LIABILITY

6

DENYING LIABILITY

A. Non-disclosure and Misrepresentation

6.01 A reinsurer will expect to be given placing information by the reinsured or its broker in order to inform itself about the risk and assess the value of the business. It is vital that this information is accurate and complete: if inaccurate it may lead to the defence of misrepresentation being raised and, if incomplete, it may lead to reliance on the defence of non-disclosure. It is not uncommon for a risk to turn out to be something quite different from that which the reinsurer intended to reinsure. Reinsurers are quick in those circumstances to look at what was and what was not said about the risk prior to the scratching of the reinsurance contract, to explore the possible defence of non-disclosure or misrepresentation. The defences, if established, will entitle the reinsurer to avoid the contract.

(1) The Duty of Utmost Good Faith

6.02 Before any reinsurance contract is concluded, the reinsured is under a duty to disclose to the reinsurer every circumstance which is material to the risk in the sense that it would influence the judgement of a prudent reinsurer in fixing the premium or determining whether he will take the risk. He is also under a duty not to misrepresent any material facts.¹ This is because a contract of reinsurance, in common with insurance, is a contract based upon utmost good faith between the parties.

6.03 The modern restatement and reformulation of the duty is found in the reinsurance case of Pan Atlantic Insurance Co v Pine Top Insurance Co in which the claimants were reinsured under excess of loss treaties. The reinsurers sought to avoid on the basis of the non-disclosure of the full loss record by the broker and misrepresentation by the presentation of an inaccurate loss record in one year, which failed to include a substantial amount of losses. The judge found on the facts that the full loss record had been available to the reinsurers, even though the risk was broked in a way which concentrated their mind on the short form of record. This, he found, was a fair presentation and the reinsurers ought to have studied the full record. However, he found that the inaccuracy was material and entitled the reinsurers to avoid. It was only in the House of Lords that the right to avoid was rejected, albeit on the grounds of lack of inducement.²

6.04 The basis for the extra-contractual³ duty of good faith is that one party is in a much stronger position than the other to know or to discover the material facts and the other is at the equivalent disadvantage.⁴ Whether the misrepresentation or concealment was the result of ignorance, mistake or was intentional, the outcome is the same⁵ as the duty is not dependent on some unlawful conduct such as a deliberate, fraudulent or negligent failure to disclose. The duty is there to redress the balance in what would otherwise be an unequal bargain. It is arguable whether this justification is applicable in certain classes of reinsurance business. There are some types of broker-led business where reinsurance terms have already been negotiated before potential reinsureds are approached. In such cases the reinsurers and the brokers may have a greater knowledge of the risks and circumstances than the reinsureds themselves. Lord Hobhouse questioned in the film finance cases whether it was appropriate for the duty of good faith to place such a burden on the reinsured.⁶ However, in many classes of reinsurance where contracts are made with minimal formality, on the basis of abbreviated slips and summaries of information, the duty of utmost good faith is vital for ensuring that efficient and reliable business transactions can be made. Reinsurers can quickly sign up to enormous potential liabilities on the slimmest of documentation sure in the knowledge that the duty to give proper disclosure of the material necessary to make a good business decision is firmly on the reinsured and its brokers. A prudent reinsurer will ask questions to ensure that it has a good knowledge of the risk, but the principal duty of ensuring a fair presentation of the risk remains with the reinsured.

(2) Discharging the Duty of Utmost Good Faith

6.05 In general, a reinsurer will be heavily reliant on the reinsured and its broker for information about the risk and the circumstances of the underlying insured. In such a situation there is not simply the usual duty to refrain from material misstatements,⁷ but a positive duty to disclose all known material facts. As Lord Mustill pointed out in Pan Atlantic Insurance Co v Pine Top Insurance Co,⁸ ‘in practice the line between misrepresentation and non-disclosure is often imperceptible’. The line can be blurred even further as in some situations silence, where there is a duty to speak, may amount to misrepresentation.⁹ Usually the distinction will make little practical difference, except that a misrepresentation may also give rise to a claim for damages under the Misrepresentation Act 1967 or a claim for negligent misstatement.¹⁰

6.06 Reinsurance slips usually include information that is subject to the duty of good faith.¹¹ The ‘information’ section on the slip may contain various items of information about the original risk, which will constitute representations of fact (not just belief) by the reinsured to the reinsurer,¹² but are not usually warranties.¹³ Any information that a broker thinks is important to include on a slip is likely to be material to the risk, since its inclusion tends to suggest it was considered relevant to the underwriter’s decision. Other sections of a slip or draft slip may be looked at more critically if it is submitted that they contain or constitute representations of fact. A 50% retention clause in a draft reinsurance treaty was held not to be a representation of the present intention of the reinsured but was simply a condition or obligation of the contract.¹⁴

6.07 In order to comply with the duty of utmost good faith, the underlying insured must disclose to its insurer, the reinsured, every material circumstance known to it. In turn, the reinsured must pass on that information and all other material circumstances within its knowledge to the reinsurer. The reinsured is deemed to know every circumstance which, in the ordinary course of business, ought to be known to him and this will certainly include all the information in the underlying insured’s proposal form and attached information. Material circumstances are those which would influence the judgement of a prudent reinsurer in fixing the premium, or determining whether he will take the risk. However, there is no duty to disclose any circumstance which diminishes the risk or any circumstance which is known or presumed to be known to the reinsurer. The reinsurer is presumed to know matters which it ought to know in the ordinary course of its business and also knows matters which are common knowledge.

(3) Post-contractual Duty of Utmost Good Faith

6.08 Although there is no express restriction of the duty of utmost good faith in s 17 of the Marine Insurance Act 1906 to pre-contractual disclosures, it is clear that the duty of disclosure does not continue in full force after conclusion of the contract of reinsurance.¹⁵ The duty will be revived by an amendment or variation to the reinsurance contract as the parties are entering into a partially new bargain, but the new duty of disclosure only applies with regard to any matters which are material to the variation. Although it is possible to incorporate an express continuing obligation of disclosure it is difficult if not impossible to imply one. There is a clear distinction between the pre-contractual duty of disclosure and any continuing duty, the main difference being that it would be inequitable to allow a reinsurer to avoid a contract ab initio for a breach of good faith which might occur long afterwards.¹⁶ Where a false statement is made to a reinsurer after it has scratched the reinsurance slip, that reinsurer cannot avoid the policy as the false information was not relevant to its decision to accept the risk.¹⁷

6.09 The Court of Appeal in Bonner v Cox¹⁸ noted with apparent approval that Morison J ‘was clearly inclined to feel’ that the scratch on the slip ought to be the moment in time up to which the duty of disclosure should run. The Court considered that Morison J probably had in mind a passage in the judgment of Lord Hobhouse in The Star Sea¹⁹ to the effect that an underwriter cannot depart from the terms thus agreed in the slip ‘without a breach of faith’ so that there is no duty to disclose information which ‘would expose him to a temptation to break his contract…he [the insured] is not bound to lead his neighbour into temptation’.²⁰ This accords with the approach of the Marine Insurance Act 1906 under which the obligation to disclose is before the contract is concluded in circumstances where s 21 provides that a contract is ‘deemed to be concluded when the proposal of the assured is accepted by the insurer, whether the policy be then issued or not; and, for the purpose of showing when the proposal was accepted, reference may be made to the slip…’. In Bonner the experts (and therefore the parties) agreed that disclosure should continue until the reinsured accepts the offer by becoming a party to the cover as at that moment the contract is made and the pre-contractual duty of disclosure comes to an end.²¹

6.10 Whatever post-contractual duty of good faith exists, it probably adds little to the reinsurer’s armoury of defences as it will be co-extensive with its contractual rights to terminate for a repudiatory breach, such as fraud in the making of a claim under the policy.²² Once the contract has been made and the claims process has begun, the inequality of bargaining and information which existed pre-contract is no longer relevant.²³ The reinsurer is able to, and often will, send its loss adjuster or other agent to investigate independently before paying a claim.

6.11 Continuous contracts of reinsurance will contain provisions permitting cancellation at each anniversary date. Reinsurers will often either write or stamp on the slip with the letters ‘NCAD’ meaning ‘Notice of Cancellation at Anniversary Date’ (the effect of which will be that a notice of cancellation is treated as having been served at each anniversary date) or serve a provisional notice of cancellation. In the latter case the notice is ‘provisional’ (rather than definite) in that the reinsurer is indicating a willingness to consider continuing with the contract. The existence of a right to serve a notice of cancellation does not give rise to a duty on the reinsured to give material disclosure of matters that might cause it to exercise that right.²⁴ In Iron Trades Mutual v Companhia de Seguros Imperio,²⁵ Hobhouse J held that a duty of disclosure did not arise by virtue of the service of a notice of cancellation either, on the grounds that the reinsured might be indifferent as to whether the reinsurer remained on risk. The reinsured’s only duty would be not to misrepresent any material facts. In Kingscroft Insurance Co v Nissan Fire & Marine Insurance Co (No 2)²⁶ Moore-Bick J suggested that what Hobhouse J had said in the Iron Trades case only applied where the reinsured simply waited for the reinsurer to approach him with a request to withdraw the cancellation but it would be surprising if the existence of a duty of disclosure depended on who approached whom first. In the Kingscroft case, the reinsurer purported to withdraw its notice of cancellation. The issue for Moore-Bick J to decide was whether the reinsurer could rely on any misrepresentation or non-disclosure prior to inception of the contract in relation to the contract as continued after withdrawal of the notice of cancellation. He held that it could:²⁷

Giving provisional notice of cancellation meant that the contract would automatically terminate in the absence of some further agreement between the parties. By providing statistics for Nissan’s consideration Weavers were, in effect, inviting it to continue on the same terms. It was not a case of a simple variation, but equally it was not a case of presenting a completely new risk. In my judgment the parties continued to owe each other a duty of the utmost good faith, but it was one which was conditioned by the existing relationship between them. Any misrepresentation or failure to make proper disclosure at the time when the treaties were originally offered to Nissan could still be presumed to have its effect on the mind of the underwriter, unless it had been overtaken by subsequent events.²⁸

6.12 As has been explained in Chapter 2,²⁹ it is common for a series of reinsurance contracts to be made over a period of time as various reinsurers scratch a slip that is passed around the market. If information comes to light during the course of this process it can place a reinsured in a difficult position whereby the information has not been disclosed to the first reinsurer to scratch, but must be disclosed to all potential following reinsurers. The usual duty of utmost good faith has expired in relation to the earlier reinsurer and so there is no duty to go back and make disclosure, but it still survives in relation to the following reinsurers who may well insist on a different premium or different terms when the disclosure is made. The reinsured may as a result end up with different terms and conditions applying to one reinsurance slip. The earlier reinsurer should protect itself against such a situation by the inclusion of a term that it will be entitled to the benefit of any more advantageous terms or conditions imposed by the following market. It must be remembered that each reinsurer on the slip is treated as a separate party and a non-disclosure to one is not necessarily a non-disclosure to all and in particular each must show actual inducement.³⁰ However, the fact that a non-disclosure has been made to a leading underwriter whom other reinsurers are following and relied upon might itself be a material fact that needs to be disclosed to that following market.³¹

B. Elements of the Duty of Utmost Good Faith

6.13 Using the analysis derived from the leading case of Pan Atlantic Insurance Co v Pine Top Insurance Co,³² there is a duty to disclose and not to misrepresent facts:

(1) Materiality

6.14 Both a misrepresentation and a non-disclosure must be of a material fact. Whether any particular circumstance is material or not is, in each case, a question of fact. The starting point for the objective test is the definition taken from s 18(2) of the Marine Insurance Act 1906:

Every circumstance is material which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk.

6.15 The Court of Appeal³³ approved this test for use in general insurance and held that the presentation of the risk must be fair and substantially accurate. Kerr LJ said:³⁴

The question is simply to ask oneself having regard to all the circumstances known or deemed to be known to the insured and to his broker and ignoring those which are expressly excepted from the duty of disclosure, was the presentation in summary form to the underwriter a fair and substantially accurate presentation of the risk proposed for insurance so that the prudent insurer could form a proper judgment either on the presentation alone or by asking questions if he was sufficiently put on inquiry and wanted to know further details whether or not to accept the proposal and, if so, on what terms.

6.16 A prudent reinsurer may want to be aware of facts that influence considerations other than merely premium and risk, although these two would seem to cover most situations in practice.³⁵ It is an objective test which judges materiality against what the hypothetical reasonably prudent insurer would have wanted to be aware of in the circumstances.³⁶ The CTI test goes further than the ‘Decisive Influence’ test (that the fact must be capable of having a decisive influence on the mind of a prudent insurer) which was rejected by the House of Lords in Pan Atlantic Insurance Co v Pine Top Insurance Co as the judgement of the insurer is his decision and evaluation process, not only his decision. The CTI test also goes further than the ‘Increased Risk’ theory that the fact must be one which a prudent insurer would have regarded as increasing the risk.³⁷ A full and detailed presentation of facts is not required in all circumstances. Provided that the presentation of the material facts in summarized form is done fairly, there is no need for more: it is fair presentation on which the London market practice as well as the law is based.³⁸

6.17 In reinsurance most material facts will revolve around those circumstances which affect the subject of the cover, the ‘Physical Hazard’ such as the previous claims history of the reinsured or the particular class of reinsurance contract that is being offered. The nature of the risks underwritten by the reinsured is likely to be material.³⁹ Even a relatively minor inaccuracy in the loss history of the reinsured may be a matter that would affect the mind of a prudent reinsurer, so key can it be to the reinsurer’s decision making process.⁴⁰ However if insurance is written in the normal course of the business and that is what reinsurers were agreeing to cover, then no question of non-disclosure could arise. Also if a reinsurer fronts a risk (taking out 100% retrocession) it may have no interest in the nature of the business being written.⁴¹

6.18 Also of interest to a reinsurer may be the ‘Moral Hazard’ of the underlying insured,⁴² but there will also be many circumstances, particularly in relation to treaty reinsurance, in which there is a duty to disclose facts relating to the business of the reinsured itself. Of particular interest may well be the amount of the reinsured’s retention,⁴³ and the absence of a significant retention on the part of the reinsured may be a material matter, but this is usually something that the reinsurer would be expected to ask about.⁴⁴ A treaty reinsurer may also want to know about the underwriting policy and history of the reinsured and about the classes of business that the reinsured usually writes.⁴⁵ All these matters are likely to be material, but expert evidence should be called to substantiate materiality in most cases.

6.19 A fact that diminishes the risk is not disclosable and neither is a fact that is relevant to the reinsurer’s own reinsurance (or retrocession) arrangements rather than the reinsurance between reinsured and reinsurer. The fact that a reinsured knows that its reinsurer’s retrocession agreement is ineffective is not a material circumstance in relation to the reinsurance contract. A reinsurer’s own arrangements for reinsuring a risk are not matters which would influence the judgement of a prudent insurer in fixing the premium of the underlying reinsurance, or determining whether he will take the risk. There is no obligation to disclose matters relevant only to a different contract to which the reinsured is not a party as the whole basis of the duty of disclosure is to reveal matters within the peculiar knowledge of the reinsured.⁴⁶

6.20 Only facts need to be disclosed and not mere opinion, so the reinsured does not have to disclose matters that he has inferred from disclosed facts, unless the risk is so unusual that the reinsurer cannot be fairly expected to make his own inferences.

6.21 It is not consistent with s 20(5) of the Marine Insurance Act 1906 for a representation of expectation or belief to be subject to an implied representation that there are reasonable grounds for that belief.⁴⁷ As the statute deems an honest representation as to a matter of expectation or belief to be true, there is no scope for inquiry as to whether there were objectively reasonable grounds for that belief. However what may appear to be a representation merely of expectation or belief could in reality be an assertion of a specific fact governed by subss (3) and (4) rather than subs (5) of s 20.⁴⁸ There must be some basis for a representation of expectation or belief before it can be said to be made in good faith.⁴⁹

(2) Inducement

6.22 Pan Atlantic Insurance Co v Pine Top Insurance Co⁵⁰ brought the law of insurance and reinsurance contracts into line with general contractual principles by adding another limb to the materiality test. The reinsurer must have been induced to enter into the contract by the reinsured’s non-disclosure.⁵¹ Therefore once the objective test has been fulfilled the reinsurer must yet show the subjective element to avoid the reinsurance contract. The question of the extent to which the reinsurer needs to be induced is not expressly dealt with in Pan Atlantic Insurance Co v Pine Top Insurance Co. Reinsurance law can draw upon general contract law and the test for misrepresentation. In such cases the representation need not be the sole inducement, but must have been a real and substantial cause affecting the decision of the representee to enter into the contract, or to do so on the terms agreed.⁵² Clarke LJ adopted this approach in Assicurazioni Generali SpA v Arab Insurance Group⁵³ in which he said:⁵⁴

It seems to me that the true position is that the misrepresentation must be an effective cause of the particular insurer or reinsurer entering into the contract but need not of course be the sole cause. If the insurer would have entered into the contract on the same terms in any event, the representation or non-disclosure will not, however material, be an effective cause of the making of the contract and the insurer or reinsurer will not be entitled to avoid the contract.

6.23 No qualification to the inducement is made in that case, which may imply that any inducement to enter into the policy will be sufficient. The position is clear in cases where the reinsurer will say in evidence that he would not have agreed to reinsure had he known of the undisclosed facts. This position in practice is uncommon, as when a factor affecting the risk is known it often results in a change in the terms; by additional subjectivities, exclusions or simply an increase in the premium. However, a contract with additional exclusion clauses or at a higher premium is not the same contract that the reinsurer was induced into entering, and thus there should be sufficient inducement to avoid the contract.

6.24 Reinsurers can rely on the presumption of inducement which is of particular significance in cases where the underwriter cannot be called because he has died or has lost contact with his former employers.⁵⁵ It is not applicable where the underwriter gives evidence and that evidence is inconclusive on the question of actual inducement.⁵⁶ In St Paul Fire & Marine Co (UK) v McConnell Dowell Constructors⁵⁷ one of the insurers failed to give evidence of inducement and was held to be able to rely on this presumption which had to be rebutted by the assured.⁵⁸ The presumption arises once materiality is proved. Inducement cannot be inferred in law simply from the presence of a material non-disclosure or misrepresentation, but there may be cases where the materiality is so obvious as to justify an inference of fact that the representee was actually induced. In such exceptional cases, the inference is only a prima facie one and may be rebutted by counter-evidence.⁵⁹ The presumption simply operates where the evidence before the court is enough to lead to the inference that the reinsurer was, as a matter of fact, induced to enter into the contract.⁶⁰

(3) Knowledge of the Reinsured

6.25 The duty on the reinsured is essentially to make a fair presentation of the risk to the reinsurer of all material facts within its knowledge. It affords no defence to the reinsured that he mistakenly or forgetfully failed to disclose, as there is an absolute duty to disclose all facts known to a reinsured or, often, his broker. The duty, however, is limited to circumstances which are known or ought to be known to the reinsured. The reinsured is not under a duty to make inquiries or investigations as to facts outside his knowledge⁶¹ although there is a duty to disclose matters which are within its constructive knowledge to which it has turned a blind eye. If the reinsured, suspicious of a material circumstance which ought to be disclosed, turns a blind eye and refrains from inquiry, he is to be regarded as knowing whatever such inquiry would have revealed.⁶² However, the test of the reinsured’s constructive knowledge is not an objective test of what ought to be known by a reasonable, prudent reinsured carrying on a business of the kind in question, but a test of what ought to be known by the actual reinsured in the ordinary course of carrying on his business in the manner in which he carries on that business. A failure to disclose a matter that would and should have been revealed by the reinsured’s ordinary and reasonable inquiries is likely to be a non-disclosure.⁶³ However, in the ordinary course of business a reinsured is not taken to know that it is being defrauded.⁶⁴

6.26 The reinsured will also be deemed to know certain circumstances. In London General Insurance Co Ltd v General Marine Underwriters’ Association Ltd⁶⁵ it was held that a reinsured was deemed to have knowledge of a casualty slip received by the underwriters employed by them. The underwriters had in fact done nothing to make use of the information contained in the slips. In contrast, in Simner v New India Assurance⁶⁶ the reinsured and its broker were unaware of large scale losses when they signed up to a binder and then placed stop loss reinsurance, telling the reinsurers that there were no claims figures. The original broker who placed the binder knew about the claims, but had told only the leader and not the reinsured, and had no duty to forward new information on to the reinsured once he had signed up to the insurance.

6.27 The judge in Simner v New India Assurance summarized the law stating that the knowledge of an agent of the reinsured will be deemed to be within the knowledge of the reinsured in three situations.

6.28 The first is where the agent is relied on by a reinsured for information concerning the subject matter of the proposed reinsurance.