Insurable Interest a rule in search of rationale? - BILA · Insurable Interest – a rule in search of rationale? ... –Proposed removal of insurable interest requirement for indemnity

Insurable Interest – a rule in search of rationale?

Stephen Lewis, the Law Commission

James Davey, University of Southampton

Retaining and updating the

requirement for insurable

interest Stephen Lewis, Law Commissioner

18 September 2015

History of the Law Commission’s review

• Law Commissions consulted in 2008 and 2011. Consultees generally in favour of reform but different views on overall structure of change.

• Different views on points of detail particularly with regard to life insurance.

• Law Commissions did not include reform proposals in second insurance contract law reform bill as not confident consensus could be achieved in time and appeared to be no urgent calls for reform.

• ILAG contacted the Law Commission in 2014: from a life insurance perspective there was a need for reform; general consensus within the market.

• Further consultation with updated proposals March – June 2015.

Background to doctrine

• Valid insurance contract - insured must have insurable interest.

• Broadly means insured must benefit from preservation of insured subject or suffer disadvantage if lost.

• Simple concept but complex detail.

• Without interest contract is void and illegal (in England).

• Current law derives from C18th and C19th statutes and C18th, C19th, C20th and C21st cases.

• Definition of insurable interest uncertain – largely derived from case law – fact specific and influenced by social change.

• Definition depends on whether insurance is “indemnity” or “contingency”.

• Indemnity insurance – relationship with “indemnity principle” (i.e. must suffer loss to recover).

• Contingency insurance – fixed sum paid on insured event – specific categories of insurable interest. May be closer to gambling/derivatives etc.

Definition of insurable interest: currently very

restricted

Indemnity insurance

• Lucena v Craufurd – a legal or equitable interest in property or a right under contract (very narrow).

• Courts have expanded to (broadly) a reasonable expectation of loss.

• Cases are difficult to reconcile as courts reluctant to void policies (fact specific, social change).

• Includes valued policies.

Contingency (life) insurance

• “Natural affection” (own life and spouse).

• Financial loss “recognised by law” at time of contract (limited).

• Permitted by other statutes (eg Local Government Act).

• Feasey – added a further category based on a broad interpretation. Essentially the commercial intention of the parties.

Retaining the doctrine

• In 2008 paper, Law Commissions: – Proposed removal of insurable interest requirement for indemnity

insurance – Asked whether the requirement should be retained for life/non-indemnity

insurance.

• Most consultees argued strongly in favour of retention: – Part of the definition of insurance: distinguishing it from

derivatives/gambling – Reinforces market discipline and discourages more speculative trading – Guards against moral hazard (inducement to murder, commit fraud etc) – Protects insureds from useless policies (because judged at outset) and

insurers from invalid claims – Other specific uses eg where insurance is located, which can be

important for regulatory/tax purposes

• Law Commission is persuaded that there is a value in retaining the requirement – instinctively right - but that it should be more flexible/practical.

2015 consultation paper

• Law Commissions persuaded that concept of insurable interest should be

preserved for both indemnity and contingency insurance.

• Requirement should be in statute.

• Policies without insurable interest should be void but not illegal.

• Preserve current distinction on timing: indemnity - time of loss; contingency -

time of contract.

• However, more permissive regime: enabling development of socially useful

insurance products; less opportunity for insurers to take technical points to

avoid payment.

Summary of proposals

• Indemnity insurance proposals:

– Repeal Marine Insurance Act 1788 and Marine Insurance (Gambling Policies) 1909.

– Statutory statement that insurable interest required, with non-exhaustive definition.

– Largely intended to “tidy up” the law, probably little practical impact on the insurance market.

• Life insurance proposals:

– Expanding who can insure the life of a given person. – Economic dependency test. – Interest required at time of contract. – No statutory limits on insured amounts eg for life cover on children. – Potentially controversial social and moral considerations at play. – Proposals would have greater market effect. – Further consideration of non-life contingency products eg critical illness; key

man.

Specific indemnity

insurance proposals (1)

• A new statutory requirement for insurable interest.

• Possible non-exhaustive definition? Insured should have insurable interest if has: – Right in insured property based on contract. – A reasonable prospect of economic benefit if insured subject matter

preserved or economic loss on its destruction. – Possession of insured subject matter. – Add anything else? Consultees suggested D&O, liability etc.

• To claim, policyholder must have interest at time of loss.

• If no reasonable prospect that policyholder will acquire an insurable interest, policy void. Premiums must be returned.

• Valued policies included within this. Parametric products?

Specific life/contingency

insurance proposals

• Less prescriptive than 2011 proposals.

• Financial loss - a “reasonable prospect” that policyholder retains economic benefit in preservation of life insured or incurs economic loss on death (rather than existing very narrow test based on “pecuniary interest recognised by law”).

• Alternative/additional definition may be required to ensure that this also works for other contingency policies eg critical illness; business interruption.

• Removal of requirement for value of policy to be confined to likely value of benefit/loss judged at time of contract (indemnity element in non-indemnity contract).

Life/contingency

insurance (2)

• Natural affection – as well as current self and spouse, should include:

– children and grandchildren (of any age); – cohabitants (no minimum time period); and – trustees of pension schemes in lives of members.

• Wider economic benefit test will also allow more lives to be insured where appropriate.

• No special rules for insurance linked investment products.

More information

• Visit the Law Commission website for copies of papers (www.lawcom.gov.uk)

• [email protected]

• Insurance contract law mailing list: email [email protected]

J A M E S D A V E Y

P R O F E S S O R O F I N S U R A N C E & C O M M E R C I A L L A W

D I R E C T O R , I N S U R A N C E L A W R E S E A R C H G R O U P

M E M B E R , I N S T I T U T E O F M A R I T I M E L A W

U N I V E R S I T Y O F S O U T H A M P T O N

Insurable Interest: a Rule in Search of a Rationale

13

Finding the ‘Original’ / ‘Not Mad’ Sweet Spot?

‘It is impossible to say anything new about Magna Carta, unless you say something mad. In fact, even if you say something mad, the likelihood is that it will have been said before, probably quite recently. So you must not expect any startling new line from me, least of all in a centenary year in which something portentous is said about Magna Carta every day’, Lord Sumption, Magna Carta: Then and Now (Speech, March 2015).

A ‘portentous’ year for insurable interest?

70 years of academic criticism of insurable interest…

14

Insurable Interest 15

Common law rule: highpoint in Macaura [1925] AC 619 (HL)- requirement of a legally recognised relationship to the insured property that matches interest insured.

Macaura suggests contract unenforceable without interest. Largely not enforced in litigation [underwriters do not raise defence & even if they do, courts avoid a finding of no interest].

Subsequent case law more nuanced (esp, indemnity): Moonacre, ‘Pervasive interest’ cases, Feasey, Great Lakes.

LAA 1774: Interest, named beneficiary.

MIA 1906 & 1909: Interest, PPI clauses, criminal offence.

Why keep insurable interest? 16

Imagine we had no insurable interest requirement for non-marine insurance [as per Australia].

What new limits would we impose? And to what end?

1. A definitional purpose (insurance vs wagering and other types of risk-related contracts); and/or

2. A market discipline purpose (reduce incentives on underwriters and insureds to agree socially harmful policies); and/or

3. A technical purpose (identify the locus of the insurance obligation).

(1) Insurable Interest as Definition: and the consequences of non-compliance

17

Too much attention has been given to required relationship between insured and subject of the insurance [Lord Eldon and Lawrence J in Lucena v Craufurd].

Crucial issue is effect of non-compliance.

Current approach often refers back to 18th century need to deter wagering and not modern regulatory controls.

Existence of interest should merely be part of definition, as per fortuity rule.

(2) Insurable Interest as a Tool for Market Discipline

18

(1) Effect on underwriters: market discipline Thomas Cheshire v Vaughan Bros [1920] 3 K.B. 240, 252-53 per

Scrutton LJ. ‘‘For many years there has been an unfortunate conflict between the

statute law and the practice of business men. It has been extremely common to place in policies a p.p.i. clause providing that there shall be no necessity to prove the amount of loss, although all the time there was a statute which said that such a clause was either illegal or null and void… It is the duty of judges, if they know that a policy has that clause on it, to treat it as null and void under the Act, and a practice has grown up of deceiving the Court by parties tearing off the clause which they have put on the policy in the hope that the Court will not know that there is such a clause and will give effect to the policy. The Court does not generally know, but having had some commercial experience suspects what those two pinholes in the margin of the policy mean, and still more when it sees that a piece of paper has been torn off…’

And Marine Insurance (Gambling Policies) Act 1909.

(2) Effect on Insureds: Market discipline 19

Life Assurance and the Temptation to Murder: J Davey ‘Dial M for moral hazard? Incentives to murder and

the Life Assurance Act 1774’ (2014) 25 ILJ 120.

‘Homicide Index: 1997-2010’ / Nexis newspaper database.

C. 60 cases, ranging from murder to procuring hitman. Vast range of circumstances, motives, social status and level of pay-out sought.

CDOs and ‘shadow insurance’: accidental advantage of insurable interest?

In both circumstances, better to have flexible standards set by body with obligation to regulate the market.

(3) Insurable Interest as Conflicts Device: Locating the Indemnity

20

Locus of the insurance indemnity. Under English law, generally classified as unliquidated

damages. Underwriter assumed to be in breach of duty to ‘hold

harmless’. Measure of contractual damages well established, and

normally ‘expectation interest’: put party in position as if promise had been performed.

Commercial damages claim (outside of insurance) routinely have to consider cross-border (and other) complexities.

If so complex, simply contract (or if need be legislate) for a formula for damages: do not render contract unenforceable.

Conclusion 21

If we were designing the regulation of this area from scratch, we would not control via primary legislation.

Much better handled- within regulatory conversation- by FCA and PRA to represent social and market interest.

Insurers should decide- for themselves- when and what to insure / indemnify unless the product is a risk to society and/or the market.

Much of what is currently prohibited is unobjectionable, some of what is objectionable is lawful.

Some things- such as what personal relationships are genuine- are beyond the capacity of private law to judge, in a cost efficient manner.

BILA would like to thank

Stephen Lewis and James Davey