Revisiting co-insurance

Fraudulent claims are a particular problem for the insurance industry. Over 140,000 cases are detected annually; amounting to £1bn. Undetected fraud claims are estimated to be double this amount, with available figures indicating a rise of 7 per cent on the previous year.

Since January 2006 fraud has been one of the areas considered jointly by the Scottish Law Commission and the Law Commission as part of a root-and-branch review of insurance contract law. For consumers there is already greater fairness in provisions for proportional indemnity payments where they have made an inadvertently incorrect answer to an insurer’s questions under the Consumer (Disclosure and Representations) Act 2012.

However, as the Law Commission concluded in its review, a new bill should be proposed towards the end of this year that will codify the current common law provisions regarding fraud into statute. The bill will also introduce:

proportional remedies for businesses that make inadvertent non-disclosures or misrepresentations to an insurer;

the insured’s rights to recover damages for late payment in addition to the indemnity; and

damages where insurer causes the consumer insured distress and vexation.

Fraud reforms

One area of insurance fraud that is not undergoing any change, termed by the Financial Ombudsman Service (FOS) as ‘immaterial’ fraud, is set to pit the law and good practice against each other for the foreseeable future. Cases such as Aviva Insurance Ltd v Brown [2011] EWHC 362 (QB) would continue to receive favourable treatment by the FOS. The insured would qualify for the indemnity if the insurer ignored, or was not induced, by the insured’s fraudulent misrepresentation at the claims stage. Comparatively, in law the claim is lost as the insurers’ inducement is not a requirement. So the commission is now considering whether the UK, like other countries, should:

1. allow a co-insured to recover their ?share of a joint policy if their other co-insured has committed fraud against ?the insurer; and

2. how many cases there are of this ?kind annually.
 

If the co-insured’s interests are the same, for example joint tenants, the policy will be classed as joint and the fraudulent co-insured will taint the innocent co-insured’s claim. However if the proprietary interests are different, then a claim is severable (composite) allowing the innocent co-insured to be indemnified. This is termed the ‘traditional approach’.

In Direct Line v Khan [2001] EWCA Civ 1794, the insurer was the victim of Mr Khan’s fraud. Mr and Mrs Khan owned a house as tenants in common. Mrs Khan insured the house and contents with Direct Line and named Mr Khan as a joint policyholder. The house suffered from genuine fire damage. While the insurer undertook the necessary repairs, the Khans were required to find alternative accommodation. Mr Khan claimed that he had found accommodation and to have entered into a rental agreement whereby he had paid a deposit and rent. He proffered evidence of these to Direct Line who reimbursed Mr Khan until the time when the fraud was detected. Mr Khan actually owned the house and the rental agreement and the receipts were a sham. Therefore, Mr Khan had simply lost the opportunity to fraudulently profit at the insurer’s expense from the Khan’s misfortune.

The Court of Appeal held for Direct Line. As both Mr and Mrs Khan’s interests in the property were the same, she forfeited her claim on the basis that it was tainted by fraud. The court would not sever the policy. However, she was wholly innocent and the decision was unduly harsh on Mrs Khan, but unquestionably good for the insurer.

In Parker v National Farmers Union [2012] EWHC 2156 Mrs Parker owned the marital home in her sole name and insured it with NFU, with Mr Parker being named as a joint policyholder. This was a complex case, but NFU proved that Mr Parker was a fraudster. First, he had made a previous fraudulent claim on the contents policy.
Second, he had set out to commit arson against the property. The rationale behind this appears to be motivated by the fact that a demolition order for the marital home had been approved after planning permission was granted for a new dwelling on the same site. This way the insurer would be financing the building of the newly designed house. The court severed the policy as Mr Parker’s interests in the property were different from Mrs Parker’s, although the claim did fail on other points.

These cases can be usefully contrasted with each other. If Mrs Khan had registered the property in her sole name she could have recovered. If Mrs Parker had registered the property in joint names her share would be tainted. There, therefore, appears to be an element of luck involved in the choices made at the time of registration. This begs the question whether the Law Commission is correct to suggest reform.
The traditional approach that is followed in the UK stands in stark contrast to other jurisdictions that have adopted a modern approach, which moves the focus from proprietary interests of the insured to insurance contract construction.

Contractual interpretation

In Ontario, Canada the Court of Appeal adopted the modern approach in Higgins v Orian Insurance Co Ltd (1985) 17 DLR (4th) 90. The insureds were partners who operated a business selling sports goods; they jointly insured the premises and contents with the defendants. Unknown to Higgins, his fraudulent partner had conspired to commit arson against the premises and its contents. The court held Orian liable, but with a caveat that, while the courts should do justice to the innocent, there was a need to guard against the fraudster receiving an indirect benefit.

The Canadian Supreme Court first discussed the ‘modern approach’ in Scott v Wawanesa Mutual Insurance Co [1989] 1 S.C.R. 1445. In this case Mr Scott insured his family home with the defendant. His 15-year-old son deliberately set it alight, causing extensive damage. The insurer refused to indemnify Mr Scott because under the insurance policy the son was also classed as an insured, which tainted the claim. Therefore Wawanesa successfully defended the claim, but this was on an issue of contractual interpretation and not the traditional approach.

However, this case is noted for the minority decision of La Forest J. He suggested that on the construction of a contract the innocent party should be allowed to recover their interest. This was based upon the reasonable expectation of the policyholder. It follows that Mr Scott contracted for the insurance specifically on the basis that the house should be protected, not the son’s personal possessions.

In Tasmania, Australia, the State Supreme Court followed the modern approach in Higgins (but without the caveat) and La Forest J in Scott in Holmes v GRE Insurance Ltd [1988] TASSC 14. Here, a husband and wife insured a store and its contents with the defendant. The husband set the store alight to claim the indemnity as the store was running at a loss. As the wife was innocent, the court allowed her to claim half of all losses, as this was her reasonable expectation under the contract.

In Maulder v National Insurance Company ?of New Zealand Ltd [1993] 2 NZLR 351, the High Court of New Zealand had to determine whether Mrs Maulder could recover her half share of the property in which she was a joint tenant with her husband. Mr Maulder killed himself while setting the house alight. Based on the modern approach in Canada and Australia it was held that she could recover her half share in the property and everything she owned jointly with her husband.

The modern approach above has not only been precedent-based, but statute too has been seen to assist the innocent co-insured, furthering the modern approach. The Canadian province of British Columbia enacted the Insurance Amendment Act 2009 section 28.6(2) which allows the innocent insured to recover his share. This Act specifically targeted the Scott decision as Scott originated from this province. Similarly the province of Alberta enacted the Insurance Amendment Act 2008. This Act amended the Insurance Act 2000, section 541 and the Alberta Fair Practices Amendment Regulations, section 5.9(2). This allowed for the innocent co-insured to recover provided they co-operated with the insurer.

Definition of a victim

In Ireland the law on fraud currently ?follows the UK’s traditional approach. However, the Irish Law Reform Commission (LRC CP 65 – 2011, paragraph 8.50) is recommending that it be replaced by the modern approach, that innocent insureds be allowed to recover where it is proportionate and where the fraudster cannot receive a benefit from the fraud.

It would therefore seem that a large number of the common law countries are affected by this situation and provide a remedy to the innocent insured. The question is whether the UK should do the same. This issue affects every co-insured under a joint policy, whether consumers or businesses. Therefore, there is a potential for all co-insureds to be victims. There is a clear need for justice for the innocent insured, but the insurer is a victim too.

Change is certainly required along some line. As a matter of good practice FOS already allow for the innocent co-insured in a joint policy to recover their share. Therefore it is always worth bearing in mind that FOS should be the first option, especially as it is free to consumers and its decisions are binding upon the insurers. So on this basis it matters not what the fraud is, whether the house is destroyed through a husband’s arson, (which may be motivated by a selfish desire to prevent it becoming part of an acrimonious divorce settlement, or an attempt to solve ailing businesses fortunes) justice should not be refused to the innocent. A balanced and proportionate response is required to prevent the law and FOS’s good practice diverging as it has done since the 1980s.