aspects of insurance fraud

If we are satisfied that a complainant has perpetrated a fraud, with the intention of dishonestly obtaining something to which he or she is not entitled, then we will reject their complaint. But in deciding whether fraud has taken place, we rely solely on the evidence.

An allegation of fraud should not be made lightly. The burden of proof is on the insurer, if it suspects that fraud has taken place. Strictly speaking, the civil standard of proof ‘on the balance of probabilities’ applies. However, some courts have acknowledged that stronger evidence than this is usually required, which has the practical effect of raising the burden of proof to a degree more akin to the criminal standard of ‘beyond reasonable doubt’.

‘immaterial’ fraud

In some cases, what is sometimes described as ‘immaterial’ fraud occurs, where a policyholder acts fraudulently simply to obtain payment of a genuine insured loss.

A classic example is where the policyholder has lost the receipt for a stolen item and, facing pressure from the insurer, produces a forged receipt to try to substantiate the claim. The loss is genuine but the policyholder has lied in the course of making the claim, thereby breaching the duty to act ‘in utmost good faith’. When the lie is discovered, the insurer generally ‘forfeits’ the policy (meaning that it is not obliged to pay the claim and can refuse any future cover).

One of the leading texts on insurance law states:

‘It is well established that an assured who has made a fraudulent claim is not permitted to recover at all and forfeits any part of the claim which could have been made in all honesty.’ [MacGillivray on Insurance Law (10th edition), paragraph 19-60.]

The principal legal authority for this statement is the House of Lords case, Manifest Shipping Co Ltd v Uni-Polaris Co Ltd (referred to as ‘The Star Sea’ and reported [2001] in Volume 2 of the Weekly Law Reports at page 170). The rationale of that case is that a policyholder’s fraud, however trivial, taints the entire claim and enables the insurer to reject it and ‘forfeit’ the policy. It was deemed to be a matter of public policy that dishonest policyholders should not be able to recover any of their losses.

However, we have long considered the application of this rule to be unnecessarily harsh. A decision of the Court of Appeal has bolstered our view that fraud which does not prejudice the insurer’s liability to pay the claim should, in effect, be disregarded. The decision was made in the case of K/S Merc-Scandia XXXXII v Certain Lloyd’s Underwriters (referred to as ‘The Mercandian Continent’ and reported [2001] in Volume 2 of the Lloyd’s Law Reports at page 563). The case concerned the principle of ‘utmost good faith’ and Lord Justice Longmore — previously one of the editors of MacGillivray — held that an insurer should only be able to ‘avoid’ a policy for fraud:

	if the fraud would have an effect on the insurer’s ultimate liability; and
	where the fraud or its consequences were sufficiently serious to entitle the insurer to repudiate the policy for fundamental breach of contract, if it so desired.

Thus, where the fraudulent act or omission makes no difference to the insurer’s ultimate liability under the terms of the policy, it should not entitle the insurer to ‘forfeit’ the policy or reject the claim. In the example given above, of the forged receipt, the claim should be paid. Indeed, it was the insurer’s unreasonable insistence on strict proof that caused the policyholder to act dishonestly in the first place.

Of course, there is nothing to prevent the insurer from:

	giving the policyholder written notice that it intends to cancel the policy (in accordance with the policy terms), on the basis that it no longer wishes to deal with a particular policyholder; or
	not inviting renewal of the policy.

But at least the genuine claim should be paid.

insurers’ remedies: ‘avoidance’ versus forfeiture

Insurers sometimes submit that a complainant’s fraud amounts to a breach of his/her continuing duty of good faith, thereby enabling the insurer to ‘avoid’ the policy from its start (in other words, to treat the contract as though it had never existed). This means that the insurer not only cancels the policy from its start, it may also try to recover any monies previously paid out under the policy, even for genuine claims. And in cases of fraud, the insurer is not obliged to refund the premium(s).

It now seems clear in law that policyholders only have a continuing duty of good faith, insofar as they are obliged to deal fully and frankly with the insurer at any time when it properly requires them to provide information. Thus, a duty arises when the policy is renewed annually or when a claim is submitted. However, if a policyholder breaches that duty in the course of making a claim — for example, by submitting forged receipts — the insurer’s remedy is not to ‘avoid’ the policy from its start but to ‘forfeit’ the policy (and benefits) from the date of the breach. This means that the insurer is not obliged to pay the fraudulent claim and it can cancel the policy prospectively. But it cannot cancel the policy retrospectively and seek to recover monies previously paid for genuine claims.

There is some legal authority for this proposition: see, for example, Agapitos v Agnew (reported [2002] in Volume 3 of the Weekly Law Reports at page 616). Taking account of the law and good industry practice, we do not believe it is fair or reasonable for insurers to ‘avoid’ policies retrospectively in cases of fraud; they should only forfeit the policy from date of the fraud.

In a future issue of ombudsman news we will summarise some recent cases we have dealt with involving fraud.