Issues Paper on section 54
The IC Act had its origins in 1976 with the Attorney-General expressing concern with the lack of uniformity between the insurance laws of the Territories and the States, the relative bargaining power between the insurer and the insured and the fairness of negotiating and contracting of insurance. As a consequence he asked the Australian Law Reform Commission (ALRC) to report on:
- the adequacy of the law governing contracts of insurance (excluding marine insurance, workers compensation and compulsory third party insurance) having regard to the interests of insurer, insured and the public;
- what, if any, legislative or other measures were required to ensure a fair balance between the interests of the insurer and the insured; and
- any other related matter.
In response, the ALRC produced two reports. ALRC 16, entitled ‘Insurance Agents and Brokers’, dealt with the regulation of insurance intermediaries. ALRC 205, entitled ‘Insurance Contracts’, dealt with contracts of insurance, contract terms and remedies and the information insurers must make available to an insured.
ALRC 20 Report
The ALRC 20 Report (the Report) proposed wide-ranging reforms to the field of insurance by attempting to enhance uniformity between the laws of the States and Territories, balance the relative bargaining power between the insurer and the insured and make the negotiating and contracting of insurance fairer. The Report included draft legislation to implement these designs which formed the basis of the IC Act.
Specifically, the Report recommended that an insurer should not be entitled to terminate a contract if the insured is in breach of it, but rather be entitled to reduce the claim in proportion to the prejudice it has suffered as a result of the breach.6 As a result, a very similar version of the current section 54 of the IC Act was drafted to satisfy two of the Report recommendations as outlined below.7
Recommendation 36: Obligations during the period of cover.8
Many contracts of general insurance and some contracts of life insurance contain terms which have the effect of placing obligations on the insured in order to protect the insurer against increases in the risk during the period of cover.
Legislation should provide that, whatever the form of the relevant terms, the penalty placed on the insured for a failure to comply with an obligation imposed by the contract should be the same (para. 229). Where an insured has breached such an obligation, an insurer should only be entitled to reduce a claim by an amount that fairly represents the extent to which its interests have been prejudiced by the relevant conduct.
However, an insured should be entitled to recover if he proves, in respect of conduct which might, in principle, have contributed to a loss, that it did not do so in the particular circumstances of the case. Where the insured is able to prove that the conduct caused only a part of the loss, he should not be disentitled from recovering that part of the loss which was not caused by the conduct (para. 228, cl. 54(1)-(3), 54(5), 55).
Finally, an insured should not be disentitled from recovery where he proves that compliance with the relevant obligation was not reasonably possible in all the circumstances or where non-compliance was necessary to protect life or property (para. 230, cl. 54(4)).
Recommendation 37: Remedies for breaches of conditions subsequent.9
The recommendations made in relation to those terms designed to protect the insurer against an increase in the risk during the period of cover should apply equally to those terms which place obligations on the insured in order to protect the interests of the insurer after a loss has occurred (para. 241-2, cl. 54-5).
To illustrate the recommendations, the Report contains three examples where the section would apply. 10
A motor vehicle policy contains a term by which the insured warrants that the vehicle will be maintained in a roadworthy condition. As a result of a brake failure, the vehicle, while being driven by the insured, collides with another vehicle. The driver of the other vehicle was 50% to blame for the accident. The insured’s conduct in allowing the vehicle to become unroadworthy could reasonably be supposed to cause or contribute to a loss, hence sub-cl. (2) applies. The insured is able to prove that he was, at most, 50% to blame for the accident. Hence the insurer is entitled to deduct only 50% of the claim (sub-cl. (3)).
If the vehicle was damaged while parked, the insured could recover the full amount of his loss (sub-cl. (1)).
A’s motor vehicle policy contains a term which excludes the insurer’s liability if the driver of the vehicle is unlicensed. While driving the car, A is involved in an accident. He was unlicensed at the time, having forgotten to renew his licence, which expired 2 weeks previously. A’s conduct could not reasonably be supposed to be of a type which could contribute to an accident, so sub-cl. (1) only applies. Since the insurer could not have been prejudiced by A’s driving the car without a licence, it is liable for the full amount of the claim.
As mentioned above, the current section 54 (set out below) is substantially the same as the provision in the Draft Insurance Contracts Bill 1982 as developed by the ALRC.
54 Insurer may not refuse to pay claims in certain circumstances
The Explanatory Memorandum to the Insurance Contracts Bill 1984 (Cth) further elaborates the rationale for section 54. At paragraph 182, it states that:
The existing law is unsatisfactory in that the parties’ rights are determined by the form in which the contract is drafted rather than by reference to the harm caused. The present law can also operate inequitably in that breach of the term may lead to termination of the contract regardless of whether or not the insurer suffered any prejudice as a result of the insured’s breach. The proposed law will concentrate on the substance and effect of the term and ensure that a more equitable result is achieved between the insurer and the insured (ALRC paras. 228-230 and 241-242).
The total extract from the Explanatory Memorandum relating to section 54 is at Attachment C.
5 The Law Reform Commission, Insurance Contracts - Report No. 20 (1982). http://www.austlii.edu.au/au/other/alrc/publications/reports/20/.
6 Ibid at page xxii.
7 Ibid at Appendix A, page 267.
8 Ibid at page xxxi.
9 Ibid at page xxxii.
10 Ibid at Appendix A, page 290.