Formation of the Insurance Contract

1.  Offer and acceptance

Although special rules apply to insurance contracts, such as the duty of disclosure, they do share much common ground with other types of contracts. A contract is a legally enforceable agreement: it is ‘a promise or set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognises as a duty’.¹ The test of whether an agreement exists and what are its terms is objective: in other words, even though the judges speak about the parties’ intention, this intention is discovered not by attempting to understand what the parties themselves believed they had done, but by the appearance of their words and actions. For an insurance contract, as with any contract, there must be agreement between the parties on the principal terms,² which would presumably include the risk to be covered, the insured subject-matter, the duration of the cover, the premium and the benefit due in the event of a covered loss. Nevertheless, at the root of the courts’ approach to contract is the desire to facilitate rather than obstruct agreements, at least where commercial parties are involved and especially where they acted as though a contract existed:

Some reinsurance contracts provide that disputes under the agreement are to be referred to arbitration and that the agreement itself is to be ‘interpreted as an honourable engagement rather than as a legal obligation’. In the absence of an arbitration clause this type of provision runs the risk of the contract being held void for uncertainty. However, since the passing of the Arbitration Act 1996, section 46, it has been permissible for the parties to agree that the arbitrators can decide the dispute in accordance with principles other than legal principles, and even before the Act the courts had managed to uphold the contract by holding that the words did no more than relieve the arbitrators from adhering to strict rules of construction.⁴ To determine whether an agreement has been concluded the courts typically look for an offer and a matching acceptance. In insurance the offer will usually be made by the prospective insured completing a proposal form and sending it to the insurers. ⁵ An offer continues until it is accepted or rejected by the offeree, or a reasonable period of time has passed, or it has been revoked by the offeror prior to acceptance.⁶ Clearly, there can be no acceptance if the offeree is unaware of the existence of the offer or the offer has been made to another person since the parties could hardly be said to have come to an agreement.⁷

The acceptance must match the offer and be unconditional, otherwise it may be regarded as a counter offer, which will be a rejection of the original offer and will begin the whole process over again. It is important to distinguish a counter offer from a mere inquiry about the terms of the offer, which does not amount to a rejection.⁸ This distinction is not easily made and will depend on the particular circumstances. For example, where in response to a proposal by the prospective insured the insurer sends out a policy that includes a term of which the prospective insured was previously unaware, this might constitute a counter-offer.⁹ On the other hand, where the insurer responds with a policy in standard form, then as long as it is not inconsistent with the proposal, it may be held to be a valid acceptance even though it includes terms not expressly communicated, if the insured could reasonably be expected to know that there would be such terms.¹⁰

In the case of a new contract of insurance (as opposed to a renewal), it is likely that the offer is made by the prospective insured completing the proposal form. Generally, the acceptance of the offer must be communicated to the offeror, unless the offeror waives this requirement.¹¹ It may be possible to infer acceptance from conduct, such as where the insured pays, or the insurers accept, the premium.¹² If the offer is made by the insurer, the communication of an acceptance to a third party, such as a broker, is insufficient unless the broker is the agent of the insurer, which is not usually the case. Where the insurers offer to renew an annual motor policy by issuing a cover note that extends the old policy, the motorist can be deemed to have accepted by driving on the basis of that offer.¹³ In Rust v Abbey Life Assurance Co,¹⁴ Rust, having been given advice both by the insurers and by her own advisors, completed a proposal form and sent it to the insurance company. This action was treated by the Court of Appeal as an offer that the insurers accepted by sending out a policy, so the parties were bound. However, the court went on to say that, even if the insurer’s action in sending out the policy was merely a counter offer because it included terms not previously seen by Rust, her delay in taking seven months to object to those terms amounted to an acceptance. The court was not saying that silence amounts to an acceptance—it is a general rule that it does not¹⁵—but merely that acceptance can, in appropriate circumstances, be inferred from conduct. In view of the context of this case and in particular the extensive advice Rust had received, it was ‘an inevitable inference from the conduct of the plaintiff in doing and saying nothing for seven months that she accepted the policy as a valid contract between herself and the first defendants’.¹⁶ A case in which the insurers were bound in spite of not having communicated acceptance is Roberts v Security Co Ltd.¹⁷ Roberts completed a proposal form for burglary insurance, which stated that he agreed to the usual terms applying. Subsequently, the company completed and sealed a policy, but did not deliver it to Roberts. He then suffered a loss through a burglary. The Court of Appeal held the insurers liable since their act of writing the policy signified acceptance even though they had not notified this fact to Roberts.

It is a general principle of contract law that once an offer has been accepted and an agreement formed neither party may unilaterally withdraw.¹⁸ The contract may, of course, give the parties the right to cancel the contract. Where a policy contains a term allowing cancellation by the insurer, it will usually also provide for a portion of the premium to be repaid to the insured. There is old authority to the effect that the breadth of such clauses is not a matter in which the courts will interfere: so a clause giving the insurer an unfettered right to cancel will be enforced.¹⁹ However, at least in consumer insurance contracts, such a term might be deemed unfair, and therefore not binding under the provisions of the Unfair Terms in Consumer Contracts Regulations 1999. The insured also has certain statutory rights to cancel an insurance contract, which are independent of that contract.²⁰

It is common for an agreement on insurance to specify that either the contract is not binding or, alternatively, that the contract is binding but the risk does not commence, until a specified requirement is met, such as the payment of the premium or the completion of a satisfactory medical examination. In Canning v Farquhar,²¹ between completing the proposal form for life assurance and his agent tendering the first premium, Canning fell from a cliff and sustained an injury from which he later died. The Court of Appeal held that the insurers were not liable. Lord Esher MR and Lopes LJ decided that the offer was made when the premium was tendered and what came before that time was merely pre-contractual negotiation. Since this represents the majority opinion it is the ratio decidendi of the case, but Lindley LJ reached the same conclusion by a different method. While he agreed that what went on before the tendering of the premium did not amount to a binding contract, he believed it was important since only by referring to what the other judges called negotiations could the terms of the contract be determined. He regarded the offer by the insurers as represented by the proposal plus the extra terms, such as the amount of the premium, which were mentioned later. That offer had been made on the basis of a statement in the proposal that Canning was in good health and since this was no longer true at the time the premium was tendered, the offer had lapsed and could no longer be accepted. On this analysis, if Canning’s health had not changed, acceptance would have been by the prospective insured tendering the premium and not by the insurers accepting it since the offer by the insurers must be capable of acceptance by the prospective insured and this can only be the case if the act of acceptance is tendering the premium.²²

A condition precedent may prevent the contract from coming into existence; or it may suspend either or both parties’ obligations to perform, in whole or in part, until the condition is met, and also it may be that one or both parties is not allowed to withdraw. There may or may not be an obligation on one of the parties to fulfil the condition, so that failure to do so may or may not amount to a breach.²³ Whether a term is a condition precedent and its effect depends on the intention of the parties so merely labelling it as a ‘condition precedent’ is not conclusive. A condition subsequent, on the other hand, is where the contract comes into existence and both parties must perform as agreed, but their obligations terminate on the happening of a specified event. Finally, as will be seen later in the discussion of claims, the policy may stipulate conditions precedent to recovery: the insured may be required to do certain things before the liability of the insurer is triggered, such as inform the insurer of the loss within a particular period of time. But this merely affects the liability of the insurer and not the formation of the contract.

The other point to make is that the formation of the insurance contract is affected by regulatory provisions made under the Financial Services and Markets Act 2000: ‘A firm must take reasonable steps to ensure a customer is given appropriate information about a policy in good time and in a comprehensible form so that the customer can make an informed decision about the arrangements proposed.’²⁴ This will apply to new contracts and renewals.

2.  Premium

Each party to an insurance contract must provide consideration: normally,²⁵ the insured agrees to pay a premium and the insurers promise to provide a benefit in the event of a loss arising that falls within the terms of the policy. The premium will be set by the insurers at a level that attracts business, but that also both reflects the risk of a claim by this insured and, across the business as a whole, is likely to result in a profit.²⁶ The premium will be payable either in a single sum or, more typically in consumer cases, by instalments on credit terms. Even where the premium is payable by instalments, it is still a single premium for the entire period, so that if the risk is terminated the outstanding instalments will still have to be paid on the principle that the risk is not divisible unless the parties have agreed to the contrary.²⁷

The premium is an important aspect of the agreement, and if one has not been agreed by the parties this may indicate that they have not concluded a contract. Where an ‘agreement’ for insurance on building work specified ‘a reasonable premium’, it was held that there was no contract since ‘it cannot be said that there is a sum which can be defined and described as being undisputed’.²⁸ Yet, the failure to set the amount of the premium may not be fatal. In the case of a normal risk, such as involved in burglary insurance or motor vehicle liability, the amount of the premium is set according to the insurer’s usual tariff. Indeed, the Marine Insurance Act 1906, section 31(1) recognises the common practice of effecting marine insurance at a premium ‘to be arranged’ (generally shortened to TBA). If the parties never specify what that premium is, then ‘a reasonable premium is payable’, which means one calculated at the prevailing market rate.²⁹

The premium will usually be a payment of money,³⁰ but can take almost any form as long as there is, in the words of Lush J when speaking of consideration more broadly,³¹ ‘some right, interest, profit, or benefit accruing to the one party, or some forbearance, detriment, loss, or responsibility given, suffered, or undertaken by the other’. For instance, the Marine Insurance Act 1906, section 85(2) recognises mutual marine insurance agreements under which members do not pay a premium but agree to contribute to losses suffered by fellow members as and when they occur.³²

Offers of ‘free insurance’ have sometimes been made by a variety of businesses from credit card issuers to newspapers and car retailiers as a way of enticing potential customers to buy products or as a means of acquiring marketing information about customers.³³ In such cases, even though there is no premium in the form of money, it is not usually difficult to discover consideration. For instance, an agreement to provide insurance might be collateral to an agreement to open a credit card account: in exchange for the promise to provide insurance, the consumer promises to enter into the main agreement. Imperial Tobacco Ltd v Attorney-General,³⁴ while not on the issue of insurance, gives some indication of the willingness of the courts to surmount this problem of consideration in appropriate cases. Purchasers of a certain brand of cigarettes obtained the chance of winning a cash prize, and the House of Lords ruled that, although no extra was charged for the cigarettes, there was consideration for the chance: ‘[W]here a person buys two things for one price, it is impossible to say that he had paid only for one of them and not for the other. The fact that he could have bought one of the things at the same price as he paid for both, is in my view immaterial.’³⁵ In Fuji Finance Inc v Aetna Life Insurance Co Ltd,³⁶ Nicholls V-C did express the view that if there were no attempts to link the amount of the premium to the risk this might indicate that the agreement was not an insurance contract. This might exclude ‘free insurance’ offers since even if it is possible to find consideration it will not be based on an actuarial calculation. It seems better to use the lack of a link between the consideration and the risk as an indicator rather than as conclusive evidence that there is no insurance contract, and to be fair this seems to have been what Nicholls V-C was himself suggesting. In Nelson and Co v Board of Trade,³⁷ Nelson, a firm of tea merchants, offered an annuity for life to customers who were widowed (the offer was only open to women) and who could establish a record of tea-purchases from the company. The customers did not pay a premium, and the funds for the annuity came out of the company’s general profits. There was no policy only a card on which purchases were recorded, but the court found no difficulty in concluding that this was insurance business. However, the issue of the premium was not specifically raised. That case was not followed by the Court of Appeal in Hampton v Toxteth Co-operative Provident Society Limited.³⁸ The society ran a general shop and advertised the offer of ‘free life assurance’. Death benefits proportionate to a member’s expenditure were to be paid out of what was called an ‘Insurance Fund’. The majority of the judges took the view that the lack of either a policy or a premium and the apparent power the society had to stop allocating money to the fund showed that this was not life insurance but merely an allocation of the society’s profits that could be terminated at any time.³⁹

Payment of the premium to a broker is not payment to the insurer, unless the policy otherwise provides: some policies specifically state that the premium is to be paid to the broker. In the context of marine insurance, the obligation to pay the premium rests on the broker and not the assured, and that is the case whether or not the assured has first paid the broker,⁴⁰ so the broker carries the risk that the premium is not paid by the assured.⁴¹In marine insurance, the insurers are not bound to issue the policy until the premium has been tendered,⁴² which has important consequences since, under the Marine Insurance Act 1906, section 22, a contract of marine insurance is unenforceable unless embodied in a policy document.⁴³ Typically, an insurance contract stipulates that the insurers will not be on risk until the premium is paid,⁴⁴ although this requirement can be waived. In a case concerning burglary insurance, the policy document stated that the premium had been paid, so even though it had not, the insurers were taken to have waived the condition for prepayment of the premium and it was, therefore, held that the insurers were on risk.⁴⁵ If the contract does not require the premium to be prepaid, the insured’s promise to pay the premium will be sufficient consideration and, assuming all other requirements for a contract are present, the insurers will be on risk.⁴⁶

The insurers are not entitled to retain the premium unless the risk has begun to run.⁴⁷ Indeed, in marine policies, ‘where the risk has not been run, whether its not having been run was owing to the fault, pleasure, or will of the insured, or to any other cause, the premium shall be returned’.⁴⁸ The premium will be repayable where the insurers avoid the contract because of innocent, non-fraudulent misrepresentation or non-disclosure by the insured,⁴⁹ or where there is a mistake of fact or law which renders the contract void, as, for instance, would be the case if both parties entered into a life insurance contract in the mistaken belief that the insured life was alive.⁵⁰ Where the risk has attached, even if for a shorter period than contemplated by the policy, then no part of the premium is returnable,⁵¹ although of course the contract can expressly provide for a refund in specified circumstances, such as where the policy is cancelled before its normal expiry date.⁵² If the insured has a number of policies each covering the same subject-matter for the full amount of the loss, then, although the insured cannot claim more than an indemnity and so can only claim on one policy,⁵³ the insurers who do not pay out are not required to return the premiums received because they have been on risk.⁵⁴ Similarly, the insurers do not have to return the premium merely because the circumstances in which the loss occurs renders the policy unenforceable. For example, where the insured life commits suicide there may be no claim under a life insurance policy,⁵⁵ but the premium will not be repayable because the insurers would have been liable had the insured died from a cause which was covered.

3.  Benefit

The consideration supplied by the insurers is the promise to provide a benefit in exchange for the premium. That benefit is normally cash, but need not be. The policy may, for instance, oblige the insurers to reinstate the house if it burns down or to replace stolen items.⁵⁶

For an agreement to amount to a contract of insurance the insured must have a legal right to the benefit if the claim falls within the terms of the agreement, and the benefit must have some value. In Department of Trade and Industry v St Christopher Motorists’ Association,⁵⁷ motorists made an annual payment in exchange for which the association promised to provide a driver if the motorist became unable to drive as a result of injury or disqualification. This was held to amount to an insurance contract since there was an obligation to provide a benefit and that benefit, although not a cash payment, had value.⁵⁸

On that reasoning, an agreement will not be an insurance contract where the alleged insurers are not obliged to provide the benefit, but have a discretion whether to do so, or where the benefit is not of value. In Medical Defence Union v Department of Trade and Industry,⁵⁹ the union provided a scheme for indemnifying members where damages were awarded against them in connection with their medical practices, but while members had a right to advice and to have their claim considered, they had no right to demand indemnification, although in practice proper claims were met. Megarry V-C held that this did not amount to insurance. He regarded the right to a benefit as one of the distinguishing features of an insurance contract: ‘When a person insures, I think that he is contracting for the certainty of payment in specified events.’⁶⁰ Furthermore, while the benefit under an insurance policy could be in ‘money or money’s worth … or the provision of services to be paid for by the insurer’, he believed it was important not to adopt too broad a view of what these phrases meant otherwise ‘money’s worth’ could stretch to cover a whole host of benefits: ‘from matters such as peace and quiet to the pleasure of listening to the arguments of counsel in this case, and much else besides’.In his view, the benefit to which the member had a right needed to be more than merely the right to have a claim considered for the agreement to amount to insurance. He, therefore, decided that this scheme did not amount to insurance because members had no legal right to a benefit of value. In reaching this conclusion he seems to have been influenced by a concern that to find otherwise would create difficulties by making a wide range of professional bodies subject to the system of statutory regulation applicable to insurance business. In the circumstances of this case, he believed, ‘one is in a different world from the world of insurance’.⁶¹ This decision was not directly on the issue of contract formation, but it seems likely that, while in Megarry’s view the arrangement did not amount to insurance, there was a contract. The members’ rights to have advice and to have their application considered were of value: certainly, they were in a better position than people who were not part of the scheme.

4.  Mistake

What happens if one or both of the parties is mistaken about some aspect of the agreement? In broad terms, contract law will not intervene. However, where one party misrepresents a fact to another and the other is induced by that misrepresentation to enter into a contract, the innocent party may be able to rescind the contract or obtain damages or both. If there has been no such misrepresentation, there will be no remedy where one party is in error about the nature of the bargain, unless the contract is vitiated by mistake. The position is, of course, more complicated with respect to insurance contracts because they are contracts of utmost good faith, which, as has been seen, places both parties under a duty of disclosure. It is important, therefore, to bear this obligation in mind when considering the operation of the doctrines of misrepresentation and mistake.

The easiest type of mistake to deal with is the clerical error or ‘misnomer’: for instance, during the typing up of the policy the name of the insured is incorrect spelt, or the numbers of a car’s registration plate are transposed, or a particular business activity is described as being undertaken by A Ltd when A Ltd has been taken over by B Ltd.⁶² In such cases the court can construe the contract as if the error had not been made. However, the error must be minor. The test is:

Of more gravity is the situation where a document, which purports to record the agreement, does not in fact do so. The equitable remedy of rectification enables the courts to amend a contractual document, ⁶⁴ although this comes up against the rule that if the parties have put their agreement into writing the court should not look outside the four corners of the document.⁶⁵ The court will not alter the original agreement, it merely alters the document because it does not accurately represent that agreement:⁶⁶ ‘Courts of Equity do not rectify contracts; they may and do rectify instruments purporting to have been made in pursuance of the terms of contracts.’⁶⁷ The courts, therefore, exercise caution in ordering rectification: ‘Men must be careful if they wish to protect themselves; and it is not for this Court to relieve them from the consequences of their own carelessness.’⁶⁸ The court will not order rectification merely because one party is in some way unhappy with the original agreement or alleges a mistake occurred in that agreement, nor will it do so if, on an objective view, the document does accurately represent the agreement.⁶⁹ The conditions required for rectification to be granted are:

The mistake must ‘be proved with a high degree of conviction’.⁷¹ Thus, for example, in Dunlop Heywards (DHL) Ltd v Erinaceous Insurance Services Ltd,⁷² Rix LJ confirmed that ‘convincing proof’ is needed of the alleged common intention by which it is sought to override the evidence of the written agreement.⁷³ The only situation in which the court will order rectification where only one party is mistaken is if the other party knew the document did not comply with the terms of the agreement and also knew the innocent party believed that it did.⁷⁴ Finally, rectification will be barred by lapse of time.

There are two other types of mistake which cause rather more difficulty. The first is where the mistake throws into doubt the existence of the contract; the second is where it is alleged that, while an agreement was reached, it has been vitiated by a later mistake. If the mistake is such that there was never any real agreement, then the court will declare the so-called contract void and order the return of any premium paid.⁷⁵

The fact that one party to a contract realises that the other party is mistaken does not by itself impose a duty to point out that mistake, unless failing to do so would be a breach of the duty of disclosure, or there is an element of misrepresentation or fraud in the concealment.⁷⁶ This is because contracts are about parties making their own bargains and using their own judgement. Therefore, mistakes about the quality of an item or its value are not operative mistakes. It is otherwise if Bill knows or suspects Jane is mistaken, and, although Bill has not induced the mistake, he then makes misleading statements to divert Jane’s attention so that she will not discover the mistake. In such a case the contract is taken to have the meaning which the innocent party believed it had since that is the meaning which the other party intended and which a reasonable person would understand it to have.⁷⁷ Of course, this situation might simply be characterised in terms of a breach of the duty of disclosure or a misrepresentation. Where Mary knows that Ted is mistaken as to the promise she is making, then there will be no agreement,⁷⁸ and indeed it may be that in such a case Mary is acting fraudulently. In The Prince of Wales, &c Association v Palmer,⁷⁹ evidence was brought to show that William Palmer had induced his brother, Walter, to take out a life insurance policy on his own life with the intention of later persuading Walter to assign the benefit of that policy to William and then, in the rather understated words of Romilly MR, ‘precipitating, by his own act, the period at which those insurances were to become claims on the insurance offices’. William was later accused by a coroner’s jury of murdering Walter, but never convicted of that crime, although he was hanged for the murder of John Parsons Cobb. In an action on the policy on Walter’s life, the court concluded that the contract had been entered into for fraudulent purposes, and was, therefore, void.⁸⁰

It may be that there is genuine agreement and no misunderstanding between the parties, but they share a mistaken belief about the existence of a particular state of affairs which is fundamental to the contract: that the person whose life is being insured is alive, the ship is afloat, or the house is standing when, in fact, she is dead, the ship is at the bottom of the sea and the house is a pile of ashes.⁸¹ The House of Lords in the leading case of Bell v Lever Brothers Ltd⁸² clearly wished to limit the possibility of pleading this type of mistake. The case has caused considerable difficulty and attracted much criticism,⁸³ but can be more easily understood if it is recognised that the courts take as their starting point that ‘the law ought to uphold rather than destroy apparent contracts’,⁸⁴ although admittedly this begs the question of how one recognises an ‘apparent’ contract. The decision was by a majority of three to two, and there were some differences in the views of the majority, but they did agree that in order to vitiate a contract the mistake had to be common to both parties and fundamental: ‘something which both must necessarily have accepted in their minds as an essential and integral element of the subject-matter’,⁸⁵ or ‘must render the subject matter of the contract essentially and radically different from the subject matter which the parties believed to exist’.⁸⁶ Shortly after the decision in Bell, Lord Wright, delivering the opinion of the Privy Council in an insurance case, said:

In Bell, the company reached an agreement which provided compensation to two employees whose contracts were being terminated. It was later discovered that the employees had committed breaches of their contracts which would have enabled the company to terminate them without compensation. The House of Lords decided that there was not a fundamental mistake and, therefore, the agreement was not void because the main objective had been to terminate the contracts so as to facilitate a merger and this had been achieved.⁸⁸

In Pritchard v Merchants’ and Tradesmen’s Mutual Life Assurance Society,⁸⁹ the insurers accepted the renewal of an annual life insurance policy without requiring proof of the good health of the insured life, although the terms of the agreement allowed them to demand it. Neither the insurers nor the person renewing the policy was aware that the insured life had already died. The court held that the payment of the premium and its acceptance were founded on a mistake. The court reasoned that the continued good health of the insured life must have been regarded by the parties as central to the contract, otherwise it would have been pointless to mention it.⁹⁰ Similarly, in Scott v Coulson⁹¹ the sale of a life assurance contract was void for mistake because both parties wrongly believed the person whose life was the subject of the contract was still alive. The difficulty with that decision is that it could be seen as a case in which the mistake was not fundamental in that the contract was concerned with the sale of a life assurance contract and the mistake was only about how much that contract was worth. Bell does not preclude the possibility of such mistakes being sufficient to make a contract void, although Scott does show that it is difficult to draw the boundaries around the Bell decision. In Strickland v Turner,⁹² a contract for the sale of an annuity on the life a man who, unknown to both parties, was already dead was held to be void because there was a total failure of consideration, the purchaser having received nothing in exchange for the price paid.

The decision in Bell v Lever Brothers Ltd has been both praised and criticised for narrowing the possibility of the doctrine of mistake: praised because it created certainty and protected innocent third parties who may have acquired the property that had passed under the original contract; criticised because it lacked flexibility. It was the latter criticism that Denning LJ sought to address in Solle v Butcher by devising the doctrine of mistake in equity.⁹³ This doctrine was wider and more flexible than common law mistake, which he claimed to be the basis of the decision in Bell. There were two difficulties: the first was to determine the difference between the circumstances in which common law and equitable mistake operated; the second was that one had to be prepared to accept Denning LJ’s proposition that the House of Lords in Bell neglected to consider the possibility of mistake in equity so that their decision was per incuriam. In Magee v Pennine Insurance Co,⁹⁴ an agreement to compromise an insurance claim was made on the mistaken belief of both parties that the policy was binding when, in fact, it was voidable because of an innocent misrepresentation by the insured. The Court of Appeal held that the insurers could avoid the contract for mistake in equity. The problem with the decision is that it is difficult to distinguish from the facts in Bell, and indeed Winn LJ dissented on that ground. The majority took the view that in Bell the House of Lords had, indeed, been only concerned with mistake at common law, whereas here the issue was one of mistake in equity. This left one wondering why it did not occur to the House of Lords in Bell