Characteristics of insurance
The fundamental characteristic of a contract of insurance (COI) is that it involves the insurer taking on “risk.” The risk assumed is not confined to the possibility of unknown perils, but also includes:
- threats of legislative changes impacting the insured risk;
- the possibility of courts making findings adverse to the insurer’s interests (i.e. Arsalan v Rixon’s findings on consequential loss);
- the risk of collusion or fraudulent activity, even by those not party to the contract; and
- external developments such as public infrastructure modifications, urban expansions, or land use changes (i.e. new railways, alterations to roads, or overhead power lines).
It follows that a COI is a contract based on speculation. It is an agreement between the insurer and the policyholder, whereby the insurer promises to indemnify the insured for risks defined under the policy in return for payment of a premium.
Discretion in insurance
It is necessary to distinguish a COI from a contract providing a party with indemnity subject to the discretion of another party.
A COI cannot be discretionary. If the insured does not have the right to be indemnified, or if the insurer has discretion as to whether or not to pay the insured, then the arrangement will not constitute insurance.
This principle was affirmed in CVG Siderúrgica del Orinoco SA v London Steamship Owners’ Mutual Insurance Association (The Vaingueur José) [1979] 1 Lloyd’s Rep 557 at 580 (“CVG”), where it was held that in the absence of an enforceable right to recover under the contract, and where payment depended solely on the insurer’s discretion, the agreement was not a COI.
In CVG, the insured was a party to a COI with a mutual insurance association or a club. A number of the rules of the club granted the insurer discretion in relation to certain aspects of a claim, including – recovery from the insurer, deductions from claims and adherence to the terms for making a claim. The relevant rules used expressions such as: “the committee shall have power”, “at the discretion of the committee” “at the sole discretion of the committee” and “in such manner as the committee may in their absolute discretion”. Moccata J held that the common law principles, which included fairness, reasonableness, bona fide and absence of misdirection in law, must apply to the exercise of such discretion. Moccata J found that the committee had acted fairly and in good faith in dealing with the claim and did not act unfairly or capriciously (at 573, 576). However, he said that the insurer was not bound to exercise its discretion consistently “except in special circumstances”.
There are two modern limits in relation to a discretion in a contract. Firstly, the terms of the discretion cannot render the promise illusory. In Evans v Davantage Group Pty Ltd [2019] FCA 884, motor vehicle warranties under the name National Warranty Company contained a term which (amongst other things) provided that Davantage: “is not obliged to pay all claims that come within the terms and conditions of the Warranty.” This term (amongst others) was held to grant Davantage an absolute discretion to reject customers’ warranty claims. The court held that the effect of the overriding discretion was that there was no circumstance in which [Davantage] may be legally obliged to pay money to the [customer]. Therefore, the warranty agreements failed for lack of consideration and as a consequence Davantage was obliged to make restitution of the consideration paid by the customer [at 14].
Secondly, as discussed above, the law has determined that there is an implied contractual term that any discretion must be exercised reasonably and must not be exercised arbitrarily, capriciously or irrationally. And in other words, unfairly.
If the insured’s only contractual right is merely “a right to have a claim fairly considered”, there is no contract of insurance (Medical Defence Union Ltd v Department of Trade [1980] Ch 82 at [95]).
In Medical Defence Union, Megarry V-C held (at 89) that where an insurer had an absolute discretion as to whether or not to meet a claim by the insured, the benefit was not money or money’s worth, and the transaction was therefore not one of insurance. The insured’s only right in such circumstances was to have the insurer “consider” whether to assist with the defence of a third-party claim.
Australian insurance regulators
Under Australian law, unregistered insurers are prohibited from issuing policies. A non-insurer representing itself as an insurer can be penalised by APRA[1]. ASIC may impose fines or commence proceedings against a party operating without an Australian Financial Securities Licence. The directors and officers of such entities risk personal liability if unlicensed operations cause financial loss, insolvency, or misuse of client funds.
In Barclay MIS Group of Companies Pty Ltd v ASIC [2003] FCA 135, ASIC commenced legal proceedings against the Barclay MIS Group, who was offering a scheme (such as rent guarantee and property damage cover) designed for landlords. AISC alleged that the products offered by the Group were insurance and that the Group did not have the required authorisation to sell such products. The Federal Court ruled that these landlord protection products were indeed financial products—and in several instances, classified as insurance contracts.
Conclusion
Offering insurance related products by unlicensed entities can have adverse consequences for both the entities offering such products and the consumers who are purchasing the same. Related products are often sold under diverse names such as schemes, arrangements and guarantees by a variety of organisations such as associations, clubs, unincorporated entities, dealerships and non-insurance businesses.
Finally, it is important for readers to differentiate between insurance, indemnity and guarantee, as a contract may look like insurance, but it may be a simple indemnity or guarantee. Please refer to our article https://mklegalgroup.com.au/post/what-is-the-difference-between-a-contract-of-indemnity-and-a-contract-of-insurance/ for the differences between these three legal concepts.
Note: Insurance is a complex area of law, and advice should be sought in all circumstances in relation to the issues discussed above.
[1] Australian Prudential Regulation Authority (“APRA”).
