22 September 2003
It is a long-established principle of English law that contracts of insurance are contracts of the utmost good faith. However, recent decisions of the courts and the Financial Ombudsman Service (FOS) indicate that the duty is becoming diluted, and in certain circumstances is extinguished altogether.
The reasoning behind the duty of good faith is entirely logical - insurance contracts are based on trust. At the time of writing the risk, the insurer has to trust the insured to give accurate information to enable them to decide whether to accept the risk, and, if so, the terms of that acceptance. Equally, once the insured submits a claim, the insurer has to rely upon the information given to them by the insured to ascertain whether the claim is covered by the policy, and the extent of the loss suffered.
The claims-making process
The insured's duty to provide truthful and accurate information at the time of inception of a risk still exists and is on the statute books. However, the exercise of the duty at the claims stage was never specifically addressed until it was considered by the Commercial Court in the case of a vessel named The Litsion Pride in 1984.
The action involved the fraudulent backdating of a notification that advised the vessel's insurers that it was about to enter into a war zone. The court found in favour of insurers and confirmed that the insured's duty to act with good faith extended to the claims-making process, and that the duty not to make fraudulent claims was an implied term in the contract of insurance. The court also stated that the insured had a duty not to make any false statement that would influence a prudent insurer's decision to accept, reject or compromise a claim.
Litigated claims - 'All bets are off'
In 2002, the principles set out in The Litsion Pride were challenged. The owners of passenger ferry The Aegeon had issued legal proceedings against insurers, and had pleaded that welding, which was an excluded peril in the policy, had not commenced until a certain date. Witness statements served by the owners revealed that welding had begun prior to the pleaded date. Insurers applied to the court to amend their defence to plead fraud. They sought to assert that the owners had lied, in their pleading, about the commencement date of the welding and had, therefore, breached their duty of good faith.
The Court of Appeal determined that the duty of good faith is superseded or exhausted by the rules of litigation once the parties are embroiled in legal proceedings. It follows that the insured is able to limit their duty of good faith by issuing proceedings at an early date. They are then able to make as many deliberately false or reckless statements as they please without fear of repercussion from their insurers.
Clearly, an insured cannot recover from their insurer when their entire claim is fraudulent, but what if they submit a legitimate claim and exaggerate the extent of their loss? Are they paid for the genuine claim, or do they lose everything?
Fraudulently exaggerated claims are not a recent trend, and in 1866 Mr Justice Wiles determined that if a fraudulent claim formed part of a larger legitimate claim, the fraudulent part tainted the whole. "It would be most dangerous to permit parties to practise such frauds, and then, notwithstanding their falsehood and fraud, to recover the real value of the goods consumed," he said. "If there is wilful falsehood and fraud in the claim, the insured forfeits all claim whatever upon the policy."
Legitimate bartering or fraud?
Judge Wiles' decision was somewhat diluted by the House of Lords in 1927, when it indicated that the fraudulent exaggeration must be more than minimal to warrant the insured failing to recover at all. The court indicated that it was an accepted fact that an insured may inflate their claim with a view to strengthening their bargaining position with insurers, but it did not seek to distinguish between what would constitute legitimate negotiation against fraudulent exaggeration.
The apparent existence of the discretion to overlook minimally exaggerated claims has been exercised by the courts and the FOS.
In 1997, the Court of Appeal considered the case of Galloway v GRE. The insured submitted a household contents claim to his insurers of approximately £18,000. Of the claim, £16,000 was legitimate and the remaining £2,000 fraudulent, with the insured submitting false documents in support of the fraudulent part of the claim. Insurers declined liability and the insured issued proceedings seeking to recover the legitimate part of the claim and to argue that the duty of good faith only related to the formation of the contract of insurance and not to the claims-making process.
The leading judgment was given by Lord Woolf, who determined that approximately 10 per cent of the claim was fraudulent and that this figure represented a substantial part of the claim as a whole. Therefore, the insured would forfeit the whole.
Lord Woolf appeared to accept that had the fraudulent part been less than substantial, the insured would have made a recovery of the legitimate part of his claim. Again, the court gave no explanation as to how to determine whether part of a claim is substantial or de minimis.
Research undertaken in October 2002 revealed that 7 per cent of people in the UK had already made a fraudulent insurance claim and that an astonishing 48 per cent would not rule out making an exaggerated insurance claim in the future. Insurance fraud costs UK industry an estimated £1bn per year. Despite those figures, the FOS advises that an exaggeration is not always fraud - the insured may be mistaken about the cost of replacing the item claimed for or has an inaccurate recollection of its purchase price. Equally, an insured who presents a forged document in support of his claim is not necessarily guilty of fraud - he may have been tempted to create a substitute document for a lost receipt. Inevitably, both scenarios involve a subjective consideration of the available evidence, which surely ought to be carried out in the appropriate forum with the insured giving oral evidence rather than a consideration of the paperwork.
The advice given by the FOS to insurers as to what would constitute a fraudulently exaggerated claim is unclear. In some instances, the FOS has indicated that it will not support the insurer where the exaggeration is less than £2,000. In other instances, it has indicated that if the insurer can show that the exaggeration will extinguish the excess that would have been payable by the insured, it will support the insurer. In further instances, it has indicated that the benchmark for determining whether the fraudulent part of the claim is substantial or not is 10 per cent. That is, of course, the precise figure referred to in Galloway.
The current practice appears to be an open invitation for dubious insured's to submit fraudulently exaggerated claims without fear of recompense in the event that their fraud is discovered. Given the cost of fraudulent insurance claims to the insurance industry and genuine policyholders, this seems a most unacceptable position. Indeed, the difficulties in exercising discretion were all too apparent to Lord Justice Millett in Galloway. "The right approach in such a case is to consider the fraudulent claim as if it were the only claim and then to consider whether, taken in isolation, the making of that claim by the insured is sufficiently serious to justify stigmatising it as a breach of his duty of good faith so as to avoid the policy," he stated.
The way forward
Until the courts decide that any fraud is a bar to the insured making a recovery, as far as the insured is concerned it appears to be in their interests to exaggerate their claim by up to 10 per cent and to issue proceedings quickly. On the other hand, the insurer may have to tighten up their policy wordings and rely upon the law of contract to protect what appears to be their diminishing common law rights.
Alison Hart is a partner at James Chapman & Co