An insurance policy is a commercial contract subject to general contract law. What sets insurance policies apart from other commercial contracts is that insurance policies are also subject to the Insurance Contracts Act 1984 (Cth) , the provisions of which cannot be contracted out of to the prejudice of the customer or someone other than the insurer , and which apply to each insurance policy in priority of the terms of the policy and the general contract law.
Australia is the world leader in pioneering insurance reform. The Insurance Contracts Act was the world’s first comprehensive consumer-oriented insurance legislation. It was enacted to ‘…reform and modernise the law relating to certain contracts of insurance so that a fair balance is struck between the interests of insurers, insureds and other members of the public and so that the provisions included in such contracts, and the practices of insurers in relation to such contracts operate fairly …’.
One of the most significant reforms introduced by the Insurance Contracts Act is section 54 which alters the remedies available to the insurer if, after the policy is entered into, the insured breaches a term of the policy. Whereas under general contract law a breach by one party to a commercial contract of an essential term or condition of the contract entitles the other party to terminate the contract and/or seek damages against the party in breach, section 54 operates to prohibit the insurer from refusing to pay a claim (or refusing to cover the insured for a liability contemplated by the policy) because of a post-contractual breach by the insured of a term of the policy in certain circumstances.
Section 54 provides that where the effect of a policy of insurance would, but for this section, entitle the insurer to refuse to pay a claim, either whole or in part, by reason of some act/omission of the insured or another person after the policy was entered into, the insurer may not refuse to pay the claim by reason only of that act/omission. Instead, the insurer’s 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/omission.
Where an insurer unreasonably refuses to pay a claim, the insured may invoke section 54 to compel the insurer to cover the claim. Conversely, an insurer may invoke section 54 to limit its liability to pay a claim.
For section 54 to come into play, it is necessary that:
The basis upon which the insurer could have otherwise, but for section 54, refused to pay some or all of the claim could be – falling outside a covered risk, or coming within an exclusion, or non-compliance with a condition – it does not necessarily need to be a ‘breach’ of a term of the policy. The focus is on the actual conduct of the insured – on some act which the insured did or omitted to do.
If the insurer wishes to rely upon section 54 to reduce its liability for a claim, the insurer must also prove that:
To seek to demonstrate that the prejudice suffered is financially measurable, the insurer will seek to rely on evidence from its underwriting department that if the act/omission had not occurred the insurer would have cancelled the policy before the circumstances giving rise to the claim made by the insured upon the policy had eventuated. If the insurer demonstrates this then it would be accepted that the amount which would fairly represent the prejudice suffered would be the full cost of the claim effectively reducing the insurer’s liability for the claim to nil.
However, if the act/omission would not have led to the insurer going off risk, but instead, for example, the insurer would have charged a higher premium for the insured to purchase the policy, then the extent of the prejudice suffered to the insurer may just be the difference in the extra premium that it would have earned if the act/omission had not occurred.
Where an insurer asserts that it has been prejudiced, the insured should require the insurer to disclose the evidence upon which the insurer seeks to rely to establish this. It may be that the insurer has been prejudiced but is unable to quantify the prejudice as actual financial damage, and so not entitled to reduce its liability for the claim.
Here are the most recent reported examples where section 54 has come to the insured’s rescue:
There has been more litigation and reported legal cases surrounding section 54 than the rest of the provisions of the entire Insurance Contracts Act. Given the remedial nature of the section, this is perhaps to be expected. But the extent of the litigation produced by this section, which includes many decisions that went all the way to the High Court, shows that despite the simple and straightforward intention of the section, in practice its application can be complicated and misjudged. In our experience, the availability of relief under section 54 is often completely overlooked!
Some commentators have complained that section 54 in practice can overwrite a clear intention to exclude cover. The cases do show that no amount of clever drafting can avoid the application of section 54.
Whilst the reported cases give guidance, every case has different circumstances such that the outcomes always turn on their own facts, and so it is vitally important to promptly seek expert legal advice if you are ever in the unfortunate situation of your insurer refusing to cover all or part of your claim on the policy. It may be that section 54 can come to your rescue!
Berren Hamilton is a Special Counsel (Litigation) at Stone Group Lawyers. He is an Accredited Specialist in Commercial Litigation with the Queensland Law Society. He was admitted to practise in Queensland in 2001.