The English and Scottish Law Commissions are currently engaged in a wide ranging review of the law applicable to consumer and commercial insurance contracts. Since September 2006 they have published a series of Issues Papers and a Consultation Paper setting out their proposals for reform to the law of misrepresentation, non-disclosure, warranties and agency in the context of pre-contract information. January 2008 saw the publication of the Commissions’ fourth Issues Paper, outlining their preliminary thoughts on reforming the law of insurable interest.
What is insurable interest?
The law states that in order for an insurance policy to be valid, the policyholder must have a sufficient interest in the subject matter of the insurance. Broadly speaking, the doctrine requires that a policyholder must gain a benefit from the preservation of the subjectmatter of the insurance or suffer a disadvantage should it be lost.
The rationale for reform
It is widely acknowledged that the law on insurable interest is complex. The law is governed by different statutes depending on the subject matter of the insurance. There is no single rule on whether an interest is required and, if it is, whether it is required when the policy is taken out or when the loss is suffered. Equally, the rules on what constitutes a valid insurable interest vary according to the subject matter of the insurance. The Commissions think there is a real need for clarity in the law. As the law treats them differently, the Issues Paper deals separately with indemnity and non-indemnity insurance.
Indemnity insurance: problems with the current law
Indemnity insurance (encompassing most forms of property, goods and liability insurance) indemnifies the policyholder for losses suffered. Such policies are governed by the common law indemnity principle, which is a contractual requirement that the insured must have suffered a loss in order to recover under the policy. The policyholder therefore requires an interest in the subjectmatter of the insurance in order to have a valid claim.
The indemnity principle takes effect as an implied or actual contractual term. It determines whether the insured has suffered an actual loss and can be compensated. Where the indemnity principle takes effect as an implied term, the law applicable to the property concerned will decide whether the policyholder has suffered a loss on its destruction. Where it is expressed as an actual contractual term the partiesmay have more flexibility. However, it is unclear where the boundary of the indemnity principle lies. Where a policyholder has suffered a loss as a result of a defined event happening to the insured property, he can make a claim under that contract of insurance. However, it is open to debate whether the indemnity principle can stretch to compensate the policyholder for loss as defined under the contract, which may not be a legal/equitable or pecuniary loss.
In addition to the indemnity principle, it used to be the case that statute required the insured to have an insurable interest in the subjectmatter. However, the position changed when the Gambling Act 2005 came into force on 1 September 2007.
Prior to 1 September 2007, section 18 of the Gaming Act 1845, which stated that wagering contracts were null and void, would have applied to insurance on goods. As a wager is a contract in which neither party is able to show an interest in the subject matter, this meant that in order for an insurance contract to be enforceable, an insurable interest in the subjectmatter had to be demonstrated. However, section 335 of the Gambling Act 2005 provides that a gambling contract can be enforced. The result appears to be that policyholders no longer need to show an insurable interest at any stage. The abolition of this requirement appears to have come about by accident! The effect of repealing section 18 of the Gaming Act 1845 on the requirement for insurable interest was not discussed in the White or Green Papers or by Parliament when the Gambling Act 2005 was passed. As a result, the situation is confused and requires clarification.
Non-indemnity insurance: problemswith the current law
Non-indemnity insurance pays a set amount on the occurrence of a trigger event. Most nonindemnity policies are life, critical illness and personal accident policies and are governed by statute requiring an insurable interest. The indemnity principle does not apply to these policies as payment is not connected to the loss suffered. Case law has established various types of insurable interest, including interests arising out of natural affection and out of a pecuniary interest recognised by law.
The Issues Paper highlights a number of problems with the law as it currently stands. Firstly, it is difficult to analyse. Whilst lack of insurable interest renders the contract of insurance null, void and illegal, the courts lean in favour of an insurable interest if possible. This leads to confused law. Following the case of Feasey v Sun Life Assurance Co of Canada  AC 619 it is unclear whether and in what circumstances it is possible to dispense with the requirement of a pecuniary interest recognised by law.
A further problem is that the boundary between non-indemnity and indemnity insurance has been blurred. The Court of Appeal held in Feasey that a policy which was expressed to be on a specific subject matter, such as a life or property, was capable of being construed as “extending to the assured’s liability” in relation to that life or property. If thiswere to apply to all insurance contracts, it raises the possibility that insurers could be held liable for liability losses when they have only calculated for life/ personal accident losses. Alternatively, the case could encourage insurers or brokers to sell the wrong policies, telling insureds that their pure life or personal accident policies would extend to cover a liability loss.
Finally, for life insurance the rules appear overly restrictive. For example, cohabitants and other family members may find it difficult to obtain insurance on each others’ lives as they fall outside the sphere of ‘natural affection’. Some of the problems can be solved using assignment, but the Commissions’ view is that this adds an unnecessary level of complexity. Other problems include the fact that employers may be unduly limited in the amount for which theymay insure the lives of their key employees, that interest payable on an open-ended debt may not be insurable because the liability did not exist at the time of inception, that the Life Assurance Act 1774 requires that the names of all interested parties be listed in the policy which can make policies illegal on a technicality and that the insurable interest required for group policies is particularly difficult to analyse.
The key questions and options for reform
The first issue under consideration is whether it is necessary to have a doctrine of insurable interest at all in order to define insurance for regulatory and other purposes and/or to prevent moral hazard and gambling under the guise of insurance.
The Commissions have looked at the way insurance is defined by the Financial Services and Markets Act 2000, the FSA, the common law and for accounting/tax purposes. Whilstmost definitions require that the insurable event has some adverse consequences for the insured, this is different from the much narrower statutory and common law concepts of insurable interest. They conclude that indemnity insurance can be distinguished from betting and other risk transfer productswithout preserving the doctrine of insurable interest. It is noted that contracts for differences such as credit derivatives (being contracts on which profit or loss can be made) have no requirements of loss or risk of loss and are not contracts of insurance.
Non-indemnity insurance: the proposals
The moralhazard argument is of more importance in the non-indemnity than the indemnity insurance context. For life insurance, now that gambling contracts are legally enforceable, an issue arises as to whether it remains necessary to prevent insurance on the lives of strangers. On the one hand, there is an argument that the issue should be left to the market, so that insurers are responsible for not issuing policies which encourage moral hazard (the Australian approach). On the other hand, the Commissions acknowledge the instinctive discomfort individualswould feel at the thought of strangers having complete freedom to take out a policy on their lives. For this reason, the Commissions’ preliminary view is that the doctrine of insurable interest in life insurance should be retained.
However, some changes to the law are proposed. Firstly, the categories of interest should be expanded, giving more people rights to insure the lives of others. In particular, cohabitants and dependant children and parents should be able to insure each other’s lives. Secondly, insurance should be allowed where the policyholder has a reasonable expectation of pecuniary or economic loss on the death of the life insured. This would extend further than the current limited test, which requires a pecuniary interest recognised by law. Thirdly, the consent of the life insured should provide an alternative ground for establishing insurable interest. Fourthly, section 2 of the Life Assurance Act 1774, requiring the names of all interested parties to be listed in the life policy, should be repealed. Finally, it is proposed that where a contract ismade without the necessary insurable interest it should be void rather than illegal and, in the absence of fraud, policyholders should have their premiums returned.
Views are invited as to whether there should continue to be a requirement for insurable interest in other forms of non-indemnity insurance.
Indemnity insurance: the proposals
In relation to indemnity insurance, the Commissions find it difficult to see what a statutory requirement of insurable interest adds to the common law indemnity principle. The indemnity principle enables parties to define the risk and the extent of the policy in a more subtle way than the strict legal or equitable right demanded by the statutory requirement of insurable interest. By contrast, the statutory concept of insurable interest appears only to introduce uncertainty, particularly since the Gambling Act 2005 came into force. As a result, the tentative proposal is that no requirement of insurable interest should apply to indemnity insurance contracts. Instead, the indemnity principle can and should govern the position.
It has long been suggested, certainly in academic circles, that the principle of insurable interest is increasingly hard to justify. Many common law jurisdictions are beginning to reject the concept. In Australia, for example, with regard to life insurance the statutory requirement for an insurable interestwas abandoned entirely under The Life Insurance (Consequential Amendments and Repeals) Act 1995. Whilst not everyone would want to go that far, the Commissions’ proposals reflect the widespread acceptance that the current law is antiquated, sometimes unclear and can act as a barrier to legitimate business.
The Issues Paper sets out the Commissions’ preliminary thinking. Its purpose is to promote discussion before the formal consultation process begins with the publication of the Commissions’ second Consultation Paper later this year and it will be interesting to see the industry’s response.