Issues Paper on section 54
For a discussion on the general background to development of section 54 and the current statutory framework, see Attachment B.
Section 54 applies widely to prevent insurers from refusing to pay a claim if non-compliance with contractual requirements did not cause or contribute to the loss. If the non-compliance did contribute however, the section only gives insurers the ability to reduce a claim to the extent that their interests were adversely effected. (For the Explanatory Memorandum to section 54, see Attachment C).
For example, a motor vehicle policy may contain a term which requires the insured to maintain the vehicle in a roadworthy condition. In the situation where an accident occurs partially due to brake failure and partially due to the actions of the other driver, the insurer is only able to deduct an amount from the claim which stems from the insured’s failure to keep the vehicle in a roadworthy condition.
Generally, the operation of section 54 has not caused difficulty in its application to ‘occurrence’ insurance policies, such as motor vehicle policies. That is, policies that provide cover for claims arising from incidents that occur during the policy period.
There has, however, been much judicial consideration of the application of section 54 in relation to ‘claims made’ and ‘claims made and notified’ policies of insurance1.
‘Claims made’ and ‘claims made and notified’ policies both indemnify insureds for claims which are made against them by a third party and notified to the insurer during the period of cover. These policies also indemnify potential future claims arising from a fact or circumstance that the insured becomes aware of during the period of cover, provided that the fact or circumstance is notified to the insurer during the period of cover. Many policies contain a ‘deeming provision’ which provides that where an insured notifies facts or circumstances which might give rise to a claim to the insurer during the policy period, any claim which ultimately eventuates from those facts and circumstances will be treated as a claim under that policy. Subsection 40(3)2 of the IC Act stipulates that insurers are required to offer the circumstance or occurrence notified element regardless of whether it is provided for in the contract.
Given that professional indemnity claims (and similar types of claims) can often be made a long period after the event or circumstance giving rise to the claim, insurers have not traditionally covered such risks under ‘occurrence’ policies. This is because insurers find it difficult to account for their liabilities when they are not notified of the incident that may lead to a potential claim several years later. Such a result can lead to insurers having to set aside excessive reserves or worse, having insufficient reserves to cover claims.
From the insurer's point of view there are a number of advantages in providing cover such as professional indemnity or medical malpractice on the basis of claims made or ‘claims made and notified’ policies. These include:
- eliminating the so-called "long tail" of unascertained policy obligations. In other words, at the end of the policy period, the insurers should know exactly the claims which they will need to cover (whether those claims have been notified to them as claims or circumstances which may give rise to a claim). This is important for insurers in terms of calculating their liabilities and the reserves that they should set aside for the purpose of meeting those liabilities;
- potentially avoiding the difficulty of ascertaining which of several successive policies should respond to a claim, where the work giving rise to the claim may have spanned more than one insurance period; and
- the extent of insurance cover available at the time of notification of the claim (or circumstances which might give rise to a claim) being the amount which has been negotiated prior to the outset of the policy period based on present day claims experience rather than historical information.
Recent judicial interpretation of subsection 54(1) of the IC Act has excused the insured from the consequences of a failure to notify claims or circumstances which might give rise to a claim during the period of cover (even where the decision not to notify was deliberate) so that coverage is still available for such losses for an indeterminate period after the policy has expired. In simple terms it has been said that the result converts the policy into an ‘occurrence trigger contract’, subject to the need for insurers to provide for ‘incurred but not reported claims’ as in traditional accident-based liability insurance.3
Below is a brief discussion of some of the cases that have interpreted section 54 over the last decade. The varying interpretations have been clarified in the most recent case, Australian Hospital Care (see below).
East End Real Estate Pty Ltd v C E Heath Casualty and General Insurance Limited (1992) 25 NSWLR 400.
In relation to the ‘claims made’ element of indemnity policies, provided the claim is made during the period of the policy, it is not necessary for an insured to notify the insurer of a claim until indemnification is sought.
This case saw the NSW Court of Appeal consider a ‘claims made and notified’ professional indemnity policy. The Court held that subject to any prejudice the insurer might have suffered, subsection 54(1) allowed the insured to make a claim against the insurer even though they did not notify the insurer of the claim until after expiry of the policy. The Court rejected the submission that section 54 was to be confined to conditions, warranties and exclusion clauses rather than extending the scope of the cover.
FAI General Insurance Company Ltd v Australian Hospital Care Pty Ltd (2001) 204 CLR 641
In relation to the ‘notified’ element of indemnity policies, there is no need for the insured to notify the insurer of an occurrence that may lead to a claim in the future. Section 54 operates to remedy the insured’s failure to comply with the scope of the contract.
The High Court decision in the Australian Hospital Care case has clarified the uncertainty that has existed in relation to the ambit of section 54 by endorsing East End and Antico and essentially overruling Perry (see case summary below). Further, the reasoning in both Greentree and Permanent Trustee v FAI4 was rejected, even though the final decision was found to be correct (see case summary below).
The Australian Hospital Care case considered a ‘claims made and notified’ policy. The insured (AHC) was contacted by the solicitor of a patient, who indicated that his client was considering legal action due to the possible negligence of a doctor. Following investigation into the matter, both the insured and the patient were satisfied that there were no grounds for complaint so the insured did not notify the insurer of this occurrence. Despite these events, the patient did end up taking legal action and the insured sought to rely on section 54 in order to be indemnified from the claim.
The High Court held that the effect of section 54 was that despite an insured being aware during the policy period of incidents that may lead to a future claim, non-disclosure of these incidents until after the period of that particular policy - hence possibly avoiding a premium increase for the next policy period - is not a ground upon which the insurer can refuse to pay the claim.
FAI General Insurance Company Limited v Perry (1993) 30 NSWLR 89
The insured held a ‘claims made and notified’ policy. Despite becoming aware of a potential claim within the period of the policy, the insured did not notify the insurer. The insured unsuccessfully attempted to rely on subsection 54(1), by submitting that his failure to notify the insurer of these facts was an ‘omission’ under paragraph 54(6)(a). Although the NSW Court of Appeal found that the concept of omission did not include the insured’s failure through inaction to exercise some right that exists under the policy, the practical result of the decision has been overturned by the Australian Hospital Care case.
Antico v C E Heath Casualty & General Insurance Limited (1997) 188 CLR 652
This involved an insured who proceeded to defend claims made against him without seeking the consent of the insurer. The issue was whether a failure to obtain the consent from the insurer was an omission for the purposes of section 54.
The High Court approved the East End case (see above) and stated that the legislation was expressed broadly enough that an omission could include a failure to exercise a ‘right, choice or liberty’ that the insured enjoyed under a contract of insurance.
Greentree & Anor v FAI General Insurance Co Ltd (1998) 44 NSWLR 706
This case involved the negligent design of a building, which was only discovered by a third party after the expiry of the policy. The NSW Court of Appeal held that section 54 could not be invoked, where the effect of doing so was to alter the basic terms of the contract of insurance. It was found that this would destroy the necessary causal connection between the policy terms and the insurer’s refusal to pay the claim, upon which the application of subsection 54(1) depends.
Gosford City Council v GIO General Limited  NSWSC 511 and  NSW CA 34
This case involved a ‘claims made’ policy that did not include a provision to treat the notification of circumstances as a claim during the policy period. The New South Wales Court of Appeal held that section 54 would not apply to provide relief to an insured, who fails to notify circumstances that may give rise to a claim during the policy period (that is, the insured failed to invoke section 40(3)). The circumstances of that decision depended on the particular wording of the policy.
1 ‘Claims made’ and ‘claims made and notified’ policies include, professional indemnity, directors and officers, errors and omissions and medical malpractice insurance.
2 ‘Where the insured gave notice in writing to the insurer of facts that might give rise to a claim against the insured as soon as was reasonably practicable after the insured became aware of those facts but before the insurance cover provided by the contract expired, the insurer is not relieved of liability under the contract in respect of the claim, when made, by reason only that it was made after the expiration of the period of the insurance cover provided by the contract’: subsection 40(3).
3 3 There is still some uncertainty flowing from the various cases as to whether the late notification of circumstances which might give rise to a claim in a claims made and notified policy which does not include any provisions relating to the notification of circumstances which might give rise to a claim, can be the subject of relief under section 54.
4 Permanent Trustee Australia Ltd v FAI General Insurance Co Ltd (1998) 153 ALR 529.