Insurance Contracts and the Duty of Disclosure

Almost every family and business in New Zealand will be a party to a contract of insurance. Most homeowners will have a house and contents policy, whilst most businesses will carry public liability insurance, in case they get sued for negligence.

In the event of a dispute, insurance policies will be interpreted by the Courts like any other contract. For instance, if any term of the policy is genuinely ambiguous, the benefit of the doubt will normally go in favour of the insured, if the policy document was prepared by the insurance company - which is almost always the case.

However, because of the importance of insurance contracts to consumers and businesses, the law imposes a number of additional requirements to safeguard both parties to an insurance contract from the possibility of being unfairly deprived of insurance cover on the one hand, or held to a policy on the other.

One of the special legal rules is the "duty of utmost good faith". This duty applies to both parties to an insurance contract, but mainly has consequences for the insured. The duty requires the insured to disclose all "material" matters when applying for insurance, and at every stage thereafter during the continuance of the policy.

A "material matter" is anything that a prudent insurer would take into account when considering whether to enter into or continue a policy of insurance, or to pay out on a claim. However, the insured does not have a duty to disclose things which the insurer already knows or ought to know.

If this duty is breached, then the insurance company can treat the insurance policy as having never been validly entered into, and decline any claims made under it. If any claims previously made have been paid out, then the insurance company can seek to recover those payments.

To give an example of how the rule works, when applying for a motor vehicle insurance policy the insured must disclose any criminal convictions and in particular any convictions connected with dangerous driving or drink driving. Normally, the application for insurance (called a "proposal") will specifically ask about those matters, in which case those questions must be honestly answered. Further, even if the question isn't specifically asked, the application for insurance must nonetheless disclose any material matter such as (e.g. in the case of a motor vehicle policy) a drink/driving conviction.

In a recent New Zealand case a company purchased an industrial property in Te Kuiti and took out subsidence cover. The company failed to disclose to the insurer that substantial subsidence had occurred, and that it was ongoing. The High Court held that this amounted to material non-disclosure, that the insured had breached the duty of utmost good faith, as a consequence the insurer was not likely to pay out under the policy.

The question of what is "material" is judged from the standpoint of the insurance company, not the insured. Thus, the rule can operate harshly against an insured who does not appreciate that a particular circumstance is material, and does not think to draw it to the insurers' attention.

As mentioned, if the insurance company asks specific questions, then the insured has a duty to answer those questions honestly and accurately. If the insured fails to do so, even inadvertently, then the insurance company may treat the contract as invalid and refuse to pay out on any claim. The harshness of this rule is to some extent mitigated by the Insurance Law Reform Act 1977 which provides that an insurance company can only treat the insurance policy as invalid by reason of a false statement if the statement is substantially incorrect, and material.

The duty of utmost good faith and disclosure is effectively a continuing one. This is because most contracts of insurance are renewed on an annual basis, and a material matter which arises during the term of an insurance may well be relevant when the insurer comes to make a decision at the end of the twelve month period whether to renew.

As well, the duty extends to disclosing all material matters at the time of making a claim. Normally, insurance companies require a declaration when making a claim that the details of claim provided by the insured are true and correct. If they are not, in some material respect, then by reason of the duty of utmost good faith, the insurance company will be entitled to decline a claim.

Should you have any queries about this article or any other insurance law matter please contact us.