Don’t get caught out by the complexities of risk advice

When it comes to an adviser’s wish list, two things regularly top the list: greater simplicity and safety in respect of the advice process.

In order to improve safety two things must occur — areas of exposure have to be identified and solutions have to be developed, with the former being more difficult than the latter.

Fortunately claims and court cases assist in identifying the areas of greatest exposure.

In this article I will look at two recent court cases. Each case has been heavily summarised and much of the detail will not be provided.

As a result, this article should not be viewed as a thorough analysis of each case nor should it be used as a means of forming an opinion about the merit or otherwise of anyone’s position in the case.

A far more comprehensive study would be required before this could be attempted.

The focus should be on the implications of the cases and these should be considered as issues that might arise from these or similar situations.

CASE STUDY 1

STONE v TOWER AUSTRALIA LTD

Background

Each year Mr Stone had his risk insurance needs reviewed by his adviser.

In 1998, the adviser recommended he replace a Lumley trauma insurance policy for $1 million with a Tower trauma policy, also for $1 million.

The adviser placed a significant amount of business with Tower. He acted in the capacity of an agent.

The following question was in the application: “Will this insurance replace any other policy? If ‘Yes’, I will cancel the other policy on acceptance of the insurance being applied for”. Stone answered “yes” to this question.

The application was submitted and eventually Tower sent the adviser a fax indicating it was accepted subject to cancellation of the Lumley policy.

The next day Tower sent a further fax indicating the application had been completed and the policy schedule was being sent out.

As part of his due diligence, the adviser wrote to Stone saying: “It would now be appropriate to cancel your other policy as your replacement coverage was issued by the insurer yesterday.”

More than four years later Stone was diagnosed with a malignant cancer.

Tower discovered that the Lumley policy was still in force and in fact Stone had been paid the $1 million benefit amount under it.

Tower declined to pay the claim under its policy maintaining it had accepted Stone’s application on the understanding the Lumley policy would be cancelled.

And because the policy was not cancelled, a concluded agreement had not been reached and thus the Tower policy should be treated as void.

Stone commenced legal proceedings.

Tower in turn commenced proceedings against the adviser alleging he had breached his duty of care as he had not ensured the Lumley policy was cancelled.

Judgement

Stone maintained that at the time he completed the Tower application he intended to cancel the Lumley policy but when he received the letter from his adviser saying he should now cancel it, he decided he could afford both policies.

Quite simply, he changed his mind and the court accepted this.

The court did not believe the question and statement in the application amounted to a “promise” to cancel the original policy and thus they accepted that Stone did not believe it was a condition of the Tower policy that he cancel the Lumley one.

Tower on the other hand argued that the fax sent to the adviser stating that their policy was accepted subject to cancellation of the Lumley policy, constituted a condition of acceptance.

The court said that if this was the case, it should not be categorised as a condition of acceptance or a condition precedent to the formation of the contract but instead as a condition of performance or a condition subsequent.

But the court then rejected that it was a condition subsequent, finding that the wording of the question, “Will you replace any other policy with this policy” and “I will cancel the other policy….on acceptance of this policy” were both statements of intention rather than obligation.

The court said even if there was some ambiguity, the contra proferentem principle would apply in favour of the client as Tower had drafted the document wording.

The court disposed of all Tower’s grounds of defence and found in favour of Stone.

The case against the adviser was dismissed.

Implications

1. Influence of unknown factors

Some re-insurance agreements have clauses that state, in effect, if the insurer is at fault and a liability arises, no reinsurance applies.

I am not a party to the actual reinsurance agreements that applied in this case, but consider for example if the same reinsurer held the risk for both the Lumley and Tower policies.

If this was the case, they would hardly want to pay out a total of $2 million when their maximum exposure was meant to be $1 million.

In turn, if Tower was left with full exposure of $1 million without the possibility of reinsurance recovery, it also quite understandably would want to mitigate its position.

As a result, even though the adviser used to be one of Tower’s top writers, it still felt compelled to commence proceedings against him.

All insurers would have to consider taking a similar action if for no other reason than they would have a responsibility to their shareholders to do so.

Protection for the adviser lies with the facts of the case and how convincingly those facts can be presented. It has little or nothing to do with the adviser’s association and relationship with the insurer or the insured.

2. Avoiding the problem

The problems that arose could largely have been avoided if Stone had been followed up to ensure he cancelled the Lumley policy.

Again, this should not be taken in any way as a criticism of either the adviser or the insurer; it is simply an observation made with the wisdom of hindsight.

In fact, the adviser in this instance went further than most in that he actually wrote to the client and indicated the original policy could now be cancelled. This action became an important aspect of his defence.

This raises the question, what can the adviser do if a client has a change of mind about cancelling a policy once the new one is issued?

In brief, if the adviser feels the client is acting fraudulently, the adviser has a legal obligation to tell the insurer.

If the adviser thought the client was acting inappropriately, the matter should be discussed with the client. They can be made aware of the possible ramifications of their actions.

While this may sound like a lot of extra work, the potential alternative of litigation pales the extra effort into insignificance.

“Avoidance” by investing structured, extra time upfront is a sound strategy.

Notwithstanding this, it is appropriate for the adviser to consider the position of the insurer.

If double cover is tolerated, some clients may be seen as having a windfall, but in the end, other clients may be disadvantaged by higher premiums or tighter administrative procedures.

Insurer, insured and adviser need to work co-operatively rather than at cross-purposes.

3. Judicial logic

The wording in the application, “I will cancel the other policy on acceptance of this policy”, has been a part of applications for some years because some years ago an insurer was caught in exactly the same situation. Most companies put these words into their applications thinking they will be protected.

Unfortunately, the court ruled that the statement is not a “promissory statement” but rather a “statement of intention”.

It is not a “condition precedent”. It might have been a “condition subsequent” except the ambiguity of the statement was such that the contra preferentum rule applied in favour of the insured.

Just because you think something is going to be interpreted in a particular way, does not necessarily mean someone better qualified will interpret it differently.

But again, consider the position of insurers.

They seek to avoid putting ‘excessive cover’ in place. An adviser may not necessarily agree with the published maximum levels of cover for a particular product, but the statistics on claims frequency and duration show quite clearly that if an insurance “profit” situation is possible, the actual rate of claim far exceeds that which was assumed when the premium was calculated.

The insurer does not pay for claims; other policy owners do.

There is nothing wrong with seeking to put higher levels of cover in place but it must be done in an open and co-operative way with the insurer.

4. What about the client?

Stone was suffering from cancer, which would obviously be stressful enough, but then on top of that he had to go to court to try to get his claim paid.

In situations like this, how would the client view the ethics of the life industry? How would the client view the insurance company whose products had been recommended to him? How thrilled would the client be about the adviser’s recommendation of that insurer’s products?

Because of his health, the client would not be able to move his insurance, so is he going to be thinking, “If there is another claim in the future will my partner have to go through the same hassles again?”

5. What about the adviser?

No doubt the adviser was angry, distracted, disappointed, concerned and experienced many other emotions that would have done nothing to assist productivity and peace of mind.

CASE NO 2

NRG VICTORY v HUDSON

Background

In 1993 Hudson applied for insurance. In the application he stated he had not had a medical condition that would affect his ability to carry out the duties of his occupation and he had not had a neck, back or shoulder injury or disease that required him to have more than two weeks off work.

These two statements were untrue because he had dermatitis when he was working as a spray painter and ceased work for two years through 1991 and 1992 as a result.

At the time of his application, Hudson was employed as a packer and driver.

Hudson’s application for insurance was accepted in 1993, but late the same year he developed a rash and stopped work in 1994.

He made a claim on his policy in mid-1998.

The insurer denied his claim stating Hudson had fraudulently misrepresented his skin condition.

Judgement

The judge found that as Hudson’s dermatitis had settled by the time he completed the application, it was reasonable for him to assume that he no longer suffered from a skin condition.

Further the judge accepted that Hudson had not received medical advice that he had a medical condition that was going to affect his ability to carry out the duties of his then occupation as a packer and driver.

Section 26(1) of the Insurance Contracts Act provides that if someone makes a statement that they believe to be true and that a reasonable person in the circumstances would also believe to be true, that statement is not a misrepresentation, even if the statement is untrue.

As a result, while the statements Hudson made in his application were untrue, the statements did not constitute misrepresentations and as such they could not be fraudulent.

The case was appealed, but the original findings were upheld and Hudson was paid his claim in December 2003.

Implications

1. Claim timeline

The claim was lodged in mid 1998. It was then denied, legal action commenced, judgement was made, the case was appealed but the appeal was dismissed.

Payment was made in December 2003, five-and-a-half years after the client was initially disabled.

Why is insurance put in place? So that when an insured event occurs and a financial need arises, funds can be made available at that time, not years later.

Again, this is not necessarily the fault of the insurer. Litigation should be viewed as an absolute last resort. Far from speeding up the process, it will often slow it down and drag it out.

The preferred alternative should be for all parties to enter into meaningful discussion outside of the formal legal process.

2. Judicial logic, again

The average person might think if someone gave an incorrect answer to a question, that person would not have a leg to stand on.

Judicial logic can swing both ways — sometimes it may work to your client’s advantage; at other times it may work to your client’s disadvantage.

3. What about the insurer?

They ask questions, trust the insured will answer them correctly, the insured does not but the insurer still loses.

As mentioned before, keep in mind who ultimately pays for claims — other policy owners.

The response from the insurer may well be to draft tougher questions.

So next time you think an application is too long, the questions are too tough or underwriting is too severe, consider this case.

SUMMARY

These cases may not have delivered much in the way of increasing the simplicity of the advice process, but they certainly provide food for thought in the area of greater safety.

For the adviser

1. Be aware there may be unknown factors influencing the behaviour of the insurer. If something does not seem logical, ask questions.

2. Avoid litigation if at all possible.

3. Consider the impact of events on the insurer and following on from this, how that may subsequently impact on the adviser and the client.

4. Employ compliant procedures in all your client dealings.

For the client

1. Judicial logic is unpredictable; sometimes it will work to the advantage of the client and sometimes to the disadvantage of the client.

2. Litigation will rarely speed dispute resolution. It is much better to seek open and honest discussion with all affected parties.

For the insurer

1. Consider the impact of litigation on the client and the adviser.

Remember, investing extra time up-front will help to avoid problems later and ensure you don’t get ‘court’.

Col Fullagar is risk insurance manager with Associated Planners Financial Services.