ARTICLES

MANAGING THE RISKS OF INSURANCE Fred Hawke* This article discusses three possible scenarios of insurance risk ­ security risk, policy risk and claim risk. It article provides practical guidance on how best to minimise the insurance risk. The object is to ensure that, so far as possible, insurance policies operate as they are intended by the parties to do and that the benefits and limitations of insurance itself, as a component of the risk management process, are fully understood. A number of basic principles of commercial insurance are discussed, along with some common misconceptions regarding them and the practical difficulties which can arise in dealing with them. As will be seen, it is usually preferable to address these problems at the underwriting stage of the insurance process, rather than in the context of a disputed claim. 1. INTRODUCTION Insurance is a tool of risk management ­ perhaps the best known and longest established such tool ­ but what happens when the management tool itself fails to function? How do you manage the risk that your insurance itself may fail to perform, in whole or in part, as anticipated? The problem may be broken down into three basic categories of insurance-related risk: Security Risk: The possibility that the insurer itself may be unable to honour its contractual commitments, as a result of insolvency caused by fraud, poor underwriting, mismanagement or simply an overwhelming combination of losses; Policy Risk: The possibility that the insurer may be empowered to avoid the policy, due to nondisclosure or misrepresentation by you or by another named insured, or that the policy itself may not operate in the manner anticipated; and Claim Risk: The possibility that the insurer may be able to avoid paying a claim:

· · · 2. because the matter falls outside the scope of the Insurance Agreement proper; because the matter is specifically excluded; or because of failure by you or by another insured to comply with an operational term of the policy. SECURITY RISK

2.1 Solvency and Capital Adequacy Until relatively recently, this was generally regarded as the least serious of the risks normally associated with corporate and financial insurance. While insurers and reinsurers can and do

* Partner, Clayton Utz.


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occasionally get into financial difficulties or fail outright,1 the standard of prudential regulation in Australia is high and both capital adequacy and solvency margins are strictly enforced by the Australian Prudential Regulatory Authority ("APRA"). The governing statute is the Insurance Act 1973 (Cth), as amended, ("the Insurance Act") and the basic requirements for an intending insurer to be authorised to underwrite general insurance business in Australia were, until recently, if it had share capital, its paid up capital must always be at least $2 million. In addition, the value of its assets were at all times required to exceed its liabilities by at least the greatest of:

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$2 million; or 20% of its premium income during the immediately preceding financial year; or 15% of its outstanding claims provision at the end of the immediately preceding financial year.

In the case of a foreign insurer doing business in Australia, the value of the assets held in Australia were required to exceed the amount of its Australian liabilities by the same margin.2 All insurers were also required to have in place satisfactory reinsurance arrangements, approved by APRA,3 to manage any risk which might otherwise compromise their solvency margins. The Australian Standard which has traditionally governed general insurance company accounting is AASB 1023, in accordance with which an insurer must set a provision for its outstanding claim liabilities which fairly reflects its exposure, at present dollar values.4 In other words, the insurer is not required to set aside the actual dollar amount of all those anticipated future liabilities, in its current accounts. It must, however, set a provision which will be adequate to cover them as and when they fall due, given the anticipated rate of loss crystallisation and the reasonably expected return on investments.5 This is not so difficult in the case of direct loss or "two party" insurance, where coverage can be determined and losses assessed reasonably promptly and nearly always within the same financial year as the loss occurrence, but it can be more complicated for insurers which underwrite significant amounts of "three party" or liability insurance. With effect from 1 July 2002, very significant changes in the prudential management and accounting of Australian General Insurers came into effect. These are the requirements of the General Insurance Reform Act 2001 (Cth), which substantially amends the Insurance Act to create a new, three-tiered supervisory regime.

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Some of the more spectacular examples in Australia, during the past two decades, have been Palmdale AGCI (bad investments); Bishopsgate Insurance (Australia) Limited (Director fraud); National Employers Mutual (poor underwriting and under provisioning), Occidental and Regal Life (external fraud) and, of course, HIH. Followers of Australia's top-rating insurance soap opera, the HIH Royal Commission, will be able to draw their own conclusions regarding the reasons for its failure. Section 29 Insurance Act. Under section 34 of the Insurance Act. "Reinsurance" is simply insurance for insurers: the means whereby risk which an insurance company may underwrite, above its retention capacity, is laid off into the wider market. It has sometimes been described as "insurance between consenting adults". As required by section 44(2)(h) of the Insurance Act. Hawke, Claim Reserves - Perspective of a Claims Manager, paper included in Challenges and Resolutions, proceedings of the 1993 Australian Insurance Law Association National Conference; see also Lamble and Wehby, Reality in Financial Reporting (1993) 16(2) AIIJ 14.


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The first level consists of the amendments to the Insurance Act itself, imposing a number of substantially more onerous corporate governance requirements upon general insurers, including a fit and proper person test for directors and a requirement for a majority of non-executive directors, prescribed terms of reference for an audit committee and the appointment of an Approved Actuary. Previously, only life insurers have been subject to legislative requirements that they consult actuaries in connection with the reserving and pricing of their business. Whistle blowing responsibilities, similar to those imposed upon the Appointed Actuaries of life companies, have been given to the Approved Actuary and APRA's powers of intervention, in circumstances where it has any reason to believe that there may be a risk to a general insurer's assets or its ability to fulfil its obligations toward its policy holders, have been considerably strengthened. The potential for personal liability to damages and/or civil penalties, on the part of directors and other persons involved in the management of general insurers, has also been enhanced.6 The second tier of new regulation is the formulation by APRA of Prudential Standards for the management and accounting of general insurers, of which the following six have so far been released:

· · · · · · GPS 110 ­ Capital adequacy; GPS 120 ­ Assets in Australia; GPS 210 ­ Liability Valuation; GPS 220 ­ Risk Management; GPS 230 ­ Reinsurance; and GPS 410 ­ Transfer and Amalgamation of Insurance Business.

In the words of APRA: "These Standards, in combination, require general insurers to have in place appropriate risk management procedures and internal systems of control to manage risks with the potential to undermine the financial soundness of the insurer. Risks that cannot be effectively and efficiently mitigated should be covered by capital, giving the insurer a very high prospect of survival as a viable, ongoing concern. Insurance companies will be required to rigorously self-assess and attest to their own compliance with these Standards."7 While the Prudential Standards now articulate the principal compliance obligations on Australian General Insurers and a revised version of AASB 1023 (still in preparation at the time of writing) will govern their accounting standards, additional guidance is provided by the third tier of regulation, the APRA Guidance Notes. These are issued in conjunction with the Prudential Standards and refer to them, fleshing out the requirements in considerably more detail but still leaving the insurers room and responsibility to apply the underlying principles of the Prudential Standards to their particular business profiles and circumstances. For example, in addition to increasing the lowest amount of capital which a general insurer can have from $2 million to $5 million, GPS 110 Capital Adequacy and the five Guidance Notes issued under it create a far more sophisticated basis for determining an insurer's Minimum Capital Requirement ("MCR") than the simple, assets over premium income or outstanding claims test under the old legislation, described in paragraph 2.2 below.

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For a comprehensive overview of the aims and objectives of the General Insurance Reform Act 2001 (Cth) see APRA Policy Discussion Paper ­ Prudential Supervision of General Insurance ­ March 2001. APRA Discussion Paper op cit at p 8.


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It should be kept in mind that APRA prefers general insurers to hold "eligible" capital (as defined by GGN 110.1) in excess of their MCR. As to calculating the MCR itself, there are two options available to the insurer:

· · the Internal Model Based method, developed by the insurer by reference to its own resources and business profile but in accordance with criteria set out in GGN 110.2; or the Prescribed Method. This method essentially involves calculating the Capital

Requirements in respect of three distinct areas of risk and combining them to form the MCR. These are the Insurance Risk, the Investment Risk and the Concentration Risk and the methods of calculating the capital charges attributable to them are set out in GGN 110.3, GGN 110.4 and GGN 110.5 respectively. A detailed exposition of these methods is beyond the scope of this article, however, illustrative calculations are available in the attachments to the Guidance Notes. A similar degree of sophistication is being brought to the implementation of the other Prudential Standards listed above, especially the four other critical ones relating to Assets in Australia, Liability Valuation, Risk Management and Reinsurance. The result should be a significantly enhanced level of confidence in the security of the Australian General Insurance Industry, at the cost of some further premium increases and reduction in competition as insurers which are unable or unwilling to comply with the new requirements either merge their businesses or leave the market. As we shall see below, however, improved regulation can only take us so far in assessing and managing the security risks which insurers present. 2.2 Reserves and Ratings In the 1992 edition of the Australian Insurance Institute Study Text, Insurance Company Operations,8 it is pointed out that: "... the insurance industry is unique in that its largest single liability is not one readily amenable to accurate quantification and ... there is little consensus around the world on how to measure the adequacy of claims provisions. Claims provisions make up about one half of the total liabilities appearing in the balance sheets of insurance companies in Australia." In the case of liability policies, what is being insured against is not a direct loss suffered by the policy holder, through injury or damage to itself or its own property, but the policy holder's possible liability to a third party for having caused it to suffer personal injury, property damage, financial loss or whatever. In the case of these classes of insurance, which include occupiers liability, professional indemnity, director's and officer's liability and other commercial insurance lines, there will often be a substantial hiatus ("the tail") between the trigger of coverage under the policy, whether it be the occurrence of injury or damage to a third party or the making of a claim upon the insured in respect of it, and the eventual settlement of the claim under the policy. The tail can sometimes be many years long and it will often be several years after a policy is triggered, before the insurer can estimate accurately what its eventual dollar pay out is likely to be or even confirm that its policy covers the loss.9

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Associateship General Program Subject III: Insurance Company Operations, copyright 1992 Australian Insurance Institute, at pp 54 and 55. For example, the amount of an insured's potential liability, or even the making of a claim against the insured, may be contingent upon the outcome of future litigation or on some event quite outside the insured's or the insurer's control, such as the outcome of an argument to extend a limitation period, or of


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Under these circumstances, claim reserving becomes an art as much as a science and the insurer's Approved Actuary and Financial Controller, in determining the Outstanding Claims Provision for the purposes of the statutory accounts, are highly dependent upon the individual claim reserves set by the Claims Manager and his or her Examiners. These are the people who deal with the individual claims made under the insurer's policies, investigating, accepting and settling them in accordance with the insurer's legal obligations. In setting the reserve against a particular claim file, the Claims Manager should not be concerned with the present value of money or with how the company provides, in its general accounts, for the present cost of that future liability. Funding, discounting and the taxation implications of claim provisions are the proper responsibilities of the Approved Actuary and the Financial Controller, who uses the claim reserves as the raw data for such calculations. The business of the Claims Examiners is to estimate, as promptly and accurately as possible on the basis of all available information, evaluated in the light of their own invaluable personal experience, the likely total number of dollars which the insurer is eventually going to have to pay in respect of each reported actual or potential claim.10 This figure should include both indemnity and expenses associated with the claim, other than the insurer's own operating costs. The setting of timely and accurate liability claim reserves is notoriously difficult and contentious, since, by the very nature of the process, these two characteristics will often be mutually exclusive.11 On the regulatory side, there is tension between APRA's desire to see insurers conservatively provisioned, and the Australian Taxation Office's concern that claim reserves be fully justifiable and not used as a means of artificially reducing declared profits. On the corporate side, since the claims experience of a line of business impacts directly upon the premium rates charged, the trade off is between under reserving, which may lead to business being written at unprofitable rates or to unjustified dividends being declared; and over reserving, which may prompt the insurer to increase its rates to the point where it becomes uncompetitive in the market. These factors can sometimes lead to conflicting pressures upon the insurer's claims staff or to management intervention, compromising the claim reserving process. Upon the integrity of that process hangs the accuracy of the insurer's Outstanding Claims Provision, and therefore its statutory accounts. Under these circumstances, mere outward compliance of the insurer with AASB 1023, with the Statutory Solvency Margin and Prudential Standards may provide little real guidance as to the insurer's security status and claims paying ability. An important consideration, therefore, in the selection of an insurer, is the independence and professionalism with which its claims staff set their reserves and the corresponding reliance which may be placed upon the accounts. Fortunately, there are rating agencies active in the field whose

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a third party's Objection to a taxation assessment. Hawke, op cit. See also Miller, Claim Reserves in a Practical Light, an Insurer's Perspective, in the same publication. Insurers normally reserve their claim liabilities net of coinsurance but gross of reinsurance, in accordance with proper accounting treatment of actual liabilities. Reinsurance is brought to account as a recovery. A claim development factor for Incurred but not Reported losses, and for Incurred but not Enough Reported, is added to the total portfolio reserves along with an allowance, if appropriate, for super-imposed inflation. See Andrews and Pearson, Public and Products Liability - Experience, Expectations, Expensive? Paper presented to the Australian Association of Insurance Accountants 1997 General Insurance Conference, 4 June 1997; also Backe-Hansen, A Paper on Aspects of Broad Form Liability, presented at the Australian Insurance Institute Queensland Branch Liability Seminar, 25 July 1996.


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specialised evaluation of insurers focuses, among other things, upon the integrity of their claim evaluation and reserving processes and their independence of underwriting and general management. The best known of these agencies are AM Best, Moodys, Fitch and Standard and Poors, and a AAA or AA Plus Claim Paying Ability from one of them is as good a warrant as you can obtain of an insurer's basic financial soundness. So far as anything less than an A rating is concerned, it does not necessarily mean that the insurer will not still be there or will be unable to pay your claim if and when it arises, however the question of security, as an insurance risk, becomes progressively more sensitive as the rating level declines. As you would expect, there is some correlation between underwriter security rating and premium levels charged and the prudent business insured will rely upon its Risk Manager, or upon the advice of an experienced General Insurance Broker, in deciding at what point the premium advantage of dealing with lower rated insurers is offset by the higher risk of non payment of claims. An additional factor to be taken into account in this calculation is the insurer's presence, or lack of it, in the local market and its representation in the jurisdiction. While all foreign and locally incorporated insurers which actually transact the business of insurance in Australia are subject to the solvency and regulatory requirements discussed above, in these Internet days there is nothing to prevent you from buying your coverage off the website of the Waffle and Jargon Insurance Company, of which neither APRA or your Broker has ever heard and which is incorporated in the Turks and Caicos Islands, if you are feeling lucky. Getting your claim paid three years later, when the only address for service on the policy is a post office box in Grand Turk, may present some challenges however. To use a less extreme example there is often an advantage, in terms of price or capacity, to placing your insurance directly into the London or US markets rather than locally, even though some insurers in those markets have Australian offices or subsidiaries. The great majority of those underwriters are honourable, as are the legal systems of the jurisdictions in which they do business. In the case of underwriters at Lloyds, their local representatives are themselves subject to separate provisions of the Insurance Act.12 Nevertheless, as a matter of practical reality, claim negotiations often proceed more slowly where one party is located entirely out of the jurisdiction. It is also fair to say that insurers whose primary markets are overseas, tend to be less sensitive to such commercial pressure as local policy holders even substantial corporate ones can exert on their own, than are the local players.13 3. POLICY RISK 3.1 Scope of the Contract The main concern here is to ensure, firstly, that the insurance policies purchased are appropriate for your business needs; and secondly that their operation is not compromised by breach either of the Duty of Disclosure or of any of their operative provisions. With regard to the first question, it is surprising how often basic features of insurance contracts are overlooked, by both lawyers and business people, in drafting and negotiating the "Insurance Provisions" of commercial agreements. For example, in the case of the insurance of liabilities, it is

12 13

Currently Division 6 and the Schedule. One of the advantages of placing your insurance through a major, international insurance broker, or at least one with good connections in the overseas markets.


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axiomatic that insurance follows the liability, and not the other way around. Accordingly, all potential liabilities need to be identified and clearly defined before such insurance is taken out. It is quite pointless, therefore, to agree the terms of a contract with (for example) a service supplier or outsource contractor, so that they substantially limit that party's liability for negligence or breach of the contract, then to stipulate that they must take out product liability or professional indemnity insurance to cover the balance of the risk. Those policies will only oblige the insurers to indemnify against legal liabilities of their insured; and if the contractor or supplier is not liable to you, under the terms of your contract with it, then neither will its insurer be obliged to settle your claim. The insurer can simply insist that its policy holder deny liability and defend the claim, indemnifying it for the legal costs of defence if necessary. This is in fact what frequently occurs in product liability cases, where the insured may feel that it has a moral or business obligation to compensate a business customer, for damage caused by a defective product, but the terms of contract effectively limit its liability to the replacement cost of the product in question.14 It follows that if you are unable to negotiate to avoid the contractual limitation of liability, in respect of a particular category of loss, it is better to insure the relevant risk directly. Put more succinctly, unless the burden of a particular loss actually falls on a party, that party's insurance generally will not respond to it. That, in a nutshell, is the Principle of Indemnity.15 By the same token, if your contractual arrangements place the risk and the burden of loss of or damage to particular property solely upon the counterparty, at a given point in time, then that is the party for whose benefit they must be insured. While a strict legal or equitable interest in damaged property at the time of actual damage is no longer required,16 the person claiming under a policy in respect of that damage must still have suffered or stand to suffer some form of pecuniary loss as a result of it, in order to be entitled to indemnity. In other words, the loss of or damage to the property insured must result in some financial or other detriment to the insured to enable them to claim, although they do not have to be the owner of it. Otherwise insurance is no more than a bet and would be legally unenforceable. Another point to bear in mind, when considering the range of insurances required in respect of a particular facility or project, is that the names given to policies do not always reflect the ordinary person's understanding of those terms. This is partly due to the insurance industry's traditional (and annoying) propensity for attaching its own, arcane meanings to everyday words. "Average" for example, when you see it in a policy, has nothing to do with the common understanding of that term as the arithmetic mean of a series of values. In Marine insurance, it can mean a loss under the policy (general average or particular average17). In Property insurances, average is another

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Which, incidentally, is almost invariably excluded from cover under such a policy. As to which see the ancient and venerable, but still very relevant, case of Castellain v Preston (1883) 11 QBD 380. Section 17 Insurance Contracts Act 1984 Commonwealth (the Insurance Contracts Act). Thought to be from the French "Avarie" or early Italian "Avaria", meaning simply "loss", but who knows?


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term for co-insurance, the common contractual requirement that an insured which has underinsured its property share proportionately in the burden of losses within the policy limit.18 In the case of policy names, confusion sometimes arises as a result of the piecemeal way in which particular types of insurance have evolved to cover specifically defined risks, while excluding others which might be thought to fall conceptually in the same category. You will usually find, however, that when the operation of the exclusion is analysed, the underlying philosophical reason for it becomes apparent. For example, it has long been the general rule that Product Liability insurance covers only liabilities associated with third party personal injury or property damage, caused by an insured's product,19 and does not respond to the so called "efficacy risk" of the products themselves simply failing to function as represented and intended. While it is sometimes said that such policies do not cover contractual liabilities, that is not strictly correct. A product liability policy will respond if an insured is sued in contract, in respect of personal injury or property damage caused by the product, provided that the warranty or other term allegedly breached is one imposed under the general law.20 What it will not respond to is a liability of the insured for having merely failed to fulfil its performance obligation under the contract, to supply a product which is of merchantable quality, is fit for its intended purpose, corresponds to description or sample etc etc. By the same token, Professional Indemnity insurance normally only covers the liability for resultant financial loss, suffered by the professional's client or others, as a result of the professional's negligence. It does not indemnify the professional for the cost of rectifying or reperforming the original, negligently performed services. This is straightforward enough when what is excluded is simply the cost of an accountant reworking a set of books or a lawyer redrafting a negligently prepared document, however, in the case of some professionals engaged in mining or industrial project-related work it can present complications. For example, an engineering firm which undertakes responsibility under a "design and construct" contract may well find that its Professional Indemnity insurance covers it only for consequential

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Modified by section 44(2) of the Insurance Contracts Act in the case of policies covering domestic residences. For all general insurance contracts, section 44(1) requires that written notice of an average provision be given to the insured, before the policy is entered into. Including resultant financial loss if it is recoverable from the insured. It is misleading to state, simply, that such policies "do not cover financial loss". They do respond to this, when it takes the form of loss consequential upon physical injury or property damage caused by an occurrence. What they do not cover is "pure" financial loss suffered without any personal injury or property damage (as defined in the policy and including loss of use) having occurred. In the case of Professional Indemnity insurance, a similar provision often requires simply that the "liability" be one which would nevertheless have attached to the insured, in the absence of the contract. Since the High Court case of Astley v Austrust Ltd (1999) 161 ALR 155, that has had the potential severely to limit the scope of P.I. coverage, since an insured who is sued for breach of a contractual retainer will not be entitled to a reduction in damages because of the plaintiff's contributory negligence, which would be available if the action were brought only in the tort of negligence. It is important, therefore, to ensure that the common policy exclusion of liabilities arising solely under contract, also contains a "carve out" or stipulation to the effect that the exclusion will not apply to the percentage of the total damages, awarded against an insured, by which the insured's liability could have been reduced for contributory negligence of the Plaintiff had the insured been sued only in negligence. Astley v Austrust has now been reversed by statute in most Australian jurisdictions, however, as a matter of legal principle the decision was correct under the legislation to which it related and could well be applied in other common law jurisdictions where the issue of policy coverage might arise.


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liabilities arising out of a negligent design, not for the contractual cost of rectifying or replacing the items supplied. As the most likely liability to which the insured is exposed in this situation is one for having failed to perform the contract, through not designing and supplying a product to specification, and since the remedy for this will simply be replacement or rectification of said product, an Engineer's Professional Indemnity policy with such a limitation may provide inadequate protection for both the insured and its client. A Product Liability policy, of course, will not be much use either. On the other hand, in the case of a geologist who negligently carried out a survey, the P.I. policy would exclude the costs of re-performing the necessary work but would cover in principle a liability for losses incurred as a result of reliance upon the negligently-prepared data. The rationale behind both these exclusions is simply that insurance responds to unforeseen and unintended contingencies. It does not, generally, apply to the ordinary costs of contractual performance: to commercial and professional obligations voluntarily assumed. Only when the failure to fulfil such obligations leads to some consequence other than mere loss of the cost of performance, should insurance step in and indemnify. This is not to say that lost profits and performance obligations are always uninsurable. In principle, any risk is insurable at the right price. For example, the cost of re-supplying defective product can be covered under a less common and much more expensive form of cover called a Product Guarantee policy.21 It is also possible to obtain cover for design and construct performance obligations and for the liabilities associated with construction supervision, which will generally be excluded from a "design only" Professional Indemnity policy.22 What it does mean is that in considering what insurances each of the parties to a Facility Agreement or a Project ought to take out, and whether the ones which they have obtained meet the insurance requirements imposed upon them by the main contracts, it is not safe to make assumptions about what those policies cover based simply upon their labels. Careful attention must be paid to the actual terms of coverage, including any endorsements. Ideally a detailed comparison analysis should be carried out, between the main contract obligations and the scope of insurances purchased, to ensure as close a correspondence as may be achievable upon reasonable commercial terms. It is also desirable that, in the general contractual negotiations, the difference between realistically insurable and uninsurable risks and the limits of the policies in question be clearly understood by all parties. Those risks which cannot efficiently be dealt with by way of insurance can then be allocated to the parties best able to manage them.

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The cost of recalling potentially dangerous products, in order to avoid personal injury or property damage, is also excluded from a "standard" Product Liability policy, even though it usually contains a Condition requiring the insured to do so. Some of the recalled costs may be insured under a specialised "Product Recall" coverage which may be purchased in tandem with Product Liability. For seamless protection, of course, the well-insured manufacturer/supplier really needs to take out the trifecta: Product Liability, Product Recall and Product Guarantee, but it may be cheaper to invest in better quality control. The key feature to look for, in determining the scope of coverage under a Professional Indemnity or, for that matter any other form of Commercial or Professional Liability policy, is the definition of the insured's "business or profession". The Insuring Agreement will normally refer only to liabilities directly arising out of or in connection with this. The next most important provisions to consider are the exclusions.


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3.2 The Duty of Disclosure Having sorted out what type of insurance is required and who will have the responsibility of procuring it, it is then a matter of ensuring that the policies are not compromised by breach of the Duty of Disclosure. In order to keep it to a manageable length, this article will deal only with the legal position under Australian general insurance policies, to which the Insurance Contracts Act applies.23 It is worth bearing in mind, however, that in addition to the security issue discussed earlier, insuring off-shore may mean that the policy is governed by a different legal regime, notwithstanding that the risk insured and the policyholder are both located in Australia.24 The Insurance Contracts Act is, generally speaking, a reasonably fair and sensible code governing the operation of Contracts of Insurance and is certainly more favourable to the interests of insured than is, for example, the English common law. Under the Insurance Contracts Act25 the intending insured has an obligation to disclose, to the insurer, everything within the insured's actual knowledge which the insured knows, or which a reasonable person in the circumstances could be expected to know, is relevant to the insurer's decision whether to accept the risk and on what terms. The insured is not required to disclose anything:

· · · · which diminishes the risk; that is common knowledge; that the insurer already knows or in the ordinary course of its business ought to know; or about which the insurer waives disclosure.

Naturally, any express questions which the insurer may ask, for example on a proposal or application form, are matters which the insured will be considered to know are relevant to the insurer's decision and must be answered. If, however, a question is left blank or an obviously incomplete or irrelevant answer is given and the insurer does not follow this up, then the insurer is deemed to have waived disclosure in relation to that issue. The insurer's remedy for breach of the Duty of Disclosure (which for present purposes may be taken to include either non-disclosure or misrepresentation), in connection with general insurance,

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Essentially, all policies entered into in Australia other than contracts of Marine Insurance, Re-insurance, Health Insurance, Workers Compensation, CTP, Commercial Aviation Insurance and contracts entered into by a friendly society, by the Export Finance and Insurance Corporation, or in the course of State or Northern Territory Insurance. Note that former State government instrumentalities which have become freestanding corporations, such as GIO Insurance Limited, are caught by the Act. In the case of some contracts issued by Mutual Indemnity Funds, such as Medical Defence Organisations, it is arguable that these are not subject to the Act on the basis that they do not meet the definition of Contracts of Insurance. See John Kaldor Fabric Maker Pty Ltd v Mitchell Cotts Freight (Australia) Pty Ltd (1990) 6 ANZ Insurance Cases 60-960; cf Akai Pty Ltd v The People's Insurance Co Limited (1996) 188 CLR 418 but note that in that case, an English Court granted an injunction to prevent the insured from pursuing its claim under Australian Law, which had initially been stayed by the NSW Court of Appeal. Notwithstanding the favourable decision which the insured obtained from the High Court of Australia, setting aside the order for a stay and allowing the matter to proceed in NSW on the basis of section 8 of the Insurance Contracts Act 1984 (Cth), the insured risked being in contempt of the English court if it proceeded. The case, which involved a policy actually underwritten in Singapore but covering Australian risks, was subsequently settled. Section 21.


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is set out in section 28 of the Insurance Contracts Act. A threshold question is whether, had the breach not occurred and full disclosure been made, the insurer would nevertheless have still entered into the same Contract of Insurance with the insured, on the same terms. If it would have done so, then it effectively has no legal remedy in respect of the breach. Assuming that the insurer would not have offered precisely the same terms had there been full disclosure, the following alternatives apply:

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if the non-disclosure or misrepresentation was fraudulent, the insurer may avoid the policy from inception. In other words, it can treat the insurance as never having been in force;26 if the non-disclosure or misrepresentation was not fraudulent, the insurer may cancel the remaining period of coverage and may reduce its liability in respect of any claim, arising during the time it was on risk, to the amount which places it in the position in which it would have been had the non-disclosure or misrepresentation not occurred. In other words, the insurer can reduce its claim liability to the amount which it would have been required to pay under whatever contractual obligations it would have assumed had there been proper disclosure.

It follows from (b) above that if the insurer's only response to full disclosure would have been to impose a higher deductible, then that is all it can do in relation to the subject claim. Likewise, if it would have charged a higher premium then it can reduce the claim by the difference between that higher premium and the one which it actually charged. If, however, the insurer can demonstrate that it would not have entered into the policy at all, or that it would only have issued a policy which totally excluded the subject claim, then it can reduce its liability for that claim to nil.27 Note though that such proof generally requires more than a simple assertion by the underwriter, even under oath, that she or he would not have written the contract had the truth been known. Such testimony certainly needs to be given, but it is capable of being refuted by evidence of the insurer's actual past practice and ultimately, if the claim reduction or denial is challenged, it is for the court to decide on all the evidence that the insurer's actual response would have been.28 So you see that there is a need to ensure full compliance with the Duty of Disclosure, in order to avoid giving the insurer a basis for denying or reducing your claim. What happens, however, if you are not in control of the disclosure process but are dependent upon some other party to ensure that your rights are protected? This can come about in two common ways:

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"Fraudulent" in this context means a representation made "with an absence of actual and honest belief in its truth: it is a deliberate decision by the assured to mislead or conceal something from the insurer, or recklessness amounting to indifference about whether this occurs". Sutton, Insurance Law in Australia (Third Edition LBC 1999) at paragraph 3.318. See also Von Braun v AAMI Limited (1998) 10 ANZ Insurance Cases 61-419. Lindsay v CIC Insurance Limited (1989) 5 ANZ Insurance Cases 60-913; Ayoub v Lombard Insurance Co (Australia) (1989) 5 ANZ Insurance Cases 60-933; Twenty First Maylux Pty Ltd v Mercantile Mutual Insurance (Australia) Limited [1990] VR 919. Bauer Tonkin Insurance Brokers v CIC Insurance Limited (1995) 9 ANZ Insurance Cases 61-298. In that case, one of the issues was the extent to which the insurer could be required to give discovery of other underwriting files and policies, as evidence relevant to the question of what its actual response to full disclosure would have been. Discovery was ordered, but limited to a specified period. See also Ferrcom Pty Ltd v Commercial Union Insurance Co of Australia Limited (1993) 176 CLR 332 and Duthie v Rolf H Wick and Associates (Australia) Pty Ltd (1994) 8 ANZ Insurance Cases 61-223.


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you may be a joint or co-insured with another party on their insurance policy, if a contract you have with that party requires it to arrange certain insurance on behalf of itself and you; your interests may be noted on another party's insurance as a person to whom the benefit of that policy extends, by virtue of section 48 of the Insurance Contracts Act,29 again pursuant to the terms of a Head Contract or a Facility Agreement.

Both these situations are common enough in commercial arrangements between parties, where it is convenient to place the insurance responsibility upon one or another of them. The question is, can the "innocent" party's cover be lost or truncated, as a result of conduct by the party responsible for procuring the insurance? The answer is that, where the conduct in question is a failure to comply with the Duty of Disclosure, it most certainly can. The High Court of Australia has held, in the case of Advance (NSW) Insurance Agencies Pty Ltd v Matthews,30 that fraudulent non-disclosure on the part of one of two joint insured under the policy enabled the insurer to avoid that policy from inception, as against both of them. Likewise, in the case of a section 48 beneficiary, anything which compromises the actual existence of the policy or its terms of coverage, such as the right of the insurer to avoid or reduce for non-disclosure or misrepresentation or to cancel the policy, will affect the rights of the beneficiary as well as those of the insured. The person to whom the policy benefit is extended cannot obtain any better rights, in terms of the status of the policy or its scope of coverage, than the insured itself possesses.31 The position is slightly different, as between joint insured and co-insured on the one hand and noted interest beneficiaries on the other, where what is involved is not precontractual breach of the Duty of Disclosure but subsequent conduct in breach of the policy, such as fraud, arson or other conduct which directly causes or contributes to a claim but does not affect the prior existence or terms of the policy. In that situation, the courts have held that section 48(3) of the Insurance Contracts Act, which stipulates that the insurer has the same defences to a claim by a noted party as it would have to a claim by the insured, does not mean that the insurer may assert the insured's fraud, or other conduct in breach of the policy's terms, against the noted party. All it means is that if the noted party is itself guilty of fraud or fails properly to comply with the policy requirements, in relation to

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See also Trident General Insurance Co Limited v McNiece Brothers Pty Ltd (1988) 165 CLR 107. Section 48 effectively provides that where a person other than the insured is referred to in a policy, by name or otherwise, as someone to whom the benefit of the insurance is intended to extend, that person may enforce the policy directly against the insurer, to the extent of their interest, even though they are not a party to it. The person seeking to enforce has the same claim obligations as the insured and the insurer has the same defences as it would have in a claim by the insured. In Trident v McNiece, the High Court established a common law rule to similar effect, so there is an exception in respect of all policies of insurance, whether or not the Insurance Contracts Act applies to them, to the general common law rule that only parties to a contract may sue upon it. (1989) 166 CLR 606. Commonwealth Bank of Australia v Baltica General Insurance Co Limited (1992) 28 NSW LR 579. The position may be varied of course if the person's interests are noted on the policy in accordance with some other, direct contractual relationship which that person has with the insurer, such as a Concessions Agreement.


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the subject matter of the insurance or the making of a claim, the insurer has the same rights as it would have if this issue arose between it and the named insured.32 The important things to remember, therefore, if your interests are noted on somebody else's insurance policy as a person to whom the benefit of that policy is to extend, in accordance with the requirements of some other contract between you and the insured but to which the insurer is not a party, are that:

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if the insured makes a misrepresentation or fails to comply with the Duty of Disclosure, before the policy is entered into, the insurer may be able to avoid that policy or reduce its liability for a claim as against you, as well as toward the primary insured; if the insured fails to comply with a provision of the policy, including by not paying the premium or by some act or omission contrary to the policy's terms; such as altering the subject matter of the insurance or allowing it to deteriorate, the insurer may cancel the policy prospectively and this will extinguish all noted parties' interests as well;33 if the insured makes a fraudulent claim or is guilty of conduct which triggers a loss under the policy, then it will naturally not be able to claim however you, as the noted party, may still be able to, subject to the policy wording. If, however, you are a joint or co-insured, rather than a section 48 beneficiary, you may not have a claim in this situation; as a party whose interests are noted, you have the same obligations to comply with the operative terms of the policy, in relation to the making of a claim, as the named insured has. You may also be bound by the implied obligation to act with utmost good faith toward the insurer, in relation to all matters arising under or in connection with the contract, pursuant to sections 13 and 14 of the Insurance Contracts Act.34

3.3 Precautionary Measures What then can be done, to minimise the risk of loss of coverage in a joint insurance or noted party interest situation? The most practical approach is to seek to negotiate terms of the policy which will remove or restrict the right of the insurer to avoid the policy or to deny a claim, as against the

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VL Credits Pty Ltd v Switzerland Insurance Co (1989) 5 ANZ Insurance Cases 60-936; Barroora Pty Ltd v Provincial Insurance (Australia) Limited (1992) 26 NSW LR 170; see also CE Heath Casualty and General Insurance Limited v Grey (1993) 32 NSW LR 25. Note however that in the recent case of General Motors Acceptance Corp Australia v RACQ Insurance Ltd [2003] QSC 080, the court made the point that s 48 cannot be used so as to expand the scope of cover provided by the policy. Thus, when the policy stipulated that a motor vehicle was only covered whilst being used for nominated purposes and was only insured against "accidental damage", the deliberate destruction of the vehicle by the insured meant that the loss was outside coverage and the insurer was able to assert this defence even against the finance company whose interest was noted on the policy, even though the destruction was fortuitous from that party's point of view. The tension between this decision and the VL Credits case is obvious and is reconcilable only on the basis of the particular policy wording in the GMAC case. The term "avoidance" of a policy, used in this context, effectively means rescission of the insurance contract from inception, as though it had never been in place. Under the Insurance Contracts Act, this is only permitted pursuant to section 28(2), in cases of fraudulent breach of the Duty of Disclosure. "Cancellation", which is governed by section 60 of the Act, is permitted for breach of the terms of the policy but only applies prospectively, from the date when it takes effect under section 59. The policy coverage may still be applied to claims triggered between the original inception date and the effective date of cancellation. CE Heath Casualty and General Insurance Limited v Grey (1993) 7 ANZ Insurance Cases 61-199 (judgment of Mahoney JA).


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"innocent" insured or beneficiary. While insurers are understandably reluctant to agree to such terms, they are often commercially achievable and in some classes of insurance, such as Professional Indemnity for partnerships and Directors' and Officers' Liability, have become common place. The most common form of protection is a "severability clause" in the proposal, which in the case of a joint policy or one covering the interests of a number of parties, provides simply that although only one proposal form has been submitted for the insurance, for the purposes of the Duty of Disclosure the insurer will treat the situation as though a separate proposal, in identical terms, had been received from each of the persons to whom the policy applies.35 Allied to this is the "nonimputation" clause, which stipulates that knowledge or a state of mind actually possessed by one insured or policy beneficiary shall not be imputed to any of the others, for the purposes of determining compliance with the duty of disclosure or the application of any of the policy provisions, for example a fraud or wilful misconduct exclusion. It is important to ensure that both these clauses are contained in both the proposal and the wording of any policy under which you may seek to benefit, either as a joint insured or as a noted party. Liability policies generally contain an exclusion in respect of any claims brought by one insured against another insured. The purpose of this is to prevent contrived liability claims by, for example, one corporate member of a policy holder group against another, in order to attach a third party liability policy to what are really internal losses of the insured.36 Where unrelated insured are covered under the same policy, it is usual for the policy to contain a "cross-liabilities" clause. This effectively provides that in the event of liabilities arising between arms length insured, the policy will operate as though a separate Contract of Insurance in the same terms had been issued to each of them without, however, increasing the insurer's overall Limit of Liability. This also is an important provision to secure. A "waiver of subrogation" by the insurer, against any of the parties comprising the insured or the noted interest, is often included as well, although if there is a full cross-liabilities clause or if the additional parties are also insured under the policy in respect of the loss subrogated, it may not strictly be necessary.37 Finally, a provision requiring the insurer, in the event that it proposes to exercise its rights of cancellation because of non-payment of premium or some other breach of the policy by the primary insured, either first to give the other parties interested in the insurance an opportunity to rectify the situation or to issue a replacement policy to them with effect from the date of cancellation, is a very useful safeguard. It is important, however, to bear in mind its limitations. Such clauses, requiring the issue of a replacement policy, are sometimes expressed also to apply in the event of exercise by the insurer of its right to avoidance from inception for fraudulent nondisclosure, however the problem there is that unless the clause also appears in the proposal, it is still only a term of the existing contract. There may be a fundamental problem where the joint

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There is a stipulation that this does not have the effect of increasing the sum insured or the premium. This is not to be confused with the so-called "Insured v Insured" exclusion under a Directors and Officers Liability policy, which gives rise to different and more complicated issues and is a topic in itself. See Co-Operative Bulk Handling Limited v Jennings Industries Limited (1997) 9 ANZ Insurance Cases 61-355; Woodside Petroleum Development Pty Ltd v H & R - E & W Pty Ltd (1998) 10 ANZ Insurance Cases 61-395; Maxitherm Boilers Pty Ltd v Pacific Dunlop Limited (1998) 10 ANZ Insurance Cases 61693. See also Warne, In search of the Rationale for the Co-Insured Sub-Contractor's Immunity from Subrogation Actions in Contractor's All Risk Policies (1999) 10 ILJ 262 and the other cases there cited.


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insured or noted party seeks to rely on a term of the policy, as against the insurer, if the insurer is legally able to treat that policy as never having existed. The safest protection against policy avoidance is to ensure full compliance with the Duty of Disclosure and to seek a full indemnity from the party carrying the responsibility to insure, if it is breached.38 4. CLAIM RISK 4.1 Triggers of Coverage Some of the risks associated with claims have already been touched on in the preceding section, for example the right of the insurer to reduce its liability in accordance with section 28(3) of the Insurance Contracts Act, where there has been inadvertent breach of Duty of Disclosure. As indicated in the preceding section it is possible to stipulate, as an additional term of the policy, that the insurer will not exercise this right as against joint insured or noted parties but will confine itself to a damages remedy against the non-disclosing insured, in the event of claims by those other persons. The most important consideration to bear in mind at the outset, in connection with claims, is the so-called "trigger of coverage". This means, simply, what has to occur as a preliminary requirement for the policy to be invoked at all, before consideration is given to compliance with conditions or applications of any exclusions. Most direct damage policies are triggered by the occurrence of an accident or a defined peril, such as injury to the policy holder or damage to the property which is covered by the insurance. In the case of "three party" or liability insurances, there is an important dichotomy between "Occurrence" or "Accident" wordings, on the one hand, and "Claims Made" policies on the other. The first type of insurance responds where the accident or event which has given rise to the insured's putative liability, toward a third party, has taken place during the Policy Period. This occurrence can be either a single event, such as a person slipping over in a supermarket or a fire caused by a defective piece of machinery, or continuous exposure to hazardous conditions such as radiation levels or ambient pollutants. While in the latter case issues of contribution between

38

Interestingly, in a recent South Australian case Debelle J, of the South Australian Supreme Court, sidestepped this whole conceptual problem of the policy's terms modifying an insurer's prior right to avoid for non-disclosure, when those terms themselves have arguably been procured by non-disclosure, rather neatly. He did so, however, by reference to the particular terms of a policy which was intended to provide cover in respect of undisclosed fraud, subject to a higher deductible. To have allowed the insurer to avoid from inception would, in that case, have defeated the commercial intentions of the parties at the time of contracting. See Sherry & Ors v FAI General Insurance Company Limited (In Liquidation) [2002] SASC 3. In the subsequent appeal, reported at [2002] SASC 431,the Full Court of the S.A. Supreme Court amended some of Debelle J's answers to the questions which had been posed to him and held that an express provision in the policy extending cover to innocent co-insured, on stipulated terms, was not to be construed in such a way as to include the fraudulent proponent in the grant of coverage. Neither judgment really comes to grips with the issue of how a provision in a contract can prevent the insurer from exercising an antecedent statutory right to avoid that contract from inception. In the writer's opinion, the best course is to ensure that severability, non-imputation or replacement coverage characteristics are also referred to in the proposal, where they will have the status of pre-contractual representations of the insurer. This may be sufficient to create a promissory estoppel, precluding the insurer from an unconditional exercise of its rights. At least it would put the insurer that did so at risk of being in breach of other legislation, such as ss 12DA and 12DB of the Australian Securities and Investments Commission Act 2001 (Cth) or the unconscionable conduct provisions of the Trade Practices Act 1974 (Cth).


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successive insurers often arise, generally it is a relatively straightforward exercise to determine whether an Occurrence or Accident Liability Policy has been triggered.39 In the case of "Claims Made" insurance, the trigger of coverage is not the occurrence of loss or damage but the making of a claim (as defined) in respect of it, by some third party against the insured. For example, an engineer insured under a Claims Made Professional Indemnity Policy may negligently carry out work during the 1997/1998 Policy Year. That negligence may not come to light until some time during the 1999-2000 Policy Year, when the results of the negligent design manifest themselves and a Notice of Claim is served. The engineer may well have changed insurers in the interim. In that event, provided that there has been no prior awareness of the potential claim on the part of the insured, it is the 1999-2000 insurer under whose policy the engineer will be entitled to seek indemnity, not the earlier one. As a general rule, "Claims Made" coverage triggers are usually found in financial liability types of policy, such as Professional Indemnity, Errors and Omissions, Directors' and Officers' Liability and the like; while the occurrence wording is usually retained for Occupiers Liability, Products Liability, Umbrella and related physical injury or damage liability policies.40 It is important, however, to be aware of the actual trigger of coverage wordings under your policies and to ensure that you can identify the relevant occurrence, or defined claim, as applicable. Claims Made insurance gives rise to a number of legal issues and a full examination of it is beyond the scope of this article.41 There are, however, a few practical points to bear in mind. Such policies generally contain a term known as a "Circumstance Notification" clause, the effect of which is that if, during the period of the policy, the insured becomes aware of some circumstance which may give rise to a claim against him or her, he or she can notify that circumstance to the insurer and even though the actual claim may not be made until after the policy has expired, the coverage is nevertheless triggered.42 The practical effect is to refer the claim, when it is eventually made, back to the Policy Period during which the circumstance was notified. It follows that if you are insured under or entitled to the benefit of any form of Claims Made insurance, and you become aware of any possibility, however remote, that you may face a liability for which you would want to claim indemnity under that policy, the basic circumstances out of

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Careful attention still needs to be paid to actual wordings. In some policies, for example, all that is required is that the personal injury or property damage take place during the period of the insurance while the "occurrence" or accident which has given rise to it may well have happened earlier. Other wordings may elide the distinction between the occurrence and happening of the damage, or may require both to take place during the period of the policy. There are some exceptions. Environmental Impairment Liability Insurance, a specialised form of gradual onset pollution cover, is generally written on a Claims Made form, and there have been sporadic attempts to generate an interest in general and products liability cover on a Claims Made basis. Generally speaking however, the market has been resistant to these and the Claims Made wording tends to be restricted to "intangible" or purely financial liability insurances, where it may be difficult to ascertain a specific point in time at which the loss or the conduct giving rise to it has occurred. This was the original rationale for Claims Made insurance. For those who are interested, see Hawke, Risky Business - A General Overview of Section 54 of the Insurance Contracts Act and Claims Made Policies (1999) 22(3) AIIJ 26 and the references there cited. Even if there is no such clause in the policy, section 40(3) of the Insurance Contracts Act is to the same effect. See Newcastle City Council v GIO General Limited (1997) 72 ALJR 97.


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which that liability may arise should be reported to the insurer as soon as possible and in any event, before the expiry of the policy.43 The practical effect of not notifying a circumstance, once you are aware of it, is that the Claims Made Insurer who was on risk at that time may attempt to refuse you indemnity, if a claim is not made against you until after its policy has expired and it only receives notice of the matter at that time.44 At the same time, the Insurer who is on risk at the time the claim is made may well also be able to refuse to indemnify you, either because the matter is expressly excluded from its policy (as a prior

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As much detail as possible should be provided in the Notification The important point is to establish the causal linkage between the claim, when it is ultimately made, and the matters notified. The degree of specificity required in a circumstance notification, and the vexed issue of whether third parties who are planning to sue an insured can themselves give effective notification under that insured's policy, are matters beyond the scope of this article. For a discussion see Schoombee, Antico's Case and Other Recent Decisions on Notification of Claims and Circumstances: Sections 54 and 40 of the Insurance Contracts Act (1997) 8 ILJ 167; Hawke, Notification of Circumstances under Claims Made Policies, Some Observations upon the Scope and Operation of the Insurance Contracts Act 1984 (Cth) (1995) 6 ILJ 252. The extent to which the Insurer may be able to deny or reduce the insured's policy entitlement, as a result of a failure to notify circumstances within the policy period, will depend upon the circumstances of the claim and may be affected by the precise wording of the policy. Since the seminal High Court decision in FAI General Insurance Co Limited v Australian Hospital Care Pty Ltd (2001) 180 ALR 374 it is clear that section 54 of the Insurance Contracts Act, which is discussed in more detail below, applies in principle to such an omission. The insurer must, therefore, demonstrate that it has suffered some material prejudice, quantifiable in monetary terms, as a result of the late notification before it can deny or reduce the claim, however, it may well be able to do so. If the claim has become more difficult to investigate or manage as a result of the delay, or if other factors influencing the insurer's business since policy expiry have increased the financial impact of the claim upon it (such as the expiry or commutation of a reinsurance treaty, for example) then there might well be quantifiable prejudice within the meaning of section 54(1) which would entitle the insurer to deny or reduce its liability for the claim. For a general discussion of prejudice issues under section 54(1) see Ferrcom v Commercial Union Insurance Company Limited (1993) 176 CLR 332; QBE Insurance Limited v Moltoni Corporation Pty Ltd (2000) 155 FLR 379. A further consideration is that, increasingly, insurers under "claims made" policies are attempting to circumvent the Australian Hospital Care case and the application of section 54 by simply removing the circumstance notification entitlement from the policy altogether. The insured may still notify circumstances within the period of such a policy and attach the policy's protection to future claims, by virtue of section 40(3) of the Insurance Contracts Act. See note 42 above. An omission to do so, however, arguably may not be excused by section 54 on the basis that the insurer's entitlement to refuse indemnity does not arise as an effect of the Contract of Insurance, which would not have applied to the Circumstance Notification in any event, but as a result of the insured's failure to take advantage of a statutory provision which would have extended the policy to it. It is fair to say that there is considerable uncertainty over whether such an argument would succeed, in light of what has been said in the Australian Hospital Care case and in other judgments over the years dealing with the ambit and purpose of section 54, however two Supreme Court Judges have so far indicated agreement in principle with it. See CA and MEC McInally Nominees Pty Ltd & Ors v HTW Valuers (Brisbane) Pty Ltd & Ors [2001] QSC 388 (Chesterman J) and Gosford City Council v GIO General Limited, Bergin J, NSW Supreme Court 13 June 2002. Finally, it is clear law that if a claim is actually made upon the insured, during the period of the policy, then the insurer may not refuse indemnity solely by reason of a failure to notify it, or the circumstances out of which it arises, to the insurer until after expiry. East End Real Estate Pty Ltd v Heath Casualty and General Insurance Limited (1992) 7 ANZ Insurance Cases 61-092.


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known circumstance) or by expunging its liability for the claim under section 28(3), on the basis that it would have excluded the matter had it been disclosed on the proposal. There is a theoretical risk of falling between two stools, in this situation, and the rule for the prudent risk manager is to notify early and notify often.45 Another point to bear in mind, in connection with Claims Made Insurance, is the pernicious habit of some insurers of placing a "Retroactive Date" or "Retro Date" on the Policy Schedule. This is something to watch out for since it means that, notwithstanding the Claims Made nature of the policy, it only applies to claims arising out of circumstances which have arisen after that date. This will not necessarily be a problem in the context of insurance obligations under a Project Master Agreement or Facility Agreement, since the insured services are presumably still to be provided in that situation, however it can be important in the context of an ongoing professional relationship. A further factor to be aware of, in the context of Claims Made insurance, is that by the very nature of the coverage, once you have moved your insurance for a particular class of risk onto a Claims Made wording it is rather difficult to move back to an Occurrence or Accident policy. The obvious problem is the potential insurance gap, in respect of any occurrences unbeknownst to the insured which may have taken place during the "Claims Made Years", but which do not give rise to actual claims upon the insured until after a replacement, Occurrence wording comes into force. The only remedy for this is to carry out as comprehensive a trawl for potential claims as possible, before going off the Claims Made wording, and to notify every conceivable circumstance to the expiring insurer. This is not an entirely satisfactory solution, since you may miss something and Claims Made insurers tend to question the effectiveness of "shopping list" notifications upon expiry, however it needs to be done if you are thinking of making such a change. Due to the relatively minor overlap between the Occurrence and Claims Made classes of insurance, the problem will not often arise.46 4.2 Compliance with Policy Terms It is important to comply to the fullest extent possible with all operative terms and conditions of a policy, regardless of whether it represents Direct Loss or Third Party Liability insurance. This relates as much to management of a loss or potential claim as to minimisation of the risk of loss beforehand. An important point is that many policies will contain a condition requiring the insured to avoid doing or omitting anything which might limit or prejudice the insurer's right of subrogation, in the event of a claim, against other parties who may be responsible for the insured's loss or liability. This can be an issue when contracts have previously been entered into between the insured and other parties, such as service providers, outsource suppliers and the like, which exempt those other parties from liability toward the insured or cap their liability at an amount below the loss. Such clauses are common and generally enforceable as between commercial parties, however if they

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Of course, the best risk management of all is to have nothing to notify, however that is a counsel of perfection. If you happen to be going the other way, from an Occurrence to a Claims Made wording, then of course you have the opposite situation and there will potentially be double insurance between the expired Occurrence wording and the replacement Claims Made contract. That is not a problem for the insured however, since it can claim under either policy. It merely gives rise to equitable contribution arguments between the insurers. See section 76 of the Insurance Contracts Act.


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represent a significant departure from normal commercial practice in the insured's industry, so that they materially alter the risk which the insurer intended to assume, they may amount to a breach of this policy provision and give rise to an adjustment remedy for the insurer. At the least, the policy is likely to contain a provision requiring that the insurer be notified of the insured's intention to enter into any such contracts and its approval obtained.47 Other provisions to be borne in mind are those relating to preservation of salvage, submission of a detailed Proof of Loss, non-admission of liability, co-operation in the defence of a third party claim and the taking of all reasonable measures to avoid or minimise loss. In relation to these and all other provisions of a Contract of Insurance, it is worth bearing in mind the terms of a general, ameliorative piece of legislation: section 54 of the Insurance Contracts Act. The first three sub-sections of section 54 read as follows:

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subject to this section, where the effect of a Contract of Insurance would, but for that section, be that the insurer may refuse to pay a claim, either in whole or in part, by reason of some act [includes omissions] of the insured or of some other person, being an act that occurred after the contract was entered into but not being an act in respect of which Sub-Section (2) applies, the insurer may not refuse to pay the claim by reason only of that act but his liability in respect of the claim is reduced by the amount that fairly represents the extent to which the insurer's interests were prejudiced as a result of that act; subject to the succeeding provisions of this section, where the act could reasonably be regarded as being capable of causing or contributing to a loss in respect of which insurance cover is provided by the contract, the insurer may refuse to pay the claim; where the insured proves that no part of the loss that gave rise to the claim was caused by the act, the insurer may not refuse to pay the claim by reason only of the act.

Note the breadth of the words "the effect of a Contract of Insurance". The courts have generally taken the view that section 54 is to be given a broad, purposive interpretation48 and there is no reason to suppose that it cannot apply to any act or omission of the insured or of another party entitled to the benefit of the Contract of Insurance, other than complete failure to bring the loss or claim itself within the scope of coverage under the policy.49 The practical effect is to prevent the insurer from refusing outright to indemnify, unless the act or omission could reasonably be regarded as one capable of causing or contributing to the loss. If it could not, then the insurer's only right is to reduce its liability, in respect of the claim, by the amount which "fairly represents" the extent to which the act or omission has prejudiced its interests.50

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Section 13 of the Insurance Contracts Act would prevent that approval from being unreasonably withheld. Newcastle City Council v GIO General Limited (Note 42 above); Antico v CE Heath Casualty and General Insurance Limited (1997) 146 ALR 385. East End Real Estate Pty Ltd v Heath Casualty & General Insurance Limited (Note 44 above). See Kelly v New Zealand Insurance Co Limited (1996) 9 ANZ Insurance Cases 61-317, Greentree v FAI General Insurance Co Ltd (1998) 158 ALR 592 and FAI General Insurance co Limited v Australian Hospital Care Limited (Note 44 above). This may, nevertheless, be a significant amount. If, for example, the insured were to delay notifying a loss or claim to the insurer under the policy and in the meantime, the insurer finalised its statutory accounts or commuted a Reinsurance Treaty or Facultative Agreement in ignorance of the pending


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Section 54 is one of the most litigated provisions in the Insurance Contracts Act and a full exegesis of the case law governing its operation is beyond the scope of this article. The important point to bear in mind is that it is one of the most potent weapons in the insured's arsenal and the days are long gone, at least in Australia, when an insurer could simply refuse to pay a claim in its entirety merely because of a breach by the insured of some footling term of the policy, even one expressed as a condition precedent, which bore no relationship to the loss. This is not to say that operative terms of policies can be disregarded with impunity, since the issue of prejudice to the insurer is a real one, but it does mean that in any situation where there has been non-compliance, what matters is the actual, material effect which that has had on the insurer's position. For example, an insured might inadvertently do something to prejudice an insurer's subrogation recovery against a third party, perhaps by settling a collateral claim and granting the third party a full release. The measure of the insurer's prejudice in that situation will be the actual value of the subrogation rights forfeited and if the third party happened to have a strong defence to an action by insured, or were insolvent and unable to meet a judgment against it in any case, the value of those rights might be little or nothing and the permitted reduction in the insurer's claim payout would be correspondingly small. If, on the other hand, a viable and potentially fruitful source of recovery were lost, through the actions of the insured, then the insurer might well be able to reduce its payment to the insured by the entire amount which it would notionally have recovered from the third party, less the costs of achieving that recovery. it is a question, in every case, or assessing the real extent of the prejudice. A clear example of prejudice, for the purposes of section 54(1), often arises where the legal status of plant and machinery, or the way in which it is used, changes in a way which is material to the insurer's risk appreciation. In the case of Ferrcom Pty Ltd v Commercial Union Assurance Co of Aust Ltd,51 the policy contained a standard clause requiring notification as soon as possible to the insurer of "any change materially varying any of the facts and circumstances existing at the commencement of the policy." A mobile crane, unregistered at the time the policy was taken out, was one of the items of equipment covered under it. During the policy period the crane was registered but the insurer was not given any notice of this. The crane was subsequently overturned during a lifting operation and sustained substantial damage, however, this did not occur while it was being driven as a registered vehicle on a public road. Despite the fact that neither the change in legal status of the crane nor the failure to inform the insurer of it played any part in causing the loss, the insurer was still enabled to reduce its liability under the policy to nil. The reason for this was simply that it was able to prove that it had a commercial policy of not insuring registered plant and equipment against the risk of overturning. The reasons for this probably had to do with reinsurance. Had it been told of the crane's registration, it would have exercised the right of cancellation which the policy gave it, in those circumstances, and would only have offered alternative cover on terms which would have excluded damage caused by overturning, including while the crane was being used as a crane. The High Court of Australia held that the insurer's loss of the opportunity to

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claim, then the prejudice might well be serious, leading to a reduction of anything up to the total amount of the claim. See note 44 above. (1993) 176 CLR 332.


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exercise these rights, caused by the insured's failure to comply with the notification requirement in relation to the registration, amounted to prejudice to the insurer within the meaning of section 54(1). 5. CONCLUSION Insurance, properly taken out and administered, can be an effective tool for the management of risk however it is in no sense a "set and forget" type of facility. This is especially so in the case of major property and financial exposures, where the insurance requirements arise in the context of a complex set of legal and commercial relationships and policy wordings need to be tailored to the requirements of other contracts. In such a situation, it is necessary first to assess the security risk presented by the various insurers put forward for the program, then to ensure that the policies which are taken out accurately reflect the risks and responsibilities assumed by the parties to them. At the same time, care needs to be taken to ensure that the Duty of Disclosure is fully complied with and that the policies contain all the available ameliorative terms and conditions to protect the interests of joint insured and noted interest beneficiaries, who are not in a position to make disclosure on their own account. The purpose is to ensure, as far as possible, that the policies operate as they are understood and intended to do by the insured and by its contractual counterparties, however the inherent limitations of insurance contracts and especially the Principle of Indemnity must be well understood. In particular, assumptions should never be made regarding the scope of a policy's coverage, actual or intended, based solely upon the title given to it or how it is described in a Certificate of Currency. In the context of claims, it is necessary to understand the trigger of coverage, including the relevant definitions, and to comply as far as is reasonably possible with all operational terms and conditions. In particular, conduct which might prejudice the insurer's ability to examine and evaluate the claim, or to recover salvage or subrogation, must be eschewed. If such conduct does take place then the financial measure of that prejudice will define the insurer's right to reduce or avoid a claim, under section 54 of the Insurance Contracts Act. In relation to both claims and underwriting issues the Australian legal regime, and in particular the Insurance Contracts Act, represents in most cases a fair balance between the interests of insurers and insured and a reasonable legal code governing the operation of the insurance policies to which it applies. In several instances, its provisions have since been replicated in the common law. On this basis, it is generally desirable for insured to have the provisions of this Act applicable to their policies, either by contracting in an Australian jurisdiction or incorporating it by reference. If consideration is being given to negotiating insurance entirely off shore, whether for capacity, avoidance of GST or other factors, the legal regime and possible security risks should also be taken into account.