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Unravelled: Utmost good faith, life insurance and ASIC

5 April 2016

Written by Partner Malcolm Stephens

This year is the 250th anniversary of one of the most famous insurance cases. The judgment of Lord Mansfield in Carter v Boehm in 1766 is frequently cited as establishing the principle that parties to an insurance contract owe each other duties of utmost good faith. For 250 years this duty has primarily been relied upon by insurers to deny claims by insureds who have breached the duty of utmost good faith by failing to give proper disclosure before entering into their insurance policies. In 2016, however, the duty of utmost good faith has been turned around to become the primary legal weapon against life insurers who have allegedly failed to comply with the duty of utmost good faith in handling insurance claims.

The Insurance Contracts Act

Under the common law, at least as established by English decisions, an insured's only remedy against an insurer, for breaching the duty of utmost good faith, is to avoid the policy. This remedy is of little use to an insured which is seeking to recover its losses (and not just the premium) from an insurer. For this reason, the Australian Law Reform Commission recommended that the duty of utmost good faith be an implied term of an insurance contract. This recommendation became section 13 of the Insurance Contracts Act. An insured is therefore now entitled to recover damages if an insurer breaches the duty of utmost good faith. If the insurer's breach results in an otherwise valid claim being denied, then the insured's loss will be equivalent to the amount it would have recovered under the policy.

Section 14 of the Insurance Contracts Act explicitly states that relying on the terms of an insurance policy might breach the duty of utmost good faith. This is particularly relevant to the current controversy concerning the handling of life insurance claims. For example, it has been alleged that life insurers have acted in bad faith by relying on outdated definitions in insurance policies (or on definitions that don't reflect the common understanding of a word or phrase).

ASIC

In 2013, further amendments to the Insurance Contracts Act (made in response to recommendations of the Cameron-Milne Review):

  • made a breach of the duty of utmost good faith a breach of the Insurance Contracts Act (s13(2)); and
  • gave ASIC the same powers, in relation to a failure by an insurer to handle claims with utmost good faith, as ASIC has in relation to breaches by insurers of the financial services law (s14A).

A consequence of these amendments is that ASIC has the power to issue banning orders or to vary, suspend or revoke an insurer's licence if an insurer breaches the duty of utmost good faith in handling claims. The Explanatory Memorandum for these amendments indicated that ASIC might exercise its banning powers (and, presumably, its other powers) if there is a pattern of persistent contraventions that indicate systemic failures or a general lack of understanding of, and regard for, compliance with the duty of utmost good faith. The current investigations that have been announced by ASIC will no doubt focus on these considerations.

What is the content of the obligation of utmost good faith for a life insurer?

There have been a number of cases which have considered the duty of a life insurer to act with utmost good faith in handling TPD claims. These cases have established that life insurers, when deciding whether TPD requirements have been satisfied: must act reasonably; must apply the policy wording correctly; must consider all relevant material; and must give the relevant individual an opportunity to respond to adverse information (including video material). A practical consequence of these requirements is that a life insurer, when giving reasons for declining a TPD claim, should refer to material and submissions provided by or on behalf of the relevant individual and explain why that material and those submissions have not led to the TPD claim being accepted.

Outside the context of TPD claims, there is very little authority on the content of the duty of utmost good faith for life insurers. For many years Australian courts debated whether the duty of utmost good faith required more than honesty on the part of an insurer. That debate was resolved by the High Court in 2007 in CGU v AMP, in which all five judges confirmed that the duty did require more than honesty. In particular, the court stated that the duty required an insurer to act consistently with commercial (or community) standards of decency and fairness, with due regard to the interests of the insured.

The critical issue for life insurers is when, according to ASIC and the courts, these 'community standards of decency' will require insurers to admit claims that fall outside the policy wording. Further complications might also arise in so far as reinsurers take a different view from ASIC on the extent to which the duty of utmost good faith requires life insurers to admit such claims.

Conclusion

The duty of utmost good faith is of great importance in the handling of life insurance claims. It may even, in some circumstances, impose a legal obligation on life insurers to admit claims that fall outside the terms of cover. Furthermore, systemic failures to consider the duty may result in ASIC taking action against a life insurer, including by the imposition of conditions on the life insurer's licence. These are serious consequences for breaching a duty, the scope of which is presently so uncertain.

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