contract of guarantee or an indemnity, each of which has the object or purpose of making good the financial position of a creditor of someone other than the guarantor or indemnifier; and
- a contract of insurance, which has the object or purpose of sharing the risk of, or spreading loss from, a contingency.
Matters relevant to the characterisation of a contract of insurance will include:
- how the contract came to be effected;
- the nature of the contract; and
- how the contract is to be performed.
Insurers are in the business of providing indemnities – they provide indemnities for reward, calculated in part by reference to the risk assessment of whether the relevant contingent event will occur. An indemnity which is provided in exchange for a fee that is commensurate with the risk of the indemnity is more likely to be characterised as insurance. This is even more so if the indemnifier is in the business of providing such indemnities.
Different factors become relevant when characterising contracts of insurance in different circumstances. For instance, in distinguishing a contract of insurance from a warranty given in connection with goods or services, the extent to which the indemnifier has control over whether or not a contingency may eventuate is more likely to be a relevant factor. On the other hand, in distinguishing a contract of insurance from an investment annuity, the extent to which payments will continue to be made regardless of any contingency is more likely to be a relevant factor. The factors to take into account in characterising a contract as insurance will largely depend upon the particular circumstances in which the contract is made.
Why is it important to correctly identify a contract of insurance?
The most important reason to identify correctly when you are entering into or dealing with a contract of insurance is the regulatory consequences that follow. Carrying on insurance business in Australia without the required authorisations can expose an organisation to significant penalties and reputational damage.
The risk of inadvertently carrying on insurance business frequently arises in connection with contracts which closely resemble contracts of insurance, eg. certain extended warranty products. Reducing this risk requires that careful consideration be given to the regulatory regime that applies to contracts of insurance in both the preparation of documents and the sales process.
In the Todd case, there was a different reason why the distinction was important.
The principles to apply in the interpretation and construction of a contract of insurance are well known. The decision in Todd highlighted the fact that those principles are not always the same as other types of contracts.
In Todd, Chief Justice Allsop and Justice Gleeson stated that the rule of strict construction applies to contracts of suretyship by which one person (the surety) agrees to answer for some liability of another to a third person. The key distinction when compared to insurance is that the rule applies to uncompensated (but not compensated) sureties. The position of an insurer in the business of providing indemnities for reward is vastly different to an uncompensated surety. Accordingly, the principle has no application to a contract of insurance, even if that contract includes an indemnity from the insurer.
The effect is that, where there is any doubt as to the proper construction of an insuring clause of a policy of indemnity insurance, that doubt will not always be resolved in favour of the insurer.