The insurance industry has, in recent years, been a key focus of attention for the English and Scottish Law Commissions (the “Law Commissions”). As a result, a number of “issues papers” have been produced with the aim of clarifying and, in some instances, proposing reforms to the existing insurance law.
One example of the latter relates to the imposition on an insured party of a continuing duty of good faith after a contract has been executed, in particular, a duty to act honestly when making a claim under the contract. The scope of the duty continues to be the subject of debate amongst judges and others — hence, the drive for reform.
Since the cost of insurance fraud has recently been estimated at £5.2 million per day in the UK1, and this adds around £44 per year to the insurance costs of every UK household, this is a key issue both for insurers and insureds.
It has been suggested by some commentators that there is a moral ambivalence about insurance fraud, and that many people who would consider themselves to be honest would not, for instance, consider that “exaggerating” an insurance claim is fraudulent. This may partly be the result of the fact that most insurance fraud takes place on a relatively small scale, so although it is a criminal offence, it is not seen as a priority for police attention and is therefore rarely met with criminal sanctions. The Law Commissions’ report acknowledges this fact and seeks instead to improve the civil law position, so that insurers might have a clearer legal framework to deal with potentially fraudulent claims.
What is “fraud” in this context?
In a well-known 19th century case2, fraud was described as follows: “Fraud is proved when it is shown that a false representation has been made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false”.
In their July 2010 “Issues Paper 7” on the subject of “The Insured’s Post-Contract Duty of Good Faith”, the Law Commissions identified six possible categories of fraudulent claims: (1) where there is, in fact, no loss, (2) where the loss is deliberately caused by the insured, who then represents falsely that the loss was caused by an insured event, (3) where the claim includes elements of genuine loss as well as false items, (4) where the loss is genuine but its value is exaggerated, (5) where the claim is presented in such a way as to disguise the fact that the insurer might have a defence to the claim, and (6) where fraudulent means are used to improve the prospects of recovery for an otherwise genuine claim. These categories are not, of course, mutually exclusive.
As to the meaning of “fraud”, the Law Commissions adopted the definition suggested by Professor Malcolm Clarke, namely that fraud must be “substantial, wilful and material”. “Substantial” for these purposes means anything other than de minimis claim values.
The current legal position
It is possible for parties to extend in their contract the usual statutory and common law remedies available for fraud. Many insurance contracts, for instance, contain an express term prohibiting fraudulent claims and setting out the consequences of making one. Usually, the consequences are that the insured forfeits all benefits under the contract.
If there is no express term, however, the law appears less clear as to the remedies available to the insurer.
As set out in section 17 of the Marine Insurance Act 1906, insurance contracts are contracts of utmost good faith. In principle, if an insured acts dishonestly in making a claim and is deemed therefore to have breached the duty of utmost good faith, the insurer should be entitled to avoid the contract in its entirety. The English (and Scottish) courts have tended to shy away from this logic, however, in particular given the “disproportionate” impact on earlier, valid claims. Although confusion remains in the recent case law, the stronger view (based on Court of Appeal authority) appears to be that (1) if any part of a claim is fraudulent, no element of that claim is recoverable but (2) the contract itself remains in place and (3) any previous claims made in good faith are not affected.
In the most recent case relevant to these issues3, concerning a subsidence claim under a buildings insurance cover, the Judge found that the policyholder had acted fraudulently in seeking to claim the cost of renting alternative accommodation that (unknown to the insurer) he in fact owned and was vacant. As a consequence, the whole claim was forfeited, including genuine items relating to the cost of repair to the subsiding property. One of the stated objectives of the Law Commissions, understandably, is to seek a uniform position on the impact (if any) of section 17 of the Marine Insurance Act 1906 in the context of such fraudulent claims.
The proposed reforms
The Law Commissions propose, as a general matter, that commercial law in the UK should be coherent, principled and fair in order to be justifiable to an international audience.
As a consequence, the Law Commissions’ view is that legislation is required to clarify the position and, as appropriate, to amend section 17 of the Marine Insurance Act 1906. They consider that not only would this reduce the number of disputes, but, if the rules and potential penalties for making fraudulent claims were made clearer, this should act as a more effective deterrent in the future.
The Law Commissions’ tentative conclusions in their Issues Paper are that:
- forfeiture of the fraudulent claim is the correct remedy,
- previous honest claims should not be affected,
- while a fraudulent claim should give the insurer the right to terminate the contract, this should not prejudice a valid claim arising between the fraud and termination, and
- an insurer should, in principle, be able to recover the reasonable costs of investigating a fraudulent claim from the insured.
The Law Commissions recognise, however, the added complexities arising in the context of, for instance, co-insurance.
If the policy is expressed or deemed to be a joint (as opposed to “composite”) cover, the parties’ rights are inseparable. If a co-insured is found to have acted fraudulently, an honest co-insured is equally unable to recover in relation to any claim they put forward. To deal with this, the Law Commissions propose that there is a rebuttable presumption that any fraud committed by one co-insured is done on behalf of all parties, i.e., only if the honest insured can demonstrate that he was not party to the fraud, can he recover his loss.
The Law Commissions also reviewed the impact of proposed reforms on group insurance, for example, where an employer takes out a long-term policy for the benefit of all employees. If the employer, as policyholder, makes a fraudulent claim, then the usual remedies for fraudulent claims would apply; but individual employees are not policyholders and are not, in principle, subject to the same penalties. The Law Commissions propose that each group member should be treated as a party to the contract, so that a fraudulent claim can be dismissed.
The Law Commissions additionally considered the separate issue of whether insureds have a continuing duty to report changes which may increase the risk of loss. In Continental European insurance policies, which usually have a period of cover lasting several years, an insurer may refuse payment of a claim where the loss was caused by a change in the risk which was not reported. In the UK, where policies are more commonly written on an annual basis, absent an express term in the policy, there is no ongoing duty to report and, where there is an express term in the policy, courts have tended to interpret this restrictively.
The Law Commissions addressed a series of questions seeking responses from interested parties on a range of related issues, including the above points.
Responses to the consultation exercise
By October 2010, the Law Commissions had received 33 responses, including from the Association of British Insurers, the Bar Council, the British Insurance Law Association, the Financial Services Authority, the Lloyd’s Market Association and significant company market players, as well as academics. The vast majority agreed that the law in this area is unnecessarily complex and that it would be helpful to introduce legislation to clarify once and for all the remedies for fraudulent claims.
As to their responses:
- All but three respondees agreed that, even in the absence of an express term, insureds should be under a duty not to make a fraudulent claim and that this should be set out in statute with the remedy specified.
- Further, all but one respondee agreed that forfeiture of the tainted claim was the appropriate remedy, although it was suggested by two respondees that the courts should be able to retain some discretion in this regard.
- A majority additionally agreed that a fraudulent claim should not affect previous valid claims, although a minority took the view that there was “value” in retaining avoidance as a potential remedy in “extreme” cases.
- In relation to future claims, many respondees considered that fraud “undermined the necessary trust between the parties” and that the contract should be terminated.
- Generally, there was strong support for the proposal that an insurer should be able to recover the reasonable costs of investigating a fraudulent claim from a fraudulent insured, and it was noted that such sums can be significant. It was also considered that even if pursuing an insured for such costs would be rare and impractical, the possibility of recovering them would further emphasise the potential downside of any fraud and would act as an additional deterrent.
- Most of the respondees supported the proposals concerning joint insurance, although many recognised potential practical difficulties of proof for honest insureds.
- Turning to group insurance, all but one respondee agreed that an insurer should have the same remedies against any group member as it would ordinarily have against the actual policyholder in the event of a fraudulent claim, although there was uncertainty as to how this would operate in practice.
- On the scope of the ongoing duty to disclose “material” changes in the risk, most respondees considered that clauses dealing with this should be interpreted restrictively. Equally, most did not consider it necessary to adopt the Continental European approach.
- Finally, in relation to the question of the application of a general duty of good faith, 68% of respondees thought that the duty should apply both before and after inception of the cover in the absence of express terms dealing with it, on the basis that disclosure is a unique feature of insurance contracts and “a fluid duty of good faith was appropriate to ensure adequate protection”. There was some strenuous opposition to this, however, from those respondees who consider that it is outdated and that as it does not apply to other commercial contracts, it should have no place in insurance contracts (or at least absent any express term).
Following the Issues Paper and the responses, the Law Commissions are developing further their proposals on fraudulent claims, and intend to publish a joint Consultation Paper during 2011. So while reform of this area of law seems likely, it will still take some time for the law to be clarified fully. Watch this space!