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• The Problem
• The English Response
• The Australian Response
• Recommendation

3 Section 11 of the Insurance Law Reform Act 1977

42 SECTION 11 OF THE INSURANCE LAW REFORM ACT 1977 reads as follows:

11 Certain exclusions forbidden

Where

(a) By the provisions of a contract of insurance the circumstances in which the insurer is bound to indemnify the insured against loss are so defined as to exclude or limit the liability of the insurer to indemnify the insured on the happening of certain events or on the existence of certain circumstances; and

(b) In the view of the Court or arbitrator determining the claim of the insured the liability of the insurer has been so defined because the happening of such events or the existence of such circumstances was in the view of the insurer likely to increase the risk of such loss occurring,

the insured shall not be disentitled to be indemnified by the insurer by reason only of such provisions of the contract of insurance if the insured proves on the balance of probability that the loss in respect of which the insured seeks to be indemnified was not caused or contributed to by the happening of such events or the existence of such circumstances.

The section was recommended by the Contracts and Commercial Law Reform Committee (Aspects of Insurance Law, 1975, paras 28–30). Exclusions are justifiable if they define circumstances where there may be an increase in risk. The purpose of s 11 is to prevent exclusions being used to exclude liability where the circumstances, and so the increase in risk, exist but the loss is not attributable to that increase. The recommendation was triggered by two cases, then recent, in which the word “whilst” used in the definition of an exclusion was held to have a temporal and not a causative meaning: Parsons v Farmers Mutual Insurance Association [1972] NZLR 966; State Insurance v Harray [1973] 1 NZLR 276. The example given by the Contracts and Commercial Law Reform Committee of the wrong to be remedied was that where

a vehicle the driver of which is intoxicated or which is (perhaps unknown to the driver) in an unsafe condition is struck from behind while waiting at traffic lights [and liability to indemnify is avoided] even though the intoxication or the unsafe condition did not contribute to the loss in any way. (15)

The problem

43 The underwriter’s art is (theoretically at least) that of determining whether to accept a risk and on what terms, having regard to the likelihood of the loss occurring. The problem with s 11 as it has been interpreted is that it takes no account of the extent to which an exclusion may be framed with that statistical likelihood in mind. It is reasonable, for example, for an insurer to charge different rates of premium for vehicles used commercially and vehicles used privately because of the greater risk of accident (eg, a taxicab is more likely to be involved in an accident than the same vehicle confined to private use). But s 11 has been interpreted in a way that prevents insurers from declining liability to indemnify for losses to equipment during commercial use when the cover by its terms is confined to private use: New Zealand Insurance Co Ltd v Harris [1990] 1 NZLR 10. It has also been interpreted in a situation where the insured paid a lesser premium in return for motor vehicle cover on the basis that it was confined to a named driver but the insurer was required to indemnify for loss caused when the vehicle was in the control of a different driver: State Insurance Ltd v Lam (unreported, 10 October 1996, CA 159/96). Both these cases are decisions by the Court of Appeal. The approach has comparable implications for exclusions relating to a requirement that a driver be licensed and not be in breach of the terms of a licence and to higher deductibles imposed in respect of drivers under a certain age: Daly v Electronic Navigation Ltd [1992] DCR 379; Flight v State Insurance Office [1972] DLR 781; State Insurance Ltd v Electronic Navigation Ltd (1992) 7 ANZ Ins Cas 77,542; Allied Mutual Ltd v Crofts (1992) 7 ANZ Ins Cas 77,711. For a general discussion of the problem, see Kelly and Ball, 1991, paras 6.151–6.153.) This seems to the Commission to be unfair to insurers.

The English response

44 In its report, Insurance Law: Non-disclosure and Breach of Warranty, the Law Commission (England and Wales) sought to achieve the same policy objective as that underlying s 11 (para 6.22). Clause 10(5) of the draft statute in the report included the following:

[T]he insurer shall be liable to meet the claim if the insured proves either
(a) that the warranty concerned was intended to safeguard against, or was otherwise related to, the risk of the occurrence of the events of a description which does not include the event which gave rise to the claim; or
(b) that the breach of warranty could not have increased the risk that the event which gave rise to the claim would occur in the way in which it did in fact occur.

This recommendation has not to date been implemented.

The Australian response

45 The difficulty in translating the policy objective into statutory form is illustrated by the Australian experience. The Australian Law Reform Commission rejected s 11 as a model precisely because of its failure to take into account the statistical likelihood factor (Insurance Contracts, ALRC 20, para 228). Its proposal was enacted as the Insurance Contracts Act 1984 (Aust) s 54. It reads:

54 Insurer may not refuse to pay claims in certain circumstances

(1) Subject to this section, where the effect of a contract of insurance would, but for this section, be that the insurer may refuse to pay a claim, either in whole or in part, by reason of some act 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 subsection (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.

(2) 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.

(3) 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, so far as it concerns that part of the loss, by reason only of the act.

(4) Where the insured proves that some part of the loss that gave rise to the claim was not caused by the act, the insurer may not refuse to pay the claim, so far as it concerns that part of the loss, by reason only of the act.

(5) Where:

(a) the act was necessary to protect the safety of a person or to preserve property; or

(b) it was not reasonably possible for the insured or other person not to do the act;

the insurer may not refuse to pay the claim by reason only of that act.

(6) A reference in this section to an act includes a reference to:

(a) an omission; and

(b) an act or omission that has the effect of altering the state or condition of the subject-matter of the contract or of allowing the state or condition of that subject-matter to alter.

46 We have given careful consideration as to whether this model should be followed in New Zealand. It divides into two classes all acts and omissions after the contract is concluded that would under the contract entitle the insurer to decline liability to indemnify. If the act or omission has a loss-causing potential, then the insurer may rely on it except to the extent that the insured proves that the loss was not caused by the act or omission. In this respect s 54 follows the New Zealand s 11 but with provision for proportional recovery rather than the all-or-nothing approach of the New Zealand provision. If the act or omission does not have a loss-causing potential, then the insurer may rely on it only to the extent that the insurer’s interests were prejudiced. In our view there are a number of reasons why s 54 should not be adopted in New Zealand:

• The basic entitlement of parties to an insurance or any other contract is to determine their bargain for themselves. While we believe that it is appropriate for the legislature to interfere with contractual freedom if it corrects specific perceived injustices (eg, in the various remedial provisions of the 1977 statute), in our view this does not justify so sweeping and unfocussed a provision as s 54.
• A broadly-expressed provision that runs counter both to the interests of insurers and to the ingrained habits of lawyers experienced in the field will inevitably cause litigation and will not necessarily, in the end, be found to be judge-proof. This proposition seems to us to be well enough illustrated by the Australian experience (see Horsely, 1996; also Antico v Heath Fielding Australia Pty Ltd (1997) 188 CLR 652).
• The application of the notion of proportionality in s 11 circumstances can only be a matter of guesswork. In New Zealand Insurance Co Ltd v Harris equipment insured only in respect of non-commercial use was vandalised while being used on a job outside that category. In this case it can be argued on the one hand that, but for the non-private use, the equipment would not have been where it was and the loss would not have occurred; on the other hand, as the Court of Appeal held, it can be argued that the commercial use was not causative. In such circumstances it seems impossible to calculate an apportionment in any intellectually justifiable manner.
• It has been suggested to us that the extent of the insurer’s prejudice is readily calculable in such circumstances as those existing in New Zealand Insurance Co Ltd v Harris and State Insurance Ltd v Lam. The extent of that prejudice is simply the additional premium that the insured would have had to pay had the cover extended to the circumstances which in fact occurred. But that is surely to present the insured with a double-headed penny. Why should anyone bear the expense of insuring at the higher premium rate required for commercial use if, in the absence of fraud or misrepresentation, the only penalty for preferring the lower rate applicable to private use is (if a claim has to be made for loss suffered while the vehicle or equipment is being used commercially) to pay the difference between the two premiums?

RECOMMENDATION

47 Section 11 has been the subject of useful judicial exegesis and except in respect of the point under discussion is working well enough (see Dugdale, 1992). The solution recommended is the retention of the substance of s 11 in a replacement section that includes as subsection (3) a provision dealing with the precise areas of difficulty. While it may be fairly said that this solution falls short of perfect elegance, in our view it will provide a practical answer to the problems that have arisen. Our draft subsection (3) has been criticised for undue specificity and we gave thought to a provision (drafted with an eye to the precedent afforded by the Human Rights Act 1993 s 48) along the following lines:

A provision is not an increased risk exclusion for the purposes of this section if it is based on actuarial or statistical data establishing an increased risk of loss occurring in the circumstances in which the insurer’s liability is excluded or limited.

But it is important that any exclusion should not be so wide as to wipe out the original reform and for this and other reasons the proposal set out below seemed to us preferable.

48 We recommend that Parliament replace s 11 by enacting the following (see pages 59–81 for our complete draft Insurance Law Reform Amendment Act and commentary):

11 Increased risk exclusions

(1) An insured is not bound by an increased risk exclusion if the insured proves on the balance of probability that the loss in respect of which the insured seeks to be indemnified was not caused or contributed to by the happening of an event or the existence of a circumstance referred to in the increased risk exclusion.

(2) For the purposes of this section, an increased risk exclusion is a provision in a contract of insurance that

(a) defines the circumstances in which the insurer is bound to indemnify the insured against loss so as to exclude or limit the liability of the insurer to indemnify the insured on the happening of certain events or on the existence of certain circumstances; and

(b) so defined the liability of the insurer, in the view of the court or arbitrator determining the claim of the insured, because the happening of such events or the existence of such circumstances was in the view of the insurer likely to increase the risk of loss occurring.

(3) A provision is not an increased risk exclusion for the purposes of this section that

(a) defines the age, identity, qualifications or experience of a driver of a vehicle, a pilot of an aircraft, or an operator of a chattel; or

(b) defines the geographical area in which a loss must occur if the insurer is to be liable to indemnify the insured; or

(c) excludes loss that occurs while a vehicle, aircraft, or other chattel is being used for commercial purposes other than those permitted by the contract of insurance.