Some important features of the insurance contract

Contributed by Greg Pynt and current to 1 September 2005

THE DUTY OF UTMOST GOOD FAITH

The governing feature of the insurance contract is the duty of utmost good faith. This duty is an implied term of the insurance contract (s.13 of the ICA) and requires you and the insurance company to deal with each other honestly and fairly. If either party breaches this duty, the party in breach will be liable to pay damages to the other.

UNDERINSURANCE (CO-INSURANCE, AVERAGE)

The Sum Insured, Policy limit or Limit of indemnity is the maximum amount the insurance company is obliged to pay for your claim. The insurance company usually leaves it to the insured to nominate the amount of the Sum Insured. Generally speaking, the higher the Sum Insured, the higher the premium charged for the insurance.

Almost all first party insurance contracts contain a ‘co-insurance’ or ‘average’ clause. Subject to the operation of section 44 of the ICA, this means that if, for example, you nominate a Sum Insured for a home contents insurance policy that significantly underestimates the total value of your home contents (underinsurance), the insurance company will be entitled to reduce the amount of any claim you make for stolen or damaged contents by a percentage which reflects the extent of your underestimate (underinsurance).

WHO IS COVERED BY AN INSURANCE CONTRACT?

If you are described as an insured in an insurance contract, you are entitled to the benefit of the contract. But are you entitled to the benefit of an insurance contract if you are not described as an insured in the contract?

The answer is ‘yes’, if:

• you have a financial interest in the subject matter of someone else’s insurance contract: s.49 of the ICA;
• you have agreed to buy a building and the building is insured by the vendor of the building: s.50 of the ICA; or
• the insurance contract makes it clear that it intends to benefit you: s.11 of the Property Law Act 1969 (WA) and s.48 of the ICA.

For example, you might take out insurance on the contents of your home. The insurance contract will usually cover contents belonging to you as the insured and anyone living in your home who is closely related to you. Even if your daughter is not named as an insured, depending on how the insurance contract is worded, she may be able to claim an indemnity under the insurance contract for damage to anything belonging to her, as long as she is still living with you at home.

If you have a claim against someone who has died or cannot be found, section 51 of the ICA allows you to make a claim directly against that person’s insurance company, but only if that person:

• is legally liable to pay your claim; and
• is covered for his liability to you by a third party (liability) insurance contract issued by the insurance company.

If you have a claim against a deregistered company, section 601AG of the Corporations Law 2001 (Cth) allows claims directly against that company’s insurance company, but only if:

• the company, if it was registered, would be held legally liable to pay the claim;
• immediately before the company was deregistered, it was covered for its liability by a third party (liability) insurance contract issued by the insurance company.

The alternative to suing an insurance company under section 601AG is to arrange for the company to be re-registered so it can then be sued. It is then up to the company to seek an indemnity against the claim from its insurance company.

CAUSATION

To succeed in a claim against an insurance company, it must be proved that the connection between the insured risk and the loss suffered falls within the scope of the insurance company’s promise to pay.

Whether the connection between the insured risk and the loss is close enough is a practical question of fact to be determined by the application of common sense.

Subject to the terms of the insurance contract, you will only be able to recover your financial loss if it was ‘proximately’ caused by an insured risk and not proximately caused by an excluded risk. The parties are free to bargain for a different causal connection.

SECTION 54 OF THE ICA

This is one of the most important sections of the ICA for an insured.

At common law, an insurance company may be able to avoid the insurance contract or reject a claim if the insured has breached a Condition of the insurance contract, even if there is no connection between the breach of Condition and the loss.

Section 54 seeks to overcome the harshness of the common law position in the following manner.

Section 54 divides breaches of Condition occurring after the commencement of the insurance contract into breaches that:

• could reasonably be regarded as capable of contributing to a loss;
• could not reasonably be regarded as capable of contributing to a loss.

If a breach of Condition could reasonably be regarded as capable of contributing to the loss, the insurance company is only liable to pay so much of the loss that was not caused by the breach of Condition. For example, you will be in breach of a Condition in your insurance contract that you keep your car in a safe condition if the car has defective brakes. If you have an accident while driving the car, the insurance company will not be required to pay for the damage to your car if the accident as caused by the car having defective brakes. On the other hand, if you can prove the accident was caused by the other driver driving through a stop sign and had nothing to do with the defective brakes, the insurance company will be obliged to pay for the damage to your car.

If the breach of Condition could not reasonably be regarded as capable of contributing to the loss, the insurance company is entitled to reduce the amount of your claim by the extent to which it is prejudiced by the breach of Condition. For example, you will be in breach of a Condition in your insurance contract that you immediately notify the insurance company of an accident if you take 3 or 4 weeks to notify the insurance company of the accident. As the breach could not possibly be regarded as a cause of the accident, the insurance company is only entitled to reduce the claim by the extent to which it has been prejudiced by your late notification of the accident.

The longer you take to notify the insurance company of the accident, the more likely the insurance company will be able to prove that it has been prejudiced by the late notification.

Although the above discussion is about breaches of Condition, section 54 of the ICA is wider than that. It deals with ‘acts or omissions’, not just breaches of Condition.

STATUTORY EXTENSION AND CANCELLATION OF THE INSURANCE CONTRACT

Section 58 of the ICA will extend the insurance contract beyond its expiry date if the insurance company does not, at least 14 days before the expiry date, provide the insured with written notice informing them when the insurance contract is due to expire and whether the insurance company is prepared to negotiate to renew or extend the insurance contract.

Section 60 of the ICA sets out the circumstances in which an insurance company can cancel a contract of general insurance. Section 59 lays down the procedure for cancellation by an insurance company.

The insured can cancel their insurance contract whenever they want, for example when selling a car or moving home. In these circumstances, the insurance company will usually repay some of the premium, in recognition that it is not on risk for the balance of the insurance period.

SUBROGATION

The term ‘subrogation’ is used to refer to the insurance company’s exercise, in the insured’s name, of any rights they have against a third party in respect of any damage done by the third party to the subject-matter of the insurance.

Sections 65 and 66 of the ICA limit an insurance company’s ability to exercise a right of subrogation against an uninsured third party who:

• is a relative or good friend of the insured;
• is the employee of the insured; or
• used the insured’s car with their express or implied permission.

A typical example of how subrogation works

You take out a motor vehicle insurance policy to cover you for damage to your car. Your car is damaged in an accident caused by a negligent third party. You make a claim on your policy for the cost of repairs to your car. Your insurance company accepts the claim and pays you the repair cost.

Your insurance company is then entitled to ‘stand in your shoes’ (exercise its right of subrogation) by suing the third party, in your name, to recover the repair cost, in an effort to reduce the loss it has suffered by having to pay you the repair cost under the policy.

The third party cannot defend the claim by saying you have not suffered any loss because the insurance company has paid your claim for the repair cost.