Application of Doctrine of Utmost Good Faith in Insurance Contracts

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

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 insurance contract is a simple commercial contract, but it differs from other commercial contracts with regard to 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 on a matter of fact, which he thinks might influence the decision of the other party.

Therefore, under usual circumstances, the seller of goods is not under any obligation to disclose any defect of 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 of such a provision of law is this that the goods are tangible and visible. 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 take the defense of any defect that is discovered afterwards. 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 the shelter of 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 to 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 very limited defense to the buyer.

It says that if at the time of purchase the buyer relies onto the judgment and integrity of the seller then the seller, knowing fully of the defect of his product, should not mislead the buyer by a wrong statement so as to influence the buyer in taking a decision. In such circumstances the seller may however keep his mouth shut and/or go by Section 14 (1), putting the responsibility of making the choice onto buyer’s shoulder by requesting examination of the product.

Insurance contracts actually stand in a different category because there is nothing visible or tangible here which can be physically examined like other contracts as explained. Therefore, the law is not of “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 as to what type of bargain he is entering into.

Therefore, this doctrine requires that both the parties to an insurance contract should disclose all facts material to the risk to the other party. Although this duty applies to both, but 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 which would influence the decision of a prudent underwriter to decide whether to enter into an insurance contract or not, if to enter, at what rate terms and conditions.

Lord Mansfield in his judgment in the English case Carter V. Boehm (1766) said;

Insurance is a contract upon speculation. The special facts upon which the contingent chance is to be computed lie most commonly in the knowledge of the assured only; the under-writer trusts to his representations, and proceeds upon confidence that he does not keep back any circumstance, in his knowledge, to mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risk as if it did not exist. The keeping back of such a circumstance is a fraud, and therefore the policy is void. Although the suppression should happen through mistake, without any fraudulent intention, yet still the underwriter, is deceived, and the policy is void; because the risk run is really different from the risk understood and intended to be run at the time of the agreement. . , Good faith forbids either party by concealing what he privately knows to draw the other into a bargain from his ignorance of the fact and his believing the contrary.

Duration of the Duty

The duty of disclosure must be observed throughout the negotiations and continues 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 insurance, when an alteration is made to the existing policy, the duty applies in so far as the alteration is concerned. 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 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 which are Required to be Disclosed and which are not

The following facts are required to be disclosed:

  1. Facts which would render a risk greater than normal. In the absence of this information the insurers would consider the risk as normal and naturally deceived. For example, commercial storage of kerosene in a private dwelling house as side business.
  2. Facts, which would suggest some special motive behind insurance, e.g., excessive over-insurance.
  3. Facts which 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 which lessen the risk, e.g., existence of a fire brigade near the premises, in case of a fire insurance.
  2. Facts of public knowledge or facts, which 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 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 Factory Act.
  4. Facts possible of discovery through enquiry, provided reasonable provocation has been made through some other information already given by the proposer.
  5. Facts which should be reasonably inferred by the insurers 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 be able to 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 on it and the same may be ignored.
  7. Facts which are superfluous to disclose because of the application of warranty.

Application of the Doctrine in Underwriting and Claims

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

The insurers will not be able to underwrite a risk properly, or cannot even give a proper judgment on 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 regards 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 whereby good clients would go out of the insurance scheme because of increased cost of insurance thereby making 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 certain facts have not been asked by the insurers. 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 this philosophy can be maintained?

Nevertheless, breaches of this duty do take place 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 disclose a material fact inadvertently or 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 of 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 if still in force, or
  3. Overlook the breach. When the breach is overlooked as such, the contract remains absolutely unaffected.

Normally, it is at the time of claims that the information as to 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 breach the insurers must decide the course of action they are going to take.

Otherwise,

Lapsation of an unreasonable time, or a 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 insurer in normal good faith throughout the tenure of the contract.

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