Moral Risk

TURKSLEGAL COPYRIGHT 20061

By John Myatt & Dwana Walsh | November 2006

Moral Risk

What is a Moral Risk?

In the context of a contract of insurance, under which both parties are obliged by statute to exercise the

utmost good faith toward one another, the integrity of the insured would seem to be a matter of fundamental

importance to the insurer.

The idea that there may be “moral” issues posed by a risk may be reasonably familiar as an underwriting concept

but most insurance professionals will never have been obliged to try to define the moral risk as a concept, much

less had to grapple with what rights they may have to receive information from an insured relevant to it .

In this paper we aim to examine the concept of moral risk in the context of the insured’s duty of disclosure

and to provide some guidance about what the law compels an insured to disclose about themselves from this

perspective when they approach an insurer seeking cover.

Judges seem to have been content to use the expression “moral risk” without explanation as if it were a term of

art.1 Consequently, though the notion frequently figures in the case law in connection with the duty of disclosure,

the occasions when the concept itself has been examined by judges are few and far between.

An English judge observed many years ago that from an insurer’s viewpoint, consideration of “moral” issues in

connection with the integrity of the proposer of the insurance has a pervading character irrespective of the

nature of the risk that is being proposed, noting that:

“It is elementary that one of the matters to company in entering into contractual relations with a proposed

assured is the moral integrity of the proposer - what has been called the moral hazard.” 2

Taking their cue from how broadly the moral character of the insured impacts on the contractual relationship

with the insurer generally, some text writers3 seem to accept that any failure to disclose information, such as

a failure to disclose a prior claim for example, is something that has “moral” implications in relation to the risk

proposed.

To the extent there is an academic argument that the duty of disclosure is an aspect of the duty of utmost good

faith, this may be true to a degree. However, this paper does not attempt to address the moral risk in this broad

sense, as any kind of departure from the obligation of utmost good faith. Its scope is more specific.

Perhaps the easiest way to approach a working definition of the concept is to distinguish underwriting

information that goes to the physical risk from that which goes to the moral risk.


Information that goes to the physical risk has a bearing upon the aspects of the particular risk proposed which are

relevant to the probability of the insured event occurring during the period of cover. One of the well-respected

textbooks on Australian insurance law says “a fact is material to the physical risk if it directly increases the risk of a

loss.”4

Examples of facts that are material to the physical risk are easy to find. For instance, a history of previous fires

will be material to a fire proposal because it may show that the insured conducts his business in such a way as

to court the risk of fire.

In contrast, information material to the moral risk is described opaquely in the same textbook mentioned earlier

as one which “indirectly increases the risk of loss”.

Justice Slesser chose a different, though perhaps not inconsistent way to describe it, which may explain the

concept more usefully for the purposes of this paper. He said that what is generally intended by the moral risk

is:

“the risk of dishonesty or lack of integrity” of the insured or (in the case of a corporate insured, any of the

insured’s) “executives or key personnel”5.

In other words, the moral risk is the risk that the insured will make a dishonest claim on the insurer.

The concept was revisited in a recent Federal Court Decision6 in which the Court accepted expert evidence in a

similar vein that:

“moral risk” is a term in the insurance industry which goes to something in the character of an insured

which might lead to the insured deliberately bringing about losses to make a claim or falsifying his claim,

say to arson, untrue statements in the making of a claim or making a fraudulent claim.”

Information going to the moral risk are facts that might suggest a want of honesty or lack of integrity of the

insured and indicate that the insured is a person who an insurer may reasonably think is a person who will make

a dishonest claim.

Of course, unlike facts that relate to the specific physical risk, the relevance of information going to the moral risk

does not necessarily depend on the type of cover proposed.


The Duty to Disclose Information that Goes to the Moral Risk

THE DUTY OF DISCLOSURE UNDER THE INSURANCE CONTRACTS ACT

Under Section 21 of the Insurance Contracts Act 1984 (the “ICA”) there are two categories of information a person

seeking insurance must disclose to the insurer to which they are applying for cover.

Paraphrased, under the ICA, the insured has a duty to disclose every matter known to them that:

1. they know to be relevant to the underwriting assessment of the insurer [Section 21 (1) (a)];

and

2. a reasonable person in the circumstances could be expected to know would be relevant to

the underwriting assessment of the insurer [Section 21 (1) (b)].

There are exceptions in Section 21 (2) which may be relevant and which will be discussed specifically later.

However, as most of the decisions examined in this article were handed down prior to the enactment of the ICA

it is important to know a little about the former rules.

THE “PRUDENT INSURER” TEST

Prior to the enactment of the ICA the settled test of what an insured was bound to disclose was determined

exclusively by what a reasonable or prudent insurer would have regarded as material to the assessment of the

risk.

In terms of its most widely repeated Australian formulation, which appears in the judgment of Justice Samuels

in the case of Mayne Nickless Ltd v Pegler. Under this test:

“a fact is material if it would have reasonably affected the mind of a prudent insurer in determining

whether he will accept the insurance and if so, at what premium and on what conditions.”7

The question of whether a particular piece of information is material within the requirements of the “prudent

insurer” test is one of fact and not of law.8 Consequently, a decision that an insured was held duty bound to

disclose information in one case does not mean the same result would necessarily apply in another situation.

However, the cases decided under the old law show that when determining if information was material to the

moral risk, in order to determine what a reasonable or prudent insurer could or could not take into account, the

courts generally refer to the same kinds of yardsticks.


MIGHT THE YARDSTICKS UNDER THE PREVIOUS LAW STILL APPLY?

Insurers seldom ask questions in their application documents that directly ask questions about the insured’s

moral integrity. As a result, unless there has been a previous course of dealings which would give an insured

actual knowledge that the insurer was interested in this kind of information, it is hard to see why the insured

would have a duty to disclose it under Section 21 (1) (a) of the ICA.

However, the insured must also disclose all those things that a reasonable person in the circumstances could be

expected to know would be relevant to the underwriting assessment of the insurer under Section 21 (1) (b).

The cases that have been decided since the ICA was enacted tend to show that the courts have generally been

liberal in their approach to this requirement in the context of information that goes to the moral risk.

What a reasonable insured might properly consider they ought to disclose and what a reasonable insurer could

require to be disclosed under the terms of the “prudent insurer” test may not be all that different.

After all, under both tests insured and insurer respectively bear an obligation to make a reasonable assessment

of the impact the information will have upon the underwriter’s consideration of the risk to be insured.

To this extent the yardsticks developed in the context of the “prudent insurer” test may still give a good guide

to what information going to the moral risk a court may consider a reasonable insured ought to disclose under

Section 21 (1) (b) of the ICA.

The use of these yardsticks is demonstrated in the cases which follow that illustrate what a reasonable insurer

could require to be disclosed to it relevant to the moral risk under the law prior to the ICA.

Prior Criminal Offences

DRIVING OFFENCES

In Taylor v Eagle Star Insurance Co. Ltd 9 it was held in the context of a motor vehicle policy that all the plaintiff’s

convictions for driving offences were material and should have been disclosed along with his driving licence

suspensions and cancellations.

None of the offences involved dishonesty on the part of the insured but they formed part of the insured’s driving

record. They were therefore relevant to the underwriter’s assessment of whether the loss insured against might

occur during the period of cover. In other words, the physical risk.

In Itobar Pty Ltd v Mackinnon10 a principal crewmember’s traffic convictions (for driving under the influence of

alcohol) were held to be material in connection with a policy which covered the owners of the vessel for the loss

of the vessel by “fortuitous accidents or casualties of the seas”.

However, this was only in the context of the crewmember also having been convicted of several offences

involving dishonesty.


The trial judge expressed some hesitation in finding the failure to disclose the convictions to be material and was

significantly influenced by the fact that the plaintiff had failed to call any evidence from an expert underwriter to

contradict the defendant’s witnesses in this regard11.

Convictions for driving offences are generally only relevant to the insurer’s evaluation of the physical risk

and seldom raise questions of dishonesty which would go to the moral risk. Hence, in their text on Australian

insurance law authors Kelly and Ball conclude, “a conviction for speeding is almost certainly immaterial to all forms

of insurance except motor vehicle insurance.”12

A fraudulent failure to disclose driving offences in connection with a motor policy is unlikely to be forgiven by a

court under the power conferred upon it by Section 31 of the ICA13.

OFFENCES INVOLVING DISHONESTY

In Regina Fur Co. Ltd v Bossom14 the plaintiff company obtained an all risks policy under which it insured furs

owned by it or held by it as bailee.

One of the directors of the company, Waxman, had been convicted some years previously of receiving a quantity

of fur skins and other items knowing them to be stolen. The insurer sought to avoid the policy on the ground this

information was material to the risk and had not been disclosed.

The reasoning of the trial judge, Justice Pearson, in deciding this issue in favour of the insurer was as follows:

“Now was the fact of Mr Waxman’ s conviction material for the purposes of the policy? My first impression

was naturally that an isolated conviction more than twenty years ago must be too ancient and too

remote to have any materiality, but there are special facts in this case. At the time of the conviction Mr

Waxman was nearly thirty years old and engaged in business and was convicted of receiving a substantial

quantity of furs knowing they had been stolen ... Mr Waxman held a predominant position in relation to

the company.”15

In this brief passage the trial judge refers in rapid succession to a number of criteria frequently employed as

yardsticks of materiality.

They include the age of the conviction, whether it is an isolated instance or part of a more extensive criminal

record, the maturity of the perpetrator at the time the crime was committed, the nature and severity of the crime

and the degree of the connection between the person convicted and the insured.

These yardsticks16 are used repeatedly by judges regardless of the particular risk in question and address

themselves to whether the circumstances of the conviction provide a guide which could reasonably indicate to

a prudent insurer that the insured might make a dishonest claim if it issued a policy.

Though the cases have been broken down by category to illustrate the uses to which each of these yardsticks

have been put, it can be seen from the examples that follow that they are not used in isolation in practice but are

usually interwoven in the judge’s reasoning.


How Old is the Conviction?

The more recent the conviction the more likely it is to be found to be material. For example, in Reynolds v Phoenix

Assurance Co. Ltd 17 Forbes J, held that a minor conviction for receiving, which was eleven years old, was too old

to be material.

Legislation with respect to spent convictions exercised significant influence upon Forbes J, in reaching this

conclusion. He was of the view that the period after which an offence would become “spent” (ten years) under

the relevant legislation18 provided him with some guidance when a conviction was too old to be material in the

face of conflicting expert testimony.

In Australia, in so far as Federal offences are concerned, the Commonwealth Crimes Act19 deems adult convictions

more than ten years old and juvenile convictions more than five years old to be “lapsed” subject to various

exemptions in respect of convictions for violent offences or sexual offences against children. Legislation along

similar lines operates in NSW20 and in Queensland.

In a case decided well before the enactment of legislation about “spent” convictions, Roselodge Ltd v Castle21

a twenty year old conviction for a comparatively minor offence (attempting to bribe a police officer with ten

shillings, resulting in a fine) was held to be not material. However, the trial judge concluded a more serious

offence twelve years later ought to have been disclosed to the insurer.

The New Zealand Court of Appeal had little difficulty in finding that a conviction for an offence of fraud only

four years earlier was material in Misirkakis v New Zealand Insurance Co. Ltd22 The judgment of the Court shows

clearly that the currency of the conviction contributed to swaying it toward the finding that the conviction was

material.

Is it an Isolated Offence?

A history of offences is more likely to be found material than a single isolated offence. Hence a comparatively

minor offence is more likely to be found to be material when it is one of a string of convictions than it would if

the same offence was committed in isolation.

It is doubtful that the crew member’s conviction for driving under the influence in Itobar Pty Ltd v Mackinnon 23

would have been found to be material in the absence of a history of subsequent convictions for dishonesty.

Similarly, if there is a pattern of convictions a court may be more willing to have regard to an old conviction than

it would otherwise do. In Schoolman v Hall 24 a history of convictions beginning at age fifteen and ending when

the insured was twenty-five was held to be material even though the last conviction was fifteen years old at the

time of the proposal.

The long criminal records of two principals of the insured, comprising offences involving dishonesty and

culminating in convictions as recently as two and four years respectively prior to the date of the proposal, lead to

a concession that the insurer was entitled to avoid the policy in Fanhaven Pty Ltd v Bain Dawes Northern PtyLtd.25

The only remaining question was whether the broker was liable in respect of its failure to caution the insured to

disclose this history.


The Maturity of the Perpetrator at the Time of the Offence

Having reference to the maturity of the perpetrator at the time of the offence is perhaps not as immediately

obvious a means of gauging the materiality of a conviction as the other yardsticks that judges have used.

The object of this enquiry is clearly to determine whether the character of the perpetrator was formed at the

time of the offence and hence whether the circumstances of the conviction provided a reliable guide to whether

the perpetrator might again commit a dishonest act in connection with the policy.

The fact Waxman, as a director of the insured was a mature man at the time of the offence, and was already

engaged in the type of business engaged in by the insured, was clearly crucial evidence in convincing the trial

judge that an insurer might reasonably form that opinion about him in Regina Fur Co. Ltd v Bossom. 26

On the other hand, the circumstances of an eight year old conviction for a minor offence when the plaintiff

was eighteen years old and was unmarried did not convince Tompkins J, in the New Zealand High Court that

an insurer might reasonably form that view about him in Edwards v A. A. Mutual Insurance Co.27 He found that

conviction was not material.

Nature and Seriousness of the Offence

Any breach of the law that results in a criminal conviction might possibly be material, for example, the commission

of comparatively minor offences not involving dishonesty; such as those for driving under the influence of

alcohol in Itobar Pty Ltdv Mackinnon.28

However, generally, an offence involving dishonesty is much more likely to be regarded as material than one that

does not, and a serious offence is much more likely to be material than a trivial one.

Consequently, the Court had little difficulty deciding that a conviction for robbery was material and ought

to have been disclosed in connection with a proposal for a fire policy in Woolcott v Sun Alliance and London

Insurance Ltd 29, or that an offence involving dishonesty should have been disclosed when applying for motor

vehicle insurance in Cleland v London General Insurance Co. Ltd.30

However, the circumstances in which an offence of stealing occurred lead to it not being found to be material

in McLeod v S.I.M.U. Mutual Association31 even though the offence was only three years old at the time of the

proposal.

The insured was at a boat yard in company with his brother-in-law who siphoned some petrol from a boat. The

insured was some distance from him at the time and did not actively assist in the commission of the offence. He

nevertheless pleaded guilty to the charge and was fined $100.00.

Similarly, the offence that was found not to be material in Edwards v A.A. Mutual Insurance Co.32 was the theft from

a motor-cycle tool box of goods worth less than $20.00 for which the insured was fined $150.


The degree of the Connection between the Person Convicted and the Insured

It is not only the insured’s own convictions that may be material to the moral risk. The convictions of other

persons who are closely associated with the insured may also be material.

Clearly, in the case of an insured that is incorporated the offences of persons who are in a dominant position in

relation to the affairs of the company must be disclosed (see Regina Fur Co. Ltd v Bossom, Roselodge Ltd v Castle

and Fanhaven Pty Ltd v Bain Dawes Northern Pty Ltd.33)

Similarly, the convictions of senior employees may be material if they are in a position of trust, or are in a position

in which they can exercise particular influence over the subject matter of the insurance.

For instance, the offences of the skipper of an insured vessel were thought to be material for this reason in

Inversions Maniera S.A. v Sphere Drake Insurance Co. PLC & Others: “The Dora”34 as were those of an important crew

member in Itobar Pty Ltd v Mackinnon.35

If the insured is aware that a close family member has a criminal record those convictions may also be material

where that person is in a position to exercise influence over the subject matter of insurance.

Consequently, the failure to disclose her husband’s convictions lead to the avoidance of a policy insuring the

family home against burglary entered into by the wife in Lambert v Cooperative Insurance Society Ltd.36

The High Court of Australia adopted similar reasoning with respect to the criminal activities of a family member

in Khourv & Anor v Government Insurance Office of NSW37, though in that case the insured merely suspected that

his son had taken money from the family business and he had not in fact been convicted of any offence.

Criminal Charges that have not yet Lead to Convictions

At issue in March Cabaret Club & Casino Ltd v The London Assurance 38 was whether an offence with which a director

of the insured had been charged prior to the renewal of the policy but which had not lead to a conviction at the

time of the renewal was material and ought to have been disclosed.

The director, Skoulding, with his wife was the effective owner of all the shares in the plaintiff company. The

plaintiff in turn owned the freehold of licenced premises in which it conducted a cabaret club, restaurant and

casino. It insured them with the defendant against (among other risks) loss or damage by fire.

The defendant presented evidence which showed that it had been reluctant to accept the risk because, relevantly,

it was wary of the influence of criminals in the club industry and particularly the operation of protection rackets

within it. It said that as a consequence, insurers paid significant regard to the good repute and moral standing of

the managers of such establishments in agreeing to insure them.

The policy was relevantly renewed on 20 April 1970. Some time earlier, in May 1969, a quantity of furs to the value

of approximately, £20,000.00 was stolen from a lorry. Skoulding was not implicated in the theft but in June 1969

a friend of Skoulding, at Skoulding’s suggestion, took the furs to a farm belonging to Skoulding’s brother-in-law.

Skoulding later went over to the farm and helped to unload the furs, knowing them to be stolen.


For his trouble, Skoulding received a quantity of the furs which he kept at his own premises.

On 14 June 1969 the police visited the brother-in-law’s premises where the main body of the furs were found. As

a result of their enquiries they moved on to Skoulding’s premises where the other furs were located. Skoulding

at that time admitted the offence. He was committed to trial in November 1969 but despite his plea of not

guilty was convicted of the offence of handling stolen goods when he stood trial in June 1970. He was fined

£2,000.00.

In giving judgment, Justice May concluded:

“It is quite clear that the fact that Mr Skoulding had committed the offences is material to the moral hazard.

It went to the moral integrity of the proposer and was vital as I have already indicated much earlier in this

judgment in respect of this particular insurance.”39

His Honour then went on to address the plaintiff’s argument that considered at the time of the application for

the policy the insured was not entitled to know whether Skoulding was in fact guilty or innocent, as he had not

yet come to trial. This being so, the plaintiff’s counsel argued, the insurer was entitled at best to disclosure of

the charge and committal. This he said could not have been material information to the risk, bearing in mind the

general presumption in the criminal law in favor of the innocence of an accused person.

This submission initially caused May J, some concern in determining how he could reconcile the presumption of

innocence and the plaintiff’s right to avoid self-incrimination with the insured’s duty of disclosure. His Honour

however concluded that this was a false dichotomy in that the duty of disclosure left no room for the operation

of either principle.

His Honour consequently observed:

“One must remember that there is no estoppel by acquittal save as between the Crown and the person

acquitted. There is nothing to prevent one party to civil proceedings if the fact be material and relevant,

attempting to prove that another party to those proceedings has in turn committed the crime of which

that other party has previously been acquitted in the criminal Court.”40

In support of this position his Honour referred to Gray v Barr 41 in which the insurer proved to the appropriate civil

standard that an insured had committed a criminal offence of which he had been acquitted.

His Honour however proceeded to find for the insurer on this issue on a further ground, saying that he would

have been prepared to hold that Skoulding ought to have disclosed the fact of his arrest, charge and committal

for trial at the date of renewal even if he had in fact been innocent of the offence.

This conclusion might be justifiable if it is accepted that a prudent insurer would be concerned by the mere

possibility of criminal behavior on the part of the insured.

However, in a subsequent English case, Reynolds v Phoenix Assurance Co Ltd Ptv, Justice Forbes declined to follow

this aspect of Justice May’s judgment observing instead:


“The object of requiring disclosure of circumstances which affect the moral risk is ... to discover whether the

proposer is a person likely to be an additional risk from the point of view of insurance ... It is not only the

allegation which must be disclosed but the underlying fact that a crime has been committed.” 42

The fact that a person has been charged with a crime they did not commit cannot objectively be said to reflect

upon their moral integrity and certainly, from the perspective of an insured who knows they are innocent of the

offence could not, it is submitted, be something that they would know would affect the underwriter’s decision.

The outcome of the recent English decision in Brotherton v Aseguradora Colesguros 43 does not however sit

particularly comfortably with Justice Forbes’ comments in Reynolds. The case concerned a contract of reinsurance

issued in connection with a professional liability and banker’s bond program for a Colombian State Bank. Serious

allegations of impropriety were made about officers of the bank.

It was held that they should have been disclosed though they were only rumours which had been circulated in

the local media, though the Court clearly thought they were of a serious nature.

Curiously, neither Reynolds or March Cabaret Club & Casino appear to have been cited to the Court and the

decision turned upon the materiality of the allegations and whether the non-disclosure of them induced the

re-insurers to enter into the contract, neither of which would be issues under the ICA.

Considering that the insured’s duty of disclosure under Section 21 (1) (b) of the ICA is couched in terms of what a

reasonable person in the circumstance of the insured could be expected to know was relevant, it seems unlikely

that this would include a duty to disclose a criminal charge of which the insured is innocent.

There is limited authority on the subject in Australia, though in GIO General Insurance Ltd v Zeyad Zeidan44. the

Court took into account charges relating to driving an uninsured motor vehicle and an unregistered motor

vehicle that were pending, and to which the insured was pleading not guilty at the time he applied for the

cover.

The cover in question was however a comprehensive motor vehicle policy and in the course of the application

the insured was specifically asked “Have you in the last five years ever had any traffic accidents even if you were not

at fault, charges, convictions or infringements, such as speeding fines and red light cameras? “

Adverse Findings by Royal Commissions & Non-Judicial Bodies

The competing views with respect to whether an accusation of criminal conduct was a material matter which

ought to be disclosed were considered by Rogers J in the Supreme Court of NSW in Trimboli and Ors. v Royal

Insurance Australia Ltd45.

Trimboli was a partner in a fruit and vegetable business and obtained insurance cover from the defendant in

respect of the business. The business premises, stock and other contents were destroyed by fire and the partners

in the business, including Trimboli sought indemnity from the defendant.


Trimboli had not been convicted of any crime but the Woodward Royal Commission into Drug Trafficking had

found prior to the date of Trimboli’s proposal to the defendant that he was linked with illegal drug activities.

Rogers J concluded that this finding was material to the risk and should have been disclosed by Trimboli. The

crucial considerations which appeared to have affected his mind in reaching this conclusion were the nature

and scope of the Royal Commissioner’s enquiry and the qualifications of the Royal Commissioner himself as an

experienced judge to carry it out.

Though his Honour quotes extensively from passages in the judgments of May J and Forbes J, in the two cases

mentioned earlier, he does not express a preference for either judge’s views.

As a result, it is unclear whether his Honour concluded that the scope of the Commission’s terms of reference and

Commissioner’s qualifications meant that the findings were more likely to be true and therefore be indicative of

the commission of an offence, or merely whether these considerations just gave the findings added gravity as

allegations in the mind of a prudent insurer.

It seems that his Honour may have been adopting the latter view as he expressly noted that the findings of the

Royal Commissioner were not evidentiary of the facts found by him.46

The judgment clearly demonstrates that the conclusions of bodies other than judicial bodies may be material

facts within the context of the “prudent insurer” test.

Though his Honour’s reasoning suggests that the fact that the findings were made by a judge had some bearing,

it is hard to accept that an insured would not have a duty to disclose the adverse findings made in quasi-judicial

proceedings.

It is therefore arguable that, for example, there is a duty to disclose adverse findings as a result of disciplinary

proceedings such as those which may be taken against doctors and lawyers under the various regulatory codes

that operate around Australia.

As, under Section 21 (2 ) (b) and (c) there is no duty to disclose something that is common knowledge or which

the insurer ought to know in the ordinary course of business, if the findings of a Royal Commission are widely

reported an insured may be able to argue that there was no duty to specifically disclose them to the insurer. The

same principle would apply in relation to well-publicised convictions such as those, for example, of Alan Bond

or Rodney Adler

The Impact of the Insurance Contracts Act 1984

THE STATE OF KNOWLEDGE & EDUCATIONAL BACKGROUND OF THE INSURED

S 21 (1(b) of the ICA requires the court to determine what a reasonable person (objectively) could be expected

to know would be relevant to the underwriting assessment of the insurer (subjectively) in the circumstances of

the insured.


The reconciliation of these subjective and objective elements and the determination of the range of subjective

“circumstances” that the court should take into account have been sources of controversy since the ICA began

operation and these considerations remain an area of interest in the current process of reform of the ICA.47

In Delphin v Lumlev General Insurance Ltd, Keall J, in the District Court of Western Australia concluded that the

reference to a reasonable person in the circumstances of the insured in Section 21 (1) (b) of the ICA meant:

“a reasonable person with the state of knowledge and having the educational background of the

plaintiff.”48

He consequently went on to conclude that having regard to the state of knowledge and the educational

background of the plaintiff, her intermittent use of cannabis, use of heroin and a criminal charge in relation to

drug offences prior to her proposal to the defendant for household contents insurance were not matters she

would know would be relevant to the insurer.

However, he concluded on the same basis that a later conviction relating to the insured’s cultivation of cannabis

at the house ought to have been disclosed by her in view of its connection with the insured premises.

This may be seen as a somewhat capricious distinction. Some doubt was in fact cast upon this reasoning when

the matter went on appeal,49 though the appeal was substantially concerned with other issues.

If the conclusions of Keall J are correct and the court is required to look into the subjective state of knowledge

to the insured, it is questionable how often a criminal offence, particularly one not involving dishonesty, might

have to be disclosed.

On the other hand, In Twenty-first Maylux Pty Ltd v Mercantile Mutual Insurance (Australia’) Ltd 50 Brooking J, in the

Supreme Court of Victoria, expressed the view that Section 21(1) (b):

“did not take into account the personal and individual idiosyncrasies of the insured such as imperfect

understanding of English, cultural background or unfamiliarity with business or insurance practice.”51

His Honour considered that the matters to be taken into account were confined to the circumstances of the

negotiations leading up to the insurance, the type of cover in question and the insurer’s marketing material.

The cases involving criminal convictions that have been decided in the context of the ICA have tended to be

more consistent with the approach of Brooking J in Twenty-first Maylux than that of Keall J in Delphin.

CASES INVOLVING THE DUTY TO DISCLOSE CRIMINAL CONVICTIONS AFTER THE ICA

The courts have approached the question of the disclosure of criminal offences under the ICA pragmatically

and certainly the recent decisions dealing with the duty to disclose criminal convictions do not enquire into

the subjective characteristics of the insured. The judges seem to have been generally willing to assume that

any reasonable applicant for insurance would be expected to know that a history of criminal activity would be

relevant to the insurer’s assessment of their proposal.


In Thompson v Government Insurance Office of NSW 52 the plaintiff insured with the defendant the premises in

which he and his wife were then living and from which he also carried on the business of selling billiard tables

and ancillary equipment under separate domestic and small business policies.

The premises were destroyed by fire resulting in a claim on both policies in circumstances that gave rise to a

strong suspicion in the defendant of arson.

In addition to other grounds of defence, the defendant relied upon the plaintiff’s failure to disclose his numerous

convictions for traffic offences, including offences described as “offences of dishonesty” such as driving whilst

disqualified, giving false information to the police and convictions for stealing and assault occasioning actual

bodily harm.

In relation to his business policy, the defendant also relied upon the failure to disclose charges relating to certain

drug offences.

Rolfe J concluded that the plaintiff was an unreliable witness and, as a result of cross examination by the

defendant’s counsel, did not believe the plaintiff when he asserted that he did not know that these matters

would be relevant to the defendant’s assessment of the risk of insuring him.

His Honour was consequently willing to hold that the relevant matters ought to have been disclosed to the

defendant on the basis that the plaintiff in fact knew they were matters relevant to the defendant’s assessment

of the risk within the meaning of the test in Section 21 (1)(a) of the ICA.

His Honour’s comments with respect to Section 21(1)(b) are however of more general interest.

His Honour was of the view that as a general rule any reasonable applicant for insurance would be expected to

know that convictions for offences of dishonesty would be relevant to the insurer’s assessment of their proposal,

observing:

“Alternatively, I am satisfied that a reasonable person in the plaintiff’s circumstances could have been

expected to know the matters to be “so relevant”. I do not accept that a reasonable person seeking insurance

cover would not regard the various convictions for anti-social offences and offences involving dishonesty

(furnishing false information and stealing) and violence as not relevant to an insurer.”Consequently, in

another unreported decision, Macquarie Bank Ltd v National Mutual Life Association of Australasia

Ltd,53 Cole J concluded that a solicitor who had committed substantial frauds against his trust account

was bound to disclose this information to the life insurer to whom he applied for loan protection

insurance.

The solicitor had never been charged with any offence in relation to the fraudulent transactions prior to his

suicide, which resulted in a claim under the policy by the finance provider. The policy was declared to be void.

His Honour’s conclusion that the insured was under a duty to disclose the criminal activity, which must have

arisen under Section 2 1(1) (b) but which was not expressly considered in the judgment, was not subsequently

contested on appeal.


The issue was considered in greater detail, but to similar effect, by Sheperdson J, in yet another unreported

decision, this time in the Supreme Court of Queensland, Naomi Marble & Granite Pty Ltd v FAI General Insurance

Co.

His Honour observed that the ICA:

“strikes a new balance between the underwriter’s need for information and the insured’s need for security

in relying upon insurance. However the adjustment lies in specifying that the duty of disclosure, instead of

being measured in terms of the needs of the prudent insurer should be measured by what facts the insured

knew or which a reasonable person in the insured’s circumstances would have known to be relevant to the

insured’s assessment of the risk.”54

Perhaps somewhat surprisingly, his Honour concluded that the knowledge of a reasonable person in the

circumstances within the meaning of Section 21(1) (b) was capable of being informed by the position at common

law.

In particular, his Honour referred to the judgment of Justice May in March Cabaret Club and Casino Ltd v The

London Assurance as interpreted in Reynolds v Phoenix Assurance Co Ltd and “The Dora” (all mentioned earlier) as

setting out the relevant tests in this regard.

His Honour then proceeded to the conclusion that various charges relating to offences of dishonesty made

against the plaintiff ought to have been disclosed by him in accordance with his duty under Section 21(1)(b).

While it is now clear that the previous common law tests which were concerned with what was material to a

prudent insurer’s assessment of the risk are not part of the law under Section 21,55 the approach taken in Naomi

Marble & Granite Pty Ltd supports the view that the yardsticks that evolved in those cases may continue to have

relevance, particularly when assessing what is “reasonable” in applying Section 21(1) (b).

SECTION 21A – ELIGIBLE CONTRACTS OF INSURANCE

Section 21A of the ICA, which came into operation in 1998, modifies the insured’s disclosure obligations in

relation to some common personal lines described in the ICA as “eligible contracts of insurance’’56. These “eligible

contracts” currently include motor vehicle insurance, home buildings and contents insurance, sickness and

accident insurance, consumer credit insurance and travel insurance.

The section deems an insurer to have waived compliance with the duty of disclosure in connection with such a

contract unless before the contract was entered into it either:

(a) requests the insured to answer one or more specific questions relevant to its decision whether

or not to accept the risk; or

(b) it asks specific questions (as in (a)) and expressly requests the insured to disclose each

exceptional circumstance that is known to the insured or a reasonable person in the

circumstances could be expected to know that is a matter relevant to the insurer’s decision

whether or not to accept the risk which is not a matter the insurer could reasonably be

expected to make the subject of a question under (a) or a matter that reduces the risk.


The onus for proving compliance with the section rests upon the insurer. 57 Hence an insurer under an eligible

contract would either have to ask specific questions about the matter or be able to establish that the matter they

sought to rely upon was not something that “could reasonably be expected” to make the subject of a question.

This suggests that if an insurer considers a past history of convictions to be relevant to underwriting an eligible

contract it would be prudent to ask specific questions about them.

What an insurer could “reasonably be expected” to make the subject of a question is difficult to identify with

precision, so it remains feasible that an insured may still be required to disclose some matters that touch on the

moral where the insurer has elected to require disclosure of “exceptional circumstances”.

However as specific questions about prior criminal convictions or charges could be asked with little difficulty it

seems likely that an insurer under an eligible contract who did not ask specifically about them will be deemed

to have waived compliance with the duty of disclosure in this respect.

Matters Relevant to “the Risk”

Section 21 (1) (a) requires the insured to disclose those things which they know are “relevant to the decision of

the insurer whether to accept the risk and, if so, on what terms”. Section 21(1) (b) requires a reasonable person in

the insured’s circumstances to disclose the same matters.

In its decision in Permanent Trustee Australia Limited v FAI General Insurance Company Limited (In Liq),58 the

High Court reversed the decision of the NSW Court of Appeal and determined that matters relating to “the

risk” which must be disclosed under s 21 do not include commercial or “emotional” issues between the insurer

and insured. However, the narrow view which the Court adopted toward “the risk” raises some doubts about the

status of “moral” issues.

The facts of the case were fairly complex. Permanent Trustee Australia Limited had a multi-layered professional

indemnity insurance cover of $70 million with a number of insurers. FAI was one of the insurers that provided

excess of loss cover.

Permanent’s broker, Sedgwick, sent letters to the other insurers involved in the program inviting them to

participate in a renewal. However, Sedgwick had made a provisional decision not to offer any opportunity of

annual renewal to FAI subject to a satisfactory quotation from another underwriter.

It became necessary for Permanent to seek an extension of the existing program before the new program

could be put in place. The lead underwriter agreed to an extension of 30 days. FAI was prepared to follow the

lead underwriter’s decision to grant the extension and considered Permanent to be one of its “good accounts”.

However, Sedgwick was concerned about FAI’s attitude to the extension if it became aware that Permanent would

not be approaching it for renewal. As a result, Sedgwick made a considered decision not to inform FAI of Permanent’s

intentions regarding the commercial relationship in the course of negotiations with respect to the extension.

Sedgwick subsequently sent placing slips for the extension to FAI, which in signing them believed that it would

be invited to quote for participation in the renewal.


FAI presented evidence that it would not have granted the extension had it been informed of the commercial

intentions of Permanent.

During the period of the 30 day extension, Permanent became aware of circumstances that ultimately gave

rise to a claim arising out of their trusteeship of the Aust-Wide Property Trusts in relation to a development at 1

O’Connell Street, Sydney.

Permanent sought indemnity from their insurers, including FAI, whose contribution was some $38 million. FAI

refused to pay.

At first instance, the trial judge found that the failure of Sedgwick to inform FAI of Permanent’s intentions not to

renew was a breach of Permanent’s duty of disclosure under Section 21(1).

The trial judge also concluded that had FAI been informed of Permanent’s intention not to renew it would

not have granted the extension. Under Section 28(3) of the Act, FAI was therefore entitled to have its liability

reduced to the amount that would place it in the same position in which it would have been in if the breach

had not occurred. The Court therefore ordered that all Permanent was entitled to was the return of its premium.

FAI also alleged that there was a misrepresentation on the part of Permanent because, according to FAI, Sedgwick

was obliged to correct FAI’s false impression that it would be invited to renew. The trial judge found there had

been no misleading statements made by Sedgwick and that as FAI had said nothing on the subject either,

Sedgwick’s silence was not sufficient to amount to a misrepresentation.

In the NSW Court of Appeal, Justice Handley (with whom the other members of the Court of Appeal agreed)

also concluded that Permanent’s commercial intentions had to be disclosed to FAI under Section 21(1)(a) of

the Act as Permanent knew it to be relevant to FAI’s decision “whether to accept the risk and, if so, on what terms”.

The Court of Appeal took the view that the word “statement” in Section 26(2) of the Act, which deals with

misrepresentations, could include silence on a matter and that Sedgwick, in making a statement to FAI which

was literally true, but incomplete, made a “statement” which was a misrepresentation for the purposes of Section

26(2) of the Act.

The Court of Appeal said that the knowledge of Sedgwick regarding Permanent’s intentions was knowledge for

the purposes of deciding whether Permanent had acted in breach of its duty of disclosure under Section 21(1)(a)

of the Act and Permanent had therefore also made a misrepresentation under Section 26(2) of the Act by virtue

of Sedgwick’s silence. Thus, the knowledge of Sedgwick could be imputed to Permanent, and Permanent was

bound by the knowledge of Sedgwick, who negotiated the extension on its behalf.

The High Court decided by a narrow majority to overturn the decision of the NSW Court of Appeal and found

that there was no relevant non-disclosure or misrepresentation on the part of Permanent.

The majority comprised of Justices McHugh, Kirby and Callinan in a joint judgment reasoned by reference to the

terms of the Law Reform Commission Report which preceded the introduction of the Act and by reference to

Hansard, that the key words to be understood in Section 21 were “accept the risk”.

These words had been deliberately chosen instead of alternatives such as “enter into the contract of insurance”. The

use of the word “risk “ indicated that the duty of disclosure was focused on the particular hazard to be insured

and upon matters of relevance to that hazard, not upon the broader question of the commercial willingness of


the insurer to contract with the insured and, “still less emotional or individual reactions to that question.”

Assessment of the insurance hazard was, said the majority, more susceptible to objective ascertainment than

commercial and emotional responses.

Seeming to address the argument from the perspective of public policy as well, the majority said that to extend

the duty of disclosure to include matters of commercial relevance to the insurer would,

“be to impose an extraordinarily high burden… indeed a burden that few insureds could ever fully

discharge” and “opens a Pandora’s box involving a large range of other considerations, such as are

illustrated by the facts of the present case”.

The minority, consisting of Justices Gummow and Hayne, thought the case was very much confined to the

unusual circumstances surrounding the financial down grading of FAI on the road toward its eventual collapse

as part of the HIH group of companies.

Like the majority, they took the view that there was no room for the previous common law rules in interpreting

Section 21 but, contrary to the majority, considered there was no line worth drawing between accepting a risk

and entering into a contract.

Both Sedgwick and FAI knew, in the unusual circumstances peculiar to their commercial relationship at that

time, that the fact that FAI would probably not be approached to participate in the renewal of Permanent’s

programme was relevant to whether FAI would have been prepared to offer the extension.

The section therefore required disclosure of what Sedgwick knew to be relevant to FAI’s decision as Sedgwick’s

knowledge was deemed to reside also with its principal, Permanent.

The Implications for the Future of Moral Risk

In Permanent Trustee Australia Limited v FAI, FAI had sought to show that the common law had developed a broad

concept of what was relevant to the risk. One branch of its submissions directed the Court to several cases in

which it had been established that “moral” factors connected with the insured themselves and not just the risk

proposed by them had been held to fall within the duty of disclosure. These were generally matters such as

previous criminal offences or convictions.

While it is clear that neither the majority or minority felt that the common law offered much assistance in the

task of interpreting Section 21, the majority at least declined the opportunity to confirm that “moral” factors fell

within the boundaries of the duty of disclosure concluding:

“It is unnecessary to decide in this case whether the words “acceptance of the risk of the particular peril or

perils intended to be insured against” extend to a “moral hazard” or “moral risk” recognized as relevant by

the common law.”


The High Court’s decision in Permanent Trustee Australia Limited v FAI shows there are instances when there is

no duty to disclose a fact which both insurer and insured would both acknowledge to be relevant to the insurer.

The decision creates a new basis for technical argument that a matter does not have to be disclosed so long as

the insured can demonstrate it does not relate to “the risk”.

The majority judgment leaves unexplored what the significant aspects of “the risk” are. Is it just the physical

aspects of the risk, or are “moral” issues in relation to the insured also included? If so, why did the majority fail to

take the opportunity to confirm this?

It seems inevitable that insurers can at least expect plaintiff’s lawyers to eventually cite the judgment in support

of the conclusion that such matters do not form part of the risk and insurers may need to be more pro-active in

seeking this kind of information about their customers in the course of the application process.

It seems likely that insurers will also be called upon in future cases to be able to articulate in evidence (presumably

through their underwriters) the part that moral risk issues play as a dimension of the overall risk they are agreeing

to insure.

Prior to Permanent Trustee Australia Limited v FAI there was a reasonable body of case law concerning the ICA

which demonstrates that the courts have been happy to accept that a reasonable person seeking insurance

ought to know that the commission of an offence involving dishonesty would have an impact on the insurer’s

assessment of their proposal.

Courts have generally arrived at the conclusion that there was consequently a duty to disclose this kind of

information under Sections 21(1) (a) and (b).

The decisions which have relied up on Section 21 (1) (b) have perhaps surprisingly spent little time considering

the subjective state of knowledge to the insured or educational background. While this outcome may be

questionable in terms of the original objects of the ICA the result has been that the decided cases up until

Permanent Trustee Australia Limited v FAI followed the common law.

However, there is some reason to believe that because the insured’s obligation under Section 21 (1) (b) is couched

in terms of what a reasonable person ought to know is relevant, courts must, and in practice have, continued to

make an assessment of the probative value of the information in question in deciding whether it ought to be

disclosed to an insurer under the ICA.

To this extent the yardsticks which judges have used in earlier cases before the enactment of the legislation as a

means of gauging the probative value of information that goes to the moral risk may well remain relevant.

Insureds have been held to be obliged to disclose both convictions and criminal charges under the ICA. Though

no cases have been decided under the ICA there is probably also a duty to disclose adverse findings made by

quasi-judicial tribunals.

The position under the “prudent insurer” test as espoused by Justice May in March Cabaret Club v Casino Ltd59

was that the existence of charges had to be disclosed irrespective of whether the offence had been committed

or not.


While this might be justified if the insurer’s suspicions are relevant to the test, it is unlikely that a person who knew

themselves to be guiltless of such an offence could reasonably be expected to disclose a groundless charge.

Consequently, it is hard to imagine any circumstance in which there would be a duty to disclose an allegation

made against an insured (simply because it exists as an allegation) under Section 21 of the ICA, if the allegation

were false.

It remains to be seen what impact the High Court’s decision in Permanent Trustee Australia Limited v FAI will

have on the future of moral risk issues and in particular what use will be made of the Court’s refusal to endorse

outcomes based on the equivalent position under the common law and its narrow interpretation of what

constitutes “the risk”.

As recently as October this year the NSW Court of Appeal considered a similar species of contract of utmost

good faith, a financial guarantee which was provided by an insurer and expressed to be subject to the duty of

disclosure set out in Section 21 of the ICA.

The majority of the Court had little difficulty in concluding that a senior employee’s previous conviction for

fraud was a matter which should have been disclosed to the insurer and the insured company’s failure to do so

entitled the insurer to avoid the contract60.

The issues determined in this case demonstrate that the concept of moral risk continue to be of vital interest to

insurers. As the 21st century begins to pose more complex questions about the “moral” character of insureds it is

clear that moral risk will remain so.


References

1. See for example Sanders v Oueensland Insurance Co. Ltd (1931) 45 CLR 557 at 571 (EvattJ) and Kazacos v. Fire and all Risks

Insurance Co.Ltd (1970) 92 WN (NSW) 397 at 403.

2. Per Slesser LJ in Locker & Woolf Ltd v. Western Australian Insurance Co. [1936] 1 KB. 408 at p 4l4.

3. For instance, see Ivamy E., General Principles of Insurance Law 4th Ed. 1979.

4. David St L. Kelly and Michael Ball, Principles of Insurance Law in Australia and New Zealand 1991 at par 3.144.

5. Locker & Woolf Ltd v. Western Australian Insurance Co. Ltd (supra) at 414.

6. A & D Douglas Pty Ltd ACN 008 404 180 v Lawyers Private Mortgages Pty Ltd ACN 010 556 751 [2006] FCA 520 (12 May 2006).

The expert witness was Frank Hoffman

7. (1974) NSWLR 228 at p239.

8. See Mutual Life Insurance Co. of New York v Ontario Metal Products Ltd (1925) AC 344.

9. (1940) 67 L1.L.R. 136.

10. (1985) 3 ANZ Insurance Cases 60-610.

11. Supra at p 78,724

12. Kelly and Ball (supra) at par 3.150

13. GIO General Insurance Ltd v Zeyad Zeidan (2005) 13 ANZ Insurance Cases 61-633

14. (1957) 2 Lloyd’s Rep 466.

15. Supra at p 483.

16. Similar criteria, or yardsticks as I have described them, are mentioned at various places in Philip Clarke’s article “The

Disclosure of Criminal Information to Insurers” 1984 LMCLQ 100., though mainly see p 103.

17. (1978) 2 Lloyd’s Rep 440.

18. In this case it was the Rehabilitation of Offenders Act 1974. (UK)

19. See Section 85ZV, Pt VII C

20. The Criminal Records Act 1991

21. [1966] 2 Ll R 113


23. Supra

24. (1951) 1 Lloyd’s Rep 139.

25. (1982) 2 NSWLR 57.

26. Supra


28. Supra

29. [1978] 1WLR 493.

30. (1935) 51 Ll L. Rep 156.


32. Supra.

33. Supra.

34. (1989) 1 Lloyd’s Rep 69.

35. Supra

36. [1975] 2 Ll R 485.


38. [1975] 1 Ll R 169.

39. Supra at pp 176 to 177

40. Supra at p177

41. [1971] 2 QB 554.

42. Supra at p 460

43. [2003] 2 All ER 298.

44. (2005) 13 ANZ Insurance Cases 61-633


46. Supra at p 77,845.

47 . GIO General Insurance Ltd V Zeyad Zeidan ( supra)


45. Lumley General Insurance Ltd v Delphin (1990) 6 ANZ Insurance Cases 60-986.

49. (1990) 6 ANZ Insurance Cases 60-954


50. Supra at p 76,304

51. Unreported judgment of Rolfe J in the Supreme Court of NSW delivered 15 June 1994.

52. Unreported judgment of Cole J in the Supreme Court of NSW delivered 15 June 1994.

53. Unreported judgment of Shephardson J in the Supreme Court of Queensland delivered 4 April 1997

54. See for instance Handley J in Permanent Trustee Australia Co Ltd v FAI General Insurance Co Ltd (2001) 11 ANZ

Insurance Cases 61-491 at p 75,674, where he observed “In my judgment s 21(1)(a) leaves no room for the continued

operation of the previous test of materiality. The changes are too many and too substantial to allow this, and they must

have been deliberate. The section appears in a code and it is not possible to construe it as codifying the previous law.”

55 . Regulation 2B of the Insurance Contracts Regulations defines what are “eligible contracts of insurance’’ for the purpose of

the section. The section applies to new business entered into after 30 April 1998.

56 . S 21A (8)

57. [2003] HCA 25.

58. Supra.

59. Teoh v QBE Insurance (Australia) Ltd [2006] NSWCA 281 (19 October 2006)

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Moral Risk