REPORTS OF COMMITTEES

THE LAW COMMISSION WORKING PAPER No. 73 : NON-DISCLOSURE AND BREACH OF WARRANTY IN INSURANCE LAW

ON May 17, 1978, the Lord Chancellor, in response largely to an E.E.C. Council Draft Directive of June 1977, referred five aspects of insurance law to the Law Commission. These were:

(a) non-disclosure by the insured; (b) misrepresentation by the insured; (c) breach of warranty by the insured; (d) terms and exclusions in policies; (e) increase and decrease of risk.

The result is Working Paper No. 73, which is confined to (a) and (c) above as these were considered by the Government to be the most pressing matters. This is regrettable, for it is illogical to discuss the duty to disclose without misrepresentation and, to a lesser extent, breach of warranty without alteration of risk. As a result it will be seen that while the treatment of warranties is satisfactory, that of the duty to disclose misses the fundamental issues involved.

Warranties The initial decision here was whether to modify the existing law

so as to render its operation more acceptable, or completely to replace the existing system of warranties with a new duty involving continuing notification by the insured of material changes in circumstances, allowing regular reassessment of the premium.a Here it is difficult to disagree with the conclusion of the Working Paper in paragraph 157 that such a system “would be unduly onerous on the insured . . . it would deprive him of much of the security and peace of mind he is entitled to expect from a contract of insurance.” Given the preferability of a once and for all warranty, how should the law be reformed? There are four basic defects in the law as it operates at present.

The first concerns formation. Warranties are most commonly formed by use of the ‘‘ basis ” clause to be found at the bottom of virtually every proposal form, whereby the insured is deemed to have warranted the truth of every statement on the proposal. This device has had grotesque results, and, as has been demonstrated,8 is legally and morally beyond justification. The recommendation in paragraphs 78-86 for its abolition is long overdue and is to be

1 Paras, 98-125. All further references to paragraphs are to the Working Paper

2 Advocated in the Draft Directive, discussed in the Working Paper at paras.

8 Hasson (1971) 34 M.L.R. 29.

unless otherwise stated.

147.. 157.

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wholeheartedly welcomed. This does not solve the whole problem, for it is still open to an insurer to specify that particular statements by the insured, or particular obligations imposed upon him, are to be treated as warranties even though the warranty in question is completely irrelevant to the risk.’ The Working Paper resolves this issue by recommending in paragraph 115 that “ a term of the contract should only be effective as a warranty if it is material to the risk.” This conclusion is acceptable only if “ material ” is properly defined, a matter discussed below in the context of misrepresentation.

The second defect in the law of warranties-one not touched upon by the Working Paper-concerns the problem of classification. As well as being a straightforward warranty a statement of the insured may be interpreted as an expression of opinion (so that there is only breach if the opinion is not genuinely held), a promissory warranty (by which a promise as to future conduct is made) or merely a delimitation of the risk (specifying the times at which the insured can recover). Unfortunately it is often impossible to predict which of the four possible constructions will be applied by the courts to the statement in question.’’ This would not matter if the courts had consistently adopted an overriding use of the contra proferencem principle in favour of the insured, but, despite the bland assertion in paragraph 105 that this is the case, in reality it has simply not happenedae It should be made clear that all warranties are to be construed contra proferentem, and in particular that an insurer must specifically contract for a promissory warranty.

Thirdly, paragraph 118 correctly points out that the insured will rarely retain a copy of the proposal form so that he may be unaware of his continuing duties where they are created by that document. The solution proposed by the Working Paper, that the insurer must furnish the insured with a copy of the warranties on pain of being unable to rely on them, is eminently sensible.

The final defect arises where there has been a breach of warranty by the insured and a loss completely unconnected with that breach. Paragraph 121 recommends the extreme, but nevertheless justifiable, reform that if the insured can establish the lack of any connection between the two he may recover under the policy.

The duty to disclose The major weakness of the Working Paper is its assumption that

4 The classic examplo Is Affen v. Universal Auromobife Ins. (1933) 45 L1.L.R. 55 in which the ownei of a car warranted on u motor proposal that he had @d €285 for a car whcn in fact he had paid €271. Held: broach of warranty.

0 Birds 119771 J.B.L. 231. Paras. 101-104 seem to assume that these categories arc watertight. Contra Birds at pp. 233-234 discussing Provincfal Ins. v. Morgan [ I9331 A.C. 240.

e In some cases, such as Thomson v. Weems (1884) 9 App.Cas. 671, conrra prolerentem has been totally Ignared; in others amblguitles have been crated to avoid the harshness of the rules concerning warranties.

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a modification of the duty to disclose will resolve all the injustices of uberrima fides. It has been pointed outT that the majority of cases decided on this ground are actually about misrepresentation, and that true cases of failure to disclose are hard to find. This matter is discussed below. A further criticism is that, although the dangers of non-disclosure are rehearsed in the Working Paper, the presentation of the existing state of the law is simplistic and some- what misleading. Three matters in particular are worthy of note.

First, it is stated in paragraph 31 that opinions given in good faith are not treated as breaches uberrimae fideL8 The two examples given, those of valuation and health, fail to take into account the decisions in West v. National Motor & -4ccident Zns.8 and Thomson v. Wecms,lo both of which show that fact and opinion are not necessarily mutually exclusive. Secondly, paragraph 32 raises the possibility that where an insurer asks detailed questions on a proposal form, he may be deemed to have waived the disclosure of related information about which there is no actual question. This proposition rests largely on dicta in cases in which the argument has been rejected, and in practice the lack of a pre- sumption of immateriality concerning matters not disclosed has meant that “ the risk (to the insurer) is a slight one.” l1 Thirdly, paragraph 33 restates the oft-quoted principle that a fair and reason- able construction will be placed upon ambiguous questions, while stressing the important caveat that this may not always operate in the insured’s favour. It is sufficient to say that the cases display a wild variation in the application of this principle.1a

The real point is that the courts cannot confidently be relied upon to mitigate the rigour of the duty to disclose. The subversion of merits to principle is well illustrated by Woolcott v. Sun Alliance18 in which the insured was granted house insurance on the strength of his mortgage application form-the fact that this would happen was not expressed as such on the form. Caulfield J. held that failure to disclose one particular criminal conviction rendered the policy voidable, but the treatment of the duty to disclose in general is disturbing. First, the question “Are there any other matters which you wish to be taken into account? ” could easily have been construed as imposing only a subjective duty, at best it was ambiguous. Secondly, given that mortgages do not require disclosure beyond the questions, and given that the insurer was willing to issue insurance on that basis, could not waiver have

Hasson (1975) 38 M.L.R. 89, 90. 8 Thls paragraph perhaps illustrates the point that the major Issues are in reality

0 [ 19541 2 Lloyds Rep. 461 (warranty). 10 (1884) 9 App.Cas. 671. 11 MacGillivray and Parkington On Insurance Law (6th ed.), para. 737. 12 Contrast Kumar v. Life Insurance Cpn. of India 119741 1 Lloyds Rep. 147

l a [ 19781 1 All E.R. 1257.

concerned with misrepresentation rather than non-disclosurc.

with Glicksman v. Lancashire & General Insurance (19271 A.C. 139.

Sept. 19791 REPORTS OF COMMITTEES 547

been argued? Thirdly, the duty of disclosure as laid down in Curler v. Boemh l4 applied equally to both parties; should it not have been disclosed by the insurer that the duty to disclose attached to the mortgage application? Finally, the implication that one unconnected criminal conviction could be material, goes further than previous authority. lo

Three possible approaches to reform were considered : outright abolition of the duty to disclose; retention of the duty subject to proportionate recovery based on the premium that would have been charged with full disclosure; modification of the existing duty. The first possibility (along with an alternative suggestion to abolish the duty only in consumer contracts) and the second possibility were both rejected. The question thus became, in what form should the duty continue to exist? The Working Paper solution is as follows. Where the insured completes a proposal form the insurer is deemed to waive any information not specifically requested, but the insured is under a residual duty to disclose information in his possession which he realises would be material to the insurer (i.e. fraud). The duty must be specified on the proposal and the insurer is not able to evade these provisions by asking a general question such as “ are there any other facts which you consider would influence the judgment of a prudent insurer? ” Where no proposal is completed the duty of disclosure is retained.I0 These proposals are an apparent improvement on the present situation but could easily be evaded by the insurer simply not issuing a proposal but relying on oral answers. Why, then, did the Working Paper not go further?

Three reasons are given for retention, each bearing closer examination: The first is that Lord Mansfleld’s principle that insurance is a contract upon speculation to which the parties are on unequal terms, although less true today, still basically holds good (para. 44). Two comments may be made. First, the duty as laid down by Lord Mansfield did not extend beyond fraudulent con- cealment.17 Secondly, it is hard to believe that insurers do not yet know exactly what questions are necessary to elicit material facts, given that clause 1 (c) of The Statement of Insurance Practice requires them to ask such questions.1B Further, the duty to disclose can add little to the information obtained by insurance agents, particularly in life insurance, who complete the proposal on behalf of the insured lo in response to oral answers. In short, the duty to disclose plays little part in the insurer’s knowledge of material facts, at best it serves as a shorthand method of disposing of dubious claims which ought really to be determined on their merits by the courts.

14 (1766) 3 Burr. 1905. 16 See Merkin (1976) 39 M.L.R. 478. 10 Paras. 65-66, 71-74 (proposals); 59-64 (duty of disclosure). 17 Hasson (1969) 32 M.L.R. 613. 18 Cj. Blrds (1977) 40 M.L.R. 677, 680. 10 Legally a9 well as factually: Newsholme Bros. v. Road Transport r9r General

Ins. [ 19291 2 K.B. 356.

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Secondly, the Commission thought that the practice of granting temporary cover would be severely limited without the protection of the duty to disclose (para. 47). It is submitted that the problem is more apparent than real. It is not unduly burdensome for the insurer to elicit all necessary information by the simple device of asking an express question as to any particular risks known to the insured. Such a question is not wide enough to re-introduce the duty by the back door yet is adequate to tell the insurer all he needs to know for the provisional period. A more fundamental point raised by this argument is whether disclosure should have any part to play in the granting of cover notes. Is it reasonable to expect an insured to reel off a list of convictions, his national origins, previous emotional depressions, etc., while applying for 10 days of motor insurance over the phone? *O

The third reason given for retaining the duty is that certain types of insurance are not preceded by a proposal but rest on disclosure and inquiries by the insurer. The abolition of the duty to disclose would greatly weaken the insurer's position, yet it would be impracticable to introduce proposals to redress the balance (para. 48). Even accepting that certain commercial insurances are governed by custom and practice rather than formality, and that it would be impracticable to treat them in any other way, this can surely be no justification for a general retention of the duty of disclosure. If the duty should continue to exist, it should be allowed to do so only in the narrow class of commercial insurances involved. Outside these the proposal form, whether or not one has been completed, should be exhaustive of the insured's duty, the insurer rather than the insured bearing the burden of inadequate requests for information. It is thus suggested that an insurer should be able to plead non-disclosure only if five requirements are satisfied :

(i) no proposal form was completed, in accordance with the established practice of the insurer in the insurance involved :

(ii) the insured was a company; (iii) the insured had actual knowlcdge (either because of oral

warning or previous dealings) of the duty to disclose; (iv) the information withheld was of a type that would normally

be disclosed in the ordinary course of the insurance in question;

(v) the information was material to the particular risk. For the above reasons it is submitted that the arguments against

virtual abolition of the duty to disclose presented by the Working Paper are not compelling, and that the insurer has all the protection he needs from the law of misrepresentation. That does not end the matter. While the abolition of the duty of disclosure would serve

20 cj. Birds (1977) 40 M.L.R. 79, 80-81, commenting on Mayne Nicklcss v. PegIer [ 19741 1 N.S.W.L.R. 228.

Sept. 19791 REPORTS OF COMMITTEES 549

to eliminate the excesses evidenced in such cases as Woolcott v. Sun Alliance and Lambert v. C.I.S.21 it is necessary to go further and to ensure that the law of misrepresentation, upon which all is to rest, adequately balances the interests of insurer and insured.

Misrepresen talion Two minor recommendations only are made. First, paragraphs

69-70 seek to make it clear that where a question is framed so as to elicit an opinion, the insured should not be regarded as in breach of his duty if he gives an answer which is correct to the best of his knowledge and belief.22 Secondly, paragraph 76 suggests an over- riding test of contra proferentem for ambiguous questions on the proposal. This is to be welcomed because it restricts the previous right of the insurer to have the best of both worlds in the matter, and because it is a much needed reassertion of an ordinary con- tractual principle which the courts have seemingly been unwilling to apply to contracts of These reforms, while useful, nevertheless beg the real questions involved: when is a fact material, and what should the consequences of material mis- representation be?

As the Working Paper points out in paragraph 37, the test of materiality is now settled as that of facts that would influence a prudent insurer in fixing the evidence of other insurers being admissible. However there is a real danger that if these tests of materiality and proof are not reconsidered the abolition of the “ basis of the contract ” clause could leave the insured little better off than he is today. The Working Paper recognises in paragraph 74 that the effect of limiting or abolishing the duty to disclose would probably be to lengthen proposals to incorporate matters presently left to disclosure. Yet this would be coupled with the presumption of materiality laid down in Schoolman v. Hall plus a test of materiality that rarely lets the insurer down. The result could be the effective preservation of the “ basis ” clause, but extended to matters previously not the subject of warranties. One possibility, altering the test from that of the reasonable insurer to that of the reasonable insured, might have a marginal effect but cases such as Horne v. Polandza suggest that insureds may fare little better under this more liberal test.

2 1 119751 2 Lloyd’s Rep. 465. 22 It Is unclear if the paragraphs are limitcd to this suggestion or whether they

are making the far wider recommendation that any wholly innocent misrepresentation should not be regarded as breach of duty. Contextually, the former would appear to be the point actually being made.

28 Cf. Young. v. Sun dllionce 119761 3 All E.R. 561, noted, Merkin (1977) 40 M.L.R. 486.

14 Lamberr v. C.I.S. 119751 2 Lloyd’s Rep. 465. This case seems to put paid to the view expressed In MocCillivroy ond Porklngfon that the test varies according to whether the insurance is Mei (reasonable insured) or any other type (reasonablc insurer). 2s I19511 1 Lloyd’s Rep. 461.

26 119221 2 K.B. 364. Cf. MacGillivray ond Porkington, para. 750.

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A preferable solution could be the following: (a) The reversal of the presumption of materiality. I t should be left to the insurer to show that the information required by the proposal was actually material to the insurance in question. There would thus be no incentive for the proposal to be extended to an unjustifiable length, the insurer would be prevented from using misrepresentation for any ulterior purpose, and yet little difficulty could be anticipated in establishing the materiality of the sort of misrepresentation which would cause the insurer to want to dispute liability.

(b) Evidence of materiality produced by the insurer should be confincd to his own practice and not that of other insurers. If it is accepted that the question is not whether the insured should be punished for attempting to mislead, but rather whether the insurer was actually misled, there can be no justification for introducing any other evidence whatsoever.

When the insured has made a material misrepresentation, the law at present adopts an all or nothing approach. The policy may be avoided ab initio by the insurer and, unless the misrepresentation is waived, no recovery under the policy is possible. Further, a large number of policies deny the insured premium restitution (normally available for total failure of consideration) by express terminology. These consequences follow whether or not the misrepresentation is fraudulent, whether or not the loss stemmed from the subject- matter of the misrepresentation, and irrespective of the nature of the insurance. These three factors merit further comment.

First, while the law has rightly never had any sympathy for a fraudulent misrepresentor, the maker of an innocent misstatement has always been in a far better position. There is much to be said for retaining that distinction here.27 Secondly, in paragraphs 92-96 the Working Paper rejects the possibility of a nexus test for uberrimae fidei, but accepts the very same test for breach of warranty in paragraphs 120-122. This distinction is prima facie illogical and becomes doubly so when it is considered that a mis- statement may well fall into both categories. Further, the reasons given in paragraphs 94-95 for the rejection of a nexus test are not compelling. In the first place it is hard to see how the adoption of a nexus requirement could induce sharp practice. Secondly, the fact that nexus between moral hazard and loss may be hard to assess does not weaken the general principle. In Henwood v. Prudential Znsurancc Co. of America2* the Supreme Court of Canada held that misrepresentation as to temporary stress consequent upon a broken engagement enabled the insurer to avoid liability when the assured was killed in a car crash (caused by another) four years later. Denying any recovery whatsoever in such a case is beyond

27 1 am assuming hcre that the Working Paper did not intend to recommend tho abolition of liability for innocent mlsrepresentation In paras. 69-70. Sea note 22 supra.

28 (1967) 64 D.L.R. (2d) 715.

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moral justification. Finally, there is a strong argument in favour of a separate treatment of life insurance, for a misrepresentation by the life assured may not affect him but his dependents.

How can these particular situations be dealt with? The strongest possibility, pro rata recovery, was discussed by the Working Paper (albeit in a slightly different context 20) but ultimately rejected.5o Two particular obstacles prevented the adoption of proportionality. First, it would be necessary to assess a notional premium based on full disclosure to determine the proportion of recovery permissible, but, as there is no standard rate of premium in Britain, the calcula- tion would be difficult. Clearly the starting point must be the rates of the particular insurer,s1 but paragraph 55 points out that the difficulty of rebutting the insurer’s evidence as to his rates could give rise to abuse. This argument is yet another example of the Working Paper’s willingness to throw the baby out with the bath water, but in any case it could easily be overcome by placing the burden of proof squarely on the insurer, requiring him to introduce evidence of rates actually being charged to other insureds in com- parable positions. The second obstacle is that the insurer might not have been willing to underwrite the risk at all had the facts been available to him. Again this should be a question of evidence rather than an automatic bar to the whole concept, and, if it can be established, there is no reason that it should not be a complete defence to a claim on the policy. As above, the insurer should be able to establish the defence only by evidence that risks have previously been rejected by him on the relevant ground.

If pro ram recovery is to be regarded as incompatible with the prevailing practice of insurance, there are further options open to deal with the three situations outlined above. Thus a nexus test could be adopted generally, while rendering all life policies incon- testible after, say, two years. An absolute right to premium restitution could be given for all cases short of fraud. One final reform is desirable. It should be made clear that the agent who solicits insurance and completes the form for the insured remains the agent of the insurer throughout.

Conclusions It is unfortunate that the Working Paper docs not go beyond a

little gentle tinkering in what is widely regarded as one of the most unsatisfactory areas of law. The majority of the governing principles involved were laid down in the eighteenth and early nineteenth centuries by decisions on insurance policies made between parties

20 The Working Paper approaches pro rota recovery as an alternative to thc abolition oP thc duty to disclose, and not as alfecting misreprcsentatlon.

50 Paras. 52.57. 81 The Working Paper In paragraph 55 considers both this possibility and that

of the rates charged by a prudent insurer. It is submitted that the latter would be a futile exercise, for the variability of rates illustrates that no such person cxisls.

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of more or less equal standing. Today the bargaining power is all on one side. The law should be doing its very best to redress the balance and not to bolster the strong against the weak. A radical approach is needed, and it is to be hoped that the final thinking of the Law Commission will recognise that what was right for marine and related insurances in 1780 is not necessarily appropriate to the wide variety of consumer insurances available in 1980.

ROBERT MERRIN.