In a ruling of 15 May 2015 the Supreme Court ruled inadmissible the application of the principle of proportion in general terms and conditions of insurance contracts, if it is understood as giving the insurance company a right to limit the amount paid out by the policy whenever the value of the insurance is lower than the replacement value of the subject matter of the insurance (i.e. when there is underinsurance). In particular, this pertains to a situation where property is insured below its value already from the moment of entering into an insurance contract.
This judgment is yet another Supreme Court ruling where the application of the principle of proportion is declared inadmissible in a particular case. The case law is moving in the direction of the Insurance Ombudsman’s long-held interpretation of the rules governing insurance contracts that recognises the principle of proportion to be unlawful. If this adjudication trend continues, it may lead to the necessity to eliminate the principle of proportion from general terms and conditions of insurance, which in turn may result in increases in insurance premiums.
Applying the principle of proportion in the general terms and conditions of an insurance contract is a widespread on the insurance market. In the case at hand it meant that, if it is determined that the subject matter of the insurance is underinsured on the day a loss occurs, the liability of the insurer is reduced pro rata by the percentage by which the replacement value of the subject matter of the insurance exceeds the sum insured.
The Supreme Court ruling concerned a case where claimants sought loss payment for a loss resulting from a fire in buildings. When the insurance contract was concluded the property it covered was underinsured by more than 43% of its replacement value. The GTCs included the possibility of reducing each indemnity to be paid out, by applying the principle of proportion (subject to average), if the property was found to be underinsured on the date the loss occurred.
The Supreme Court ruled that it is unacceptable to apply the principle of proportion in a situation where there was underinsurance at the time a contract was concluded, especially in a situation where the value of the loss is higher than the sum insured under the contract. This is because, despite the sum insured determined in the contract being an amount resulting in underinsurance, this would lead to the indemnity never reaching the level of the sum insured, which in turn is the basis for calculating the amount of the insurance premium. The Supreme Court emphasised that provisions of the Civil Code grant parties the right to determine the sum insured at a level lower than the replacement value (i.e. allows underinsurance). Thus, it rejected the Court of Appeal’s position that a policyholder’s duty was to identify the replacement value of the subject of insurance and adjust the sum insured to this value.
The Supreme Court based its conclusion on the Insurance Activities Act, which provides that ambiguously formulated provisions of GTCs and insurance contracts be interpreted in favour of the policyholder or the insured, and stated that in the present case the provision of the GTCs that provided for the principle of proportion was ambiguous.
The Supreme Court also reiterated a view it had presented previously, according to which providing in the GTCs the possibility for the insurer to verify the sum insured against the replacement value of the insured property only at the stage of loss adjustment proceedings is contrary to the principle of legal equality between parties to an insurance contract and violates the principle of fair trading.