Final Report on second stage: provision other than section 54
- interim cover and contracts of life insurance;
- subrogation; and
- underwriting decisions based on genetic information, including family medical history.
11.2 Section 38 of the IC Act is concerned with interim contracts of insurance. Subsection 38(1) prevents an insurer making cover under an interim insurance contract dependent upon later completion of a satisfactory proposal.
11.3 Subsection 38(2) deals with the expiry of interim contracts. An interim contract of insurance does not expire until the earliest of the following times:
- the time when insurance cover commences under another contract of insurance, being insurance cover that is intended to replace the insurance cover provided by the interim cover;
- the time when the interim contract is cancelled; or
- the time the insured withdraws the proposal.204
11.4 If the time taken to finalise a contract of insurance is greater than the length of time prescribed in the interim cover, the interim cover continues until one of the abovementioned conditions is satisfied. Section 38 of the IC Act therefore provides the insured with cover that extends beyond the date mentioned in the cover note.
11.5 In relation to general insurance, the only method of avoiding the risk of a claim under this extended statutory cover is to cancel the contract in accordance with section 59 of the IC Act.
11.6 In its report on insurance contracts, the ALRC rejected an argument that there should be an immediate right to cancel an interim contract of insurance in some circumstances, for example, fraud.205 Indeed it recommended that:
‘Where an insured has lodged a proposal form for insurance, any interim cover taken out in respect of that insurance should remain in effect until either cover commences under another contract of insurance which is intended to replace the interim contract or the insurer cancels the contract of insurance, whichever is the earlier.’ 206
11.7 Phillips Fox submitted that the law should be amended so that interim cover expires on the date mentioned in the interim cover note itself. This is because a cancellation ‘is in effect a black mark against a person which must be disclosed when applying to another insurer. This seems inappropriate when the cancellation is of an interim contract’.207
11.8 Further, the Investment & Financial Services Association Ltd suggested that, due to the nature of life insurance, life insurers should not be required to comply with the cancellation provisions in order to no longer be liable on an interim contract of insurance.
‘While it might be reasonable to require the insurer to confirm that interim cover has ceased, it is unreasonable and inappropriate to require the insurer to provide the 20 business days notice specified in section 59 of the Act. Such a notice period performs no substantive purpose, given the objective of the interim cover (to provide limited cover while an application is being underwritten) and belies the short term nature of the cover in any event. It is also a consequence outside the concern which the Australian Law Reform Commission originally sought to address when proposing the introduction of section 38.’208
11.9 Neither the ALRC’s recommended draft provision dealing with this issue, nor section 38 of the IC Act, differentiated between interim contracts of general insurance and interim contracts of life insurance. The Explanatory Memorandum to the Insurance Contracts Bill 1984 stated that the inclusion of expiration provisions in subsection 38(2) was to provide an equitable outcome for both the insurer and the insured:
‘A cover note is invariably in force for a limited time. Where the insured has lodged a proposal form with the insurer but the insurer has not considered it at the time the cover note expires, the insured is left without protection. Usually the cover note provides that the insurer may cancel upon giving notice to the insured and, should it do so after rejecting the proposal, the insured is again left without protection and no opportunity to arrange alternative cover. A more equitable balance of the insurer’s and insured’s rights will be achieved by clause 38.’209
11.10 Given the reasoning behind section 38 of the IC Act as provided by the Explanatory Memorandum and ALRC Report 20, the Review Panel considers that no change should be made to the expiration requirements of interim contract of insurance that are found in subsection 38(2) of the IC Act.
11.11 Another issue raised in the Issues Paper is whether there should be an amendment to section 9A of the Life Insurance Act 1995 to bring interim covers for continuous disability policies within that definition.
11.12 Currently, for interim covers for continuous disability policies to be considered life insurance, permission must be sought from APRA. This is because interim covers for continuous disability policies are not life policies within the meaning of section 9 of the Life Insurance Act 1995 (as they do not fall within the definition of a continuous disability policy in section 9A of that Act (generally because they are of less than three years’ duration)).
11.13 While a number of submissions have been received about this issue, the Review Panel have been advised that the question of the need for an amendment to the Life Insurance Act 1995 has been referred for inclusion in a review of that Act. While a case had been advanced for this amendment, in the short-term, the difficulties related to the operation of the section are able to be overcome by administrative means.
11.14 In the case of indemnity insurance, unless excluded by the terms of the policy, there is a right for an insurer to act in the insured’s name in relation to any rights the insured has against third parties in respect of a loss. For example, if an insurer pays out a claim for accident damage under a motor vehicle insurance policy, the insurer will be permitted to seek, in the name of the insured, damages from third parties who contributed to causing the accident.
11.15 In a case of subrogation, the insurer acts in the name of the insured to recover loss from a third party. When this occurs, the question arises: who should receive the benefit of the proceeds of the claim — the insurer or the insured? A key aspect of the doctrine of subrogation in the context of indemnity insurance is that the insured party should not make a profit from the loss and should account to the insurer for any profit that is made.210
11.16 Section 67 of the IC Act deals with the application of funds recovered through subrogation. It provides that (subject to a contrary provision in the contract)211 where an insurer recovers monies through subrogation, the insured is entitled to an amount that cannot, when added to the amount paid by the insurer in relation to the loss, exceed the amount of the loss.212 For example, if there is a loss of $10,000 and the insurer has paid the insured $5,000 under the policy, then if the insurer later recovers $8,000 from a third party, the insured is only entitled to a maximum of $5,000 from the recovered funds. This outcome leaves the insured fully compensated, with the insurer bearing a loss of $2,000.
11.17 Under the draft Insurance Contracts Bill prepared by the ALRC (upon which the IC Act was based),213 the rule about the insured never recovering more than their loss was the only rule regarding the maximum recovery by an insured from recovered monies. However, in the Insurance Contracts Bill as introduced, a further rule was included to the effect that the insured cannot recover more than the difference between the amount recovered and the amount paid by the insurer in respect of the loss. So, in a case where the loss is $10,000, the insurer has paid $5,000 (perhaps because of a cap on the liability included in the policy) and later recovers $8,000 from a third party, the insured would only be allowed to recover $3,000 from the recovered funds. This outcome leaves the insurer in a ‘break even’ position (ignoring the costs of the action) and the insured bearing a loss of $2,000. The rationale for the additional rule (appearing as paragraph 67(2)(a)) was not explained in the Explanatory Memorandum to the Bill.
11.18 Under one interpretation of subsection 67(2) of the IC Act, the rules apply so the most the insured can recover is the lesser of what is allowed for in paragraphs 67(2)(a) and 67(2)(b).214 However, under a contrary interpretation, the insured will be entitled to the greater of what the two rules allow.
11.19 Whichever interpretation is correct, the rules are subject to any contrary agreement made by the parties after the loss has occurred (subsection 67(3)) and, under subsection 67(4), costs incurred in recovering the monies are to be deducted from monies recovered before remitting any proceeds to the insured.
11.20 It has been suggested that the additional rule (in paragraph 67(2)(a)) should be removed. This would mean that monies recovered under subrogation are applied first toward any uninsured ‘top layer’, consistent with the common law principle that where insurance is arranged in layers, losses should be borne from the ‘ground up’ and recoveries applied from the ‘top down’. Insurers would still be able to recoup costs of running the subrogated action under subsection 67(4), so no unfairness to insurers would result.
11.21 A contrary suggestion is that, rather than removing the rule in paragraph 67(2)(a), the section should be redrafted to make it very clear that the insured is only entitled to the lesser of the amounts determined under paragraphs 67(2)(a) and (b). On this view, the rule in paragraph 67(2)(a) is necessary to provide an incentive for insurers to pursue actions under subrogation. In some cases the absence of the rule would mean the insurer would only recover their costs under section 67(4), with all benefits of the recovery flowing to the insured. If insurers do not have sufficient incentive to pursue subrogated actions the costs of insurance are likely to increase — the beneficiaries of the change being the unpursued third parties.
11.22 Three further criticisms of section 67 of the IC Act have been raised.
11.23 First, there is uncertainty about the extent to which it is possible to make binding agreements in the insurance contract about how funds recovered by subrogation are to be divided as between the insurer and the insured. Subsection 67(2) clearly contemplates that the insurance contract might place higher limits on the amount an insured might recover. However, when read together with subsection 67(3)215 there is, arguably, an implication that any agreement (whether in the insurance contract or otherwise) that would result in an insured’s entitlement being less than the amounts set out in section 67(3) is of no effect unless it is made after the loss occurred. This interpretation could be justified on the basis that subsection 67(2) is supposed to protect insureds from ‘signing away’ their rights to subrogation proceeds under the provision before they are conscious of what is at stake. An alternative interpretation is that subsection 67(2) merely provides ‘default rules’, which are subject to contrary provision in the insurance contract. On that view, section 67(2) permits any kind of arrangement regarding distribution of recovered monies to be included in the insurance contract, but that agreement and the rules in subsection 67(1) and (2) may be varied by a subsequent agreement made after the loss occurred.
11.24 Second, it does not provide for any interest component to be added to the maximum amount that can be recovered. Since recovery can sometimes take many years, the maximum that insureds should be entitled to recover should include interest for that period, as well as the original loss.
11.25 Finally, section 67 is drafted on the assumption that recovered funds are paid to the insurer when, in practice, they are usually payable to the insured as creditor and only directed to the insurer at the insured’s direction. It has been suggested that the section should be redrafted so that it does not assume the monies are recovered by the insurer. However, in a case where monies recovered under subrogation are received by an insured, the insurer might be expected to extract its share of the proceeds pursuant to the terms of the policy or a subsequent agreement under subsection 67(3) of the IC Act.
11.26 The Issues Paper contained an invitation to comment on the operation of section 67. In particular, comments were sought on:
- whether the rule in paragraph 67(2)(a) of the IC Act should be removed, or whether it should made clear that the it is the lesser amount of the two rules in paragraphs 67(2)(a) and (b) to which an insured is entitled;
- whether pre-loss agreements regarding application of monies recovered by subrogation that provide lesser rights to the insured that those in subsection 67(2) be permitted and, if so, whether section 67 should be redrafted to clarify that is the outcome;
- whether section 67 should provide for insureds to receive amounts representing interest out of monies recovered by subrogation; and
- whether section 67 of the IC Act should be redrafted to remove the assumption that monies recovered under subrogation are always recovered by insurers (as opposed to insureds).
11.27 One submission suggested that subrogation should be determined exclusively by agreement between the parties, and section 67 was unnecessary. However, the balance of the opinions in submissions was generally in favour of more clarity in the operation of section 67.
11.28 In its submission, the Australian Law Reform Commission (ALRC) drew attention to the sections of its report into the Marine Insurance Act 1909 dealing with subrogation. The ALRC set out the following statements of principle that should apply in relation to the order or priority in which the recovered money should be distributed, subject to any agreement between the parties in the contract.216
- First, the party taking the recovery action should be entitled to reimbursement for the administrative and legal costs of that action from any moneys recovered. If both parties contribute, they should be reimbursed, or share the reimbursement pro rata if there is insufficient recovered money to reimburse both in full.
- Second, there are three possibilities depending on who has funded the recovery
- If the insurer funds the recovery action pursuant to its rights of subrogation, it is entitled to an amount equal to the amount that it has paid to the insured under the insurance contract. The insured is then entitled to any further amount that may be required so that it ultimately recovers from the insurer under the insurance contract or the third party in the recovery action, or both in combination, the full amount of its loss (not just the measure of indemnity under the policy). This entitlement does not diminish the insured’s right to receive payment promptly under the policy in accordance with its terms and the insurer’s obligation to pay promptly, subject to any contrary agreement between the parties.
- If the insured funds the recovery action, the order in the preceding paragraph is reversed. The insured is entitled to retain an amount so that the total that it receives from the recovery action and under the policy is equal to its total loss. The insurer is entitled at this point to an amount equal to the amount that it has paid to the insured under the insurance contract.
- If the action is funded jointly by both insurer and insured, they are entitled to the same amounts as those referred to in (a) and (b) above, pro rata if there are insufficient funds to reimburse them in full.
- Third, any excess or windfall recovery is then distributed to both parties in the same proportions as they contributed to the administrative and legal costs of the recovery action. Thus the party (or parties) shouldering the cost and risk of the recovery action for the benefit of all concerned receives the benefit of the windfall. Most commonly this would be the insurer — but the insurer only gets the benefit after the insured has received full recovery for all its losses as the insured would have been entitled to these losses as damages from the third party as a matter of principle, whether or not there was any insurance in place.
- Finally, any separate or identifiable component in respect of interest should be paid to the parties in such proportions as fairly reflects the amounts that they have each recovered and the periods of time for which they have each lost the use of their money.
11.29 The Review Panel considers that the approach recommended by the ALRC would provide suitable solutions to the criticisms and queries about the operation of section 67 of the IC Act raised in the Issues Paper. The Review Panel agrees with the ALRC’s comment that there seems to be no reason in principle why there should be divergence between the IC Act and the Marine Insurance Act 1909 in relation to subrogation rights.217
11.30 Accordingly, the Review Panel recommends that section 67 of the IC Act be amended in line with the ALRC’s equivalent recommendation regarding the Marine Insurance Act 1909.218
11.31 Subsection 48(2) of the IC Act provides that persons not party to the insurance contract but to whom the insurance under an insurance contract extends have, in relation to a claim by such persons, the same obligations to the insurer as they would have if they were an insured.219
11.32 It has been suggested that the provisions regarding subrogation in Part VIII of the IC Act should also apply to claims made by third party beneficiaries who are not ‘insured’ for the purposes of those sections.
11.33 The Issues Paper contained an invitation to comment on whether the subrogation rules should apply to claims relating to third party beneficiaries and, if so, whether any legislative changes are required, having regard to the terms of subsection 48(2). That subsection provides that third party beneficiaries with claims against insurers have the same obligations to the insurer that the insured would have had, and may discharge those obligations in relation to the loss.
11.34 No submissions opposed the proposal that the subrogation provisions should apply to third party beneficiaries and one submission supported a legislative clarification to ensure this was the case because subsection 48(2) may not already achieve this result.
11.2 The IC Act should be amended to clarify that the provisions regarding subrogation in Part VIII apply to claims made by third party beneficiaries who are not ‘insured’ for the purposes of those provisions.
11.35 Section 75 of the IC Act imposes a duty on insurers, upon request of a person who has been denied insurance, written reasons for the adverse decision.
11.36 A joint report by the Australian Law Reform Commission and the Australian Health Ethics Committee of the National Health and Medical Research Council recommended an amendment to section 75 to ‘clarify the nature of the obligation of an insurer to provide written reasons for an unfavourable underwriting decision upon the request of an applicant. Where such a decision is based on genetic information, including family medical history, the insurer should be required to give reasons that are clear and meaningful and that explain the actuarial, statistical or other basis for the decision’.220
11.37 The Review Panel notes that the Government’s response to this recommendation is being progressed separately to this review.
204 Subsection 38(2) of the IC Act.
205 The Insurance Council of Australia submitted to the ALRC that, inter alia, where for example, arson had been committed by the insured ‘it would be intolerable in these circumstances to suggest that the insurer should remain on risk for say another seven days after notifying the client that the proposal is unacceptable’. The ALRC rejected this argument because ‘it is important to ensure that rules designed or used to protect insurers from liabilities arising from fraud do not provide them with powers which may also be used against insured in cases where no question of fraud arises. An insurer which suspects arson should be required to prove it in a court of law. It should not be entitled, on suspicion of arson, to cancel without notice to the insured. It has other means of protecting itself against such a risk during a prescribed period of notice, including contact with the police’: Australian Law Reform Commission 1982, Insurance Contracts, ALRC 20, AGPS, Canberra, paragraph 209.
206 ALRC 20, paragraph 209.
207 See submission by Phillips Fox dated 21 April 2004.
208 See submission to this review by Investment & Financial Services Association Ltd dated 19 April 2004.
209 Australia, Parliament 1984, House of Representatives, Insurance Contracts Bill 1984, Explanatory Memorandum, at page 58.
210 Sutton, K. 1999, Insurance Law in Australia, 3rd edn, LBC Information Services, Sydney, paragraph 16.1.
211 The issue of the extent to which a contract can vary the provision is discussed further below.
212 Paragraph 67(2)(a) of the IC Act.
213 Australian Law Reform Commission 1982, Insurance Contracts, ALRC 20, AGPS, Canberra at page 273.
214 Sutton, K. 1999, Insurance Law in Australia, 3rd edn, LBC Information Services, Sydney at paragraph 16.63.
215 Subsection 67(3) provides that the rules in subsection 67(1) and 67(2) may be overridden by agreement made after the loss occurred.
216 Australian Law Reform Commission 2001, Review of the Marine Insurance Act 1909, ALRC 91, Australian Law Reform Commission, Sydney, paragraph [12.17].
217 ALRC 91, paragraph [12.17].
218 ALRC 91, recommendation 32. Cf Submission by the Insurance Council of Australia Limited (ICA), dated June 2004. In its submission the ICA state that ‘The key proposal to change the MI Act, now proposed by the Review Panel, was that the distribution of moneys should be determined by reference to who funded to recovery. ICA believes that this is not a proper and principled basis for revisiting the subrogation provisions. Such a basis for distribution doers not take into account of many complexities of subrogation (none of which appear to have been discussed by the ALRC) including the basis on which any over-recovery is made and there may be doubt as to whether or not there is an over-recovery or not because of the difficulties associated with determining the full quantum of the loss.’
219 Paragraph 48(2)(a) of the IC Act.
220 Australian Law Reform Commission 2003, Essentially Yours: Protection of Human Genetic Information in Australia, ALRC 96, Australian Law Reform Commission, Sydney, recommendation 27-5.
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