Utmost Good Faith in Insurance Contracts

What Is Utmost Good Faith?

According to the Utmost Good Faith principle, both parties to the insurance contract must disclose all facts material to the risk voluntarily to each other.

Meaning of Utmost Good Faith?

Any breach of this duty shall render the contract voidable at the option of the aggrieved party, i.e., the party who has suffered as a result of this breach.

Although an insurance contract is a simple commercial contract, it differs from other commercial contracts concerning the application of this principle.

In other commercial contracts, unlike insurance contracts, the rule of “let the buyer beware (Caveat emptor)” applies.

This means that the parties to the contract need not disclose facts, which would influence the other party. This means each of the parties can remain silent even in a matter of fact, which he thinks might influence the other party’s decision.

Therefore, under usual circumstances, the seller of goods is not under any obligation to disclose any defect in the goods. It is the duty of the buyer to examine the goods before purchase.

If he is not satisfied, he may not buy it, but once bought, it is over, and he cannot change it or return it simply because he has discovered a defect after purchase, i.e., after completion of the contract.

The reason for such a provision of law is that the goods are tangible and visible, and these can be very well examined before purchase.

If the buyer is not an expert on the thing he is going to buy, he may very well engage an expert to examine the thing on his behalf.

But the question remains that once the purchase is made, the buyer cannot defend any defect discovered afterward. Sometimes it is seen that at the bottom of a Cash memo, it is written,” Goods sold are not taken back.

Even though there is no notice as such, the legal position is the same. However, the seller must not take shelter from any fraud, which means that normal good faith is required to be observed.

SALE OF GOODS ACT, 1893 (of the United Kingdom) is important in this regard. Section 14 (1) of the said Act corroborates what has been said so far as to the duty of disclosure by the seller.

No defense, therefore, is usually available to the buyer unless it is a case of fraud or deceit by the seller. Section 14 (2), however, provides a minimal defense to the buyer.

It says that if the buyer relies on the seller’s judgment and integrity at the time of purchase, then the seller, knowing fully of the defect of his product, should not mislead the buyer by a wrong statement to influence the buyer into taking a decision.

The doctrine of caveat emptor.

In such circumstances, however, the seller may keep his mouth shut and/or go by Section 14 (1), putting the responsibility of making the choice onto the buyer’s shoulder by requesting an examination of the product.

Insurance contracts stand in a different category because there is nothing visible or tangible here that can be physically examined like other contracts as explained.

Therefore, the law is not to “let the buyer beware.”

Unless both the parties to the contract disclose voluntarily to the other party all facts relating to the proposed contract it is not possible for the other party to know precisely what type of bargain he is entering into.

Therefore, this doctrine requires that both parties to an insurance contract should disclose all facts material to the risk to the other party. Although this duty applies to both, in practice, it applies more to the insured.

With regard to a proposed risk, the proposer must disclose all facts material to the proposed risk to the insurer, and this has to be done voluntarily, even if not asked by the insurer.

A material fact is a fact that would influence the decision of a prudent underwriter to decide whether to enter into an insurance contract or not if to enter, and at what rate, terms, and conditions.

Duration of the Duty

The duty of disclosure must be observed throughout the negotiations and continue until the completion of the contract.

Usually, there is no such duty to be observed during the continuation of the policy period unless by means of a policy condition, it is made continuous or contractual when it becomes a contractual duty of utmost good faith.

For example, in general, in insurance, when an alteration is made to the existing policy, the duty applies to the alteration.

The duty revives at renewal if it is a fresh contract.

Otherwise, where the renewal is regarded as a continuation of the original contract or where there is a long-term agreement for continuation of the insurance for a number of years, as is in the case of life assurance contracts, the duty of disclosure does not apply afresh.

In general insurance contracts, the contract is completed on acceptance of the risk by the insurer, but in life, it is usually from the time of payment of the premium.

Facts that are Required to be Disclosed and which are not

The following facts are required to be disclosed:

1. Facts that would render a risk greater than normal. In the absence of this information, the insurers would consider the risk normal and naturally deceived—for example, commercial kerosene storage in a private dwelling house as a side business.
2. Facts which would suggest some special motive behind insurance, e.g., excessive over-insurance.
3. Facts that suggest the abnormality of the proposer himself, e.g., making frequent claims.
4. Facts explaining the exceptional nature of the risk.

The following facts need not be disclosed unless specifically asked for by the insurers:

1. Facts that lessen the risk, e.g., a fire brigade near the premises, in case of fire insurance.
2. Facts of public knowledge or facts are reasonably supposed to be known by the insurers in the ordinary course of their business. For example, a big cyclone passing over a particular area in the past or an earthquake or, say, war, etc. These being matters of common public knowledge, should reasonably be known by the insurers.
3. Facts pertaining to matters of law, e.g., precautions necessarily required to be taken by the factory owners as per the Factory Act.
4. Facts possible of discovery through inquiry provided reasonable provocation have been made through other information already given by the proposer.
5. Facts that the insurers should reasonably infer on the context of the particulars disclosed. For example, with regard to a fire proposal for a certain type of risk, the insurers should reasonably understand the normal risks associated with that type of trade.
6. Facts to which the insurers do not attach much importance, e.g., if against the question in a proposal form, the proposal puts a dash and the insurers do not make further queries, it would be assumed that the insurers are not attaching much importance to it and the same may be ignored.
7. Facts that are superfluous to disclose because of the application of the warranty.

Application of the Doctrine in Underwriting and Claims

As already explained, this doctrine is vital in insurance contracts because of the intangible nature of insurance contracts.

The insurers will not be able to underwrite a risk properly or cannot even give a proper judgment on the question of underwriting unless all facts material to the risk are voluntarily disclosed.

This is important because the insurers are in the position of trustees and, therefore must see that fair & equitable treatments are given to all of their clients.

Indiscriminate underwriting or underwriting without due regard to the importance of disclosing material facts would certainly impair the rating, and consequently, the amount available from premium would definitely fall short of claims emanating from the policies.

This will also create a condition where good clients would go out of the insurance scheme because of the increased cost, making the insurance business impossible.

Therefore, it is necessary that the proposer, throughout the negotiation period, must disclose all facts material to the risk voluntarily to the insurers.

It is no defense that the insurers have not asked for certain facts. Whether asked or not, if a fact is thought to be material, it must be disclosed.

Sometimes lot, many questions are asked through the proposal forms.

Even if all the questions are answered truthfully, nevertheless, if something is not asked and the proposer thinks it to be material, he must disclose it.

He must allow the underwriters to apply their judgment in deciding the question of acceptability or otherwise of the risk.

It is quite natural and equitable that bad risks should pay more than good risks and, therefore, unless facts are disclosed properly, how can this philosophy be maintained?

Nevertheless, breaches of this duty do occur, and then it becomes imperative to examine the legal status of the insurance contract vis-a-vis the legal position of a claim arising out of such a contract.

The legal position, however, varies with the nature of the breach, and this is examined below;

Breaches of the Duty

1. Non-disclosure: This means omission to inadvertently disclose a material fact because he innocently thought the information to be immaterial.
2. Concealment: This means concealing or suppressing a material fact intentionally, knowing it to be material.
3. Innocent misrepresentation: This means making an inaccurate or false statement pertaining to material facts innocently and believing it to be true.
4. Fraudulent misrepresentation: This means making false statements pertaining to facts material to the risk intentionally and with the intent to deceive the insurers. The maker of such a statement knows it to be false, but nevertheless, he makes it recklessly with a careless disregard for the veracity. This is actionable not only under the law of contract but also under the law of tort.

It should be clearly remembered that any breach, as mentioned herein renders the contract voidable at the option of the aggrieved party, i.e., the party who has suffered as a result of this breach. Therefore, if the insured makes a breach, the insurers may;

1. Repudiate liability with regard to any claim,
2. Cancel the policy is still in force, or
3. Overlook the breach. When the breach is overlooked as such, the contract remains absolutely unaffected.

Normally, at the time of claims, the information as to a possible breach of this duty comes to light through the surveyors or other personal references, unless, of course, it comes to light beforehand through some other media.

Whatever it is, within a reasonable time of acquiring such knowledge of the breach, the insurers must decide the course of action they will take.

Otherwise, lapsation of an unreasonable time, or behavior indicating waiver, would mean that the insurers have overlooked the breach.

General Good Faith

Apart from what has been said so far as to the duty of utmost good faith, the insured is always expected to act towards the insurer in normal good faith throughout the tenure of the contract.

This would usually mean that the insured must take reasonable precautions in preventing or minimizing losses.

Utmost Good Faith in Marine Insurance

The doctrine of caveat emptor (let the buyer beware) applies to commercial contracts, but insurance contracts are based upon the legal principle of uberrimae fides (utmost good faith).

If either of the parties does not observe this, the other party can avoid the contract.

The duty of the utmost good faith also applies to the insurer. He may not urge the proposer to affect insurance which he knows is not legal or has run off safely.

But the duty of disclosing material facts rests highly on the insured because he is aware that the material common in other insurance branches are not used in marine insurance.

Ships and cargoes proposed for insurance may be thousands of miles away, and surveys on underwriters’ behalf are usually impracticable.

Therefore, the assured must disclose all the material information that may influence the decision of the contract.

Any non-disclosure of a material fact enables the underwriter to avoid the contract, irrespective of whether the non-disclosure was intentional or inadvertent.

The assured is expected to know every circumstance which ought to be known by him in the ordinary course of business.

He cannot rely on his inefficiency or neglect.

The duty of the disclosure of all material facts falls even more heavily on the broker. He must disclose every material fact that the assured ought to disclose and also every material fact that he knows.

The broker is expected to know or inquire from the assured all the material facts.

Failure in this respect entitles the underwriter to avoid the policy, and if negligence can be held against the broker, he may be liable for damages to his client for breach of contract.

Exception: In the following circumstances, the doctrine of good faith may not be adhered to:

• Facts of common knowledge.
• Facts that are known should be known to the insurer.
• Facts that the insurers do not require.
• Facts which the insurer ought reasonably to have inferred from the details given to him.
• Facts of public knowledge.

Utmost Good Faith in Life Insurance

Life insurance requires that both parties should preserve the principle of utmost good faith.

The utmost good faith says that both the parties, the proposer (insured) and insurer, must be of the same mind at the time of the contract because only then may the risk be correctly ascertained.

They must make full and true disclosure of the facts material to the risk.

Material Facts

In life insurance, material facts are age, income, occupation, health, habits, residence, family history, and insurance plan.

Material facts are determined not on the basis of opinion. Therefore, the proposer should disclose not only those matters which the proposer may feel are material but all facts which are material.

The duty of both parties

It is not only the proposer but also the insurer responsible for disclosing all the material facts that will influence the decision of the proposer, whether apply or not to apply for insurance.

Since the decision is taken mostly on the basis of the subject matter, the life to be insured in life insurance, and the material facts relating to the subject matter are known or are expected to be known by the proposer; it is much more of responsibility of the proposer to disclose the material facts.

Full and True Disclosure

Utmost good faith says that there should be full and true disclosure of all the material facts.

Full and true means that there should be no concealment, misrepresentation, half disclosure, and fraud of the subject matter to be insured.

The extent of the duty

The duty of disclosure finishes when the proposal form has been fully and correctly fulfilled, provided there are no such facts that he considers or expects to be considered material and has not been disclosed.

The proposer cannot defend on the ground that he had omitted to disclose it by carelessness or by mistake or that; he did not regard it as material to the contract.

Legal Consequence

In the absence of utmost good faith, the contract will be voidable at the option of the person who suffered a loss due to non-disclosure.

The intentional non-disclosure counts fraud and is void “ab initio,” and the unintentional non-disclosure is voidable at the option of the party not at fault

Once the party not at fault has validated the voidable contract, he cannot avoid the contract later on.

For instance, suppose the insurer has continued to accept the premium when certain non-disclosure, say misstatement of age, has been disclosed. In that case, the insurer cannot invalidate the contract and cannot refuse to pay the amount of the claim.

If the party not at fault does not exercise its option, the contract will remain valid.

Indisputability of Policy

The doctrine of utmost good faith works as a great hardship for a long period on the plea of misstatement at the time of proposal. In such cases,

it would be very difficult to prove or disprove whether a particular statement made at the time of policy was true.

Therefore, to remove this hardship, certain sections in the concerned act are provided. The indisputable clause handles these kinds of disputes.

Facts not required to be disclosed

The following facts are not required to be disclosed:

1. Circumstances that are diminishing the risk.
2. Facts that are known or reasonably should be known to the insurer in his ordinary course of business.
3. Facts that the insurer should infer from the information given.
4. Facts that the insurer waives.
5. Facts that are superfluous to disclose by reason of a condition or warranty.
6. Facts of public knowledge.