Review of the

Insurance Contracts Act 1984(CTH)

The Treasury

ISSUES PAPER ON SECTION 54

Alan CameronNancy Milne

September 2003

Commonwealth of Australia 2003

ISBN 0642 74213 8

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The Commonwealth Copyright AdministrationIntellectual Property BranchDepartment of Communications, Information Technology and the ArtsGPO Box 2154CANBERRA ACT 2601Or posted at:http://www.dcita.gov.au/cca.

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CONTENTS

PREFACE............................................................................................................IV

PART A: INTRODUCTION .....................................................................................1

PART B: OVERVIEW OF THE OPERATION OF SECTION 54 ......................................3General overview...........................................................................................3Summary of cases .........................................................................................5

PART C: CURRENT OPERATION OF SECTION 54 DOES IT STRIKE ANAPPROPRIATE BALANCE?.....................................................................8Options for reform..........................................................................................8Other issues for consideration.......................................................................9

ATTACHMENTSAttachment A: Review of the Insurance Contracts Act 1984......................11Attachment B: Background and the current statutory framework...............12Attachment C: Explanatory memorandum to clause 54 of the

insurance contracts bill 1984 (Cth) ....................................17

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PREFACE

On 10 September 2003 Senator the Hon. Ian Campbell and Senator the Hon. HelenCoonan announced that we had been appointed to review the Insurance Contracts Act1984 (Cth) (IC Act). The Terms of Reference for the Review are at Attachment A.

Given recent concerns expressed in relation to the operation of section 54 of the IC Act,we have been asked to examine this section as the first part of our Review. Our reportinto the findings on this aspect is due by 31 October 2003.

To assist us to complete the Review, we are seeking input from industry, consumersand other interested parties. At this stage, we would appreciate submissions solely inrelation to our examination of section 54.

This issues paper is intended to explain the background to the Review and in so doingguide interested parties in drafting their submissions. The paper also discusses thecurrent judicial interpretation of section 54 and how this, together with developmentsin the insurance market, has affected the operation of the section and the availabilityand pricing of insurance cover. We also raise several questions and provide, tostimulate discussion, possible options for reform.

While the Review will involve some stakeholder meetings, in the interests of efficiencyand recognising the complexity of the subject matter, it is envisaged that writtensubmissions will form the primary means of consultation for this Review.

Submissions on the first part of the Review, the examination of section 54, are soughtby no later than 15 October 2003. If possible, all submissions should be made via e-mailto icareview@treasury.gov.au. For further details on how to lodge a submission, seepage 9.

ALAN CAMERON A.M. NANCY MILNE

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PART A: INTRODUCTION

During 2001, the Australian economy faced the beginning of what was generallyregarded as a ‘crisis’ in public liability insurance. That is, the cost of liability andindemnity classes of insurance increased at a dramatic rate over a very short period oftime. Not only did liability and indemnity insurance become less affordable, but theavailability of this insurance declined.

This phenomenon was regarded as a peak in the insurance market cycle. Governmentintervention was prompted when it became apparent that the lack of affordableindemnity insurance was having a direct impact upon community members andorganisations.

The Australian Government, through the Treasury Department, commissionedTrowbridge Consulting to report into the public liability insurance market.Trowbridge found that increases in the pricing of liability insurance could be generallyattributable to two things:

• continuing increases in claims costs for personal injury claims; and

• underpricing of indemnity insurance classes by the insurance market during mostof the 1990s (induced by unsound pricing and underwriting practices).

This report was delivered to the first Ministerial Meeting on Insurance Issues held on27 March 2002, chaired by Senator the Hon. Helen Coonan.

The Ministerial Meeting process was established as a means of discussing andcoordinating a nationally consistent approach to addressing public liability insuranceissues. It provided a means for the Commonwealth, State and Territory Ministers and arepresentative of the Australian Local Government Association (the Ministers), towork together to progress reforms aimed at improving the availability andaffordability of liability insurance over the medium to long term.

Since that time, a range of reforms has been advanced and implemented at theCommonwealth, State and Territory level. For its part, the Commonwealth has,amongst other things:

• released the Review of the Law of Negligence on 2 October 2002;

• advanced a number of amendments to the Trade Practices Act 1974 (TPA), includingto allow people to sign waivers and assume the risk of participating in inherentlyrisky recreational activities and introducing a Bill that would serve to preventindividuals and the Australian Competition and Consumer Commission (ACCC) ina representative capacity, from bringing actions for damages for personal injuries ordeath resulting from contraventions of the TPA;

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• released three price-monitoring reports by the ACCC, the latest being on4 August 2003. Another three reports are expected over the next 18 months; and

• removed the tax barriers to structured settlements.

Throughout the process of insurance and negligence law reform, the Ministers havemet on a number of occasions to discuss reform proposals.

At the last two Meetings, the Ministers discussed the effect that judicial interpretationhas had upon the operation of section 54 of the Insurance Contracts Act 1984 (IC Act).The Ministers noted that judicial interpretation might have led to changes in thepricing and availability of indemnity insurance classes (for example, professionalindemnity insurance) and as such determined that the operation of section 54 requiredexamination.

Specifically, it was agreed at the Ministerial Meeting of 6 August 2003 that reform ofprofessional indemnity insurance required a package of measures includingprofessional standards legislation, proportionate liability, amendments to the TPA andconsideration of section 54 of the IC Act.

Against this background, and as a further initiative, the Commonwealth Governmenthas commissioned a comprehensive review of the IC Act and given the importance ofissues related to section 54, has sought recommendations on it by 31 October 2003.

The Government has indicated its commitment to improving indemnity insuranceavailability, and that it appreciates the important economic and consumer protectionrole played by the IC Act, through the rights and obligations it confers upon bothparties to an insurance contract. In undertaking the Review we recognise that theeffective operation of the IC Act is essential to a well-functioning insurance market andthat the examination of section 54 and the Act as a whole must have due regard to therights and obligations of both consumers and insurers.

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PART B: OVERVIEW OF THE OPERATION OF SECTION 54

For a discussion on the general background to development of section 54 and thecurrent statutory framework, see Attachment B.

GENERAL OVERVIEW

Section 54 applies widely to prevent insurers from refusing to pay a claim ifnon-compliance with contractual requirements did not cause or contribute to the loss.If the non-compliance did contribute however, the section only gives insurers theability to reduce a claim to the extent that their interests were adversely effected. (Forthe Explanatory Memorandum to section 54, see Attachment C).

For example, a motor vehicle policy may contain a term which requires the insured tomaintain the vehicle in a roadworthy condition. In the situation where an accidentoccurs partially due to brake failure and partially due to the actions of the other driver,the insurer is only able to deduct an amount from the claim which stems from theinsured’s failure to keep the vehicle in a roadworthy condition.

Generally, the operation of section 54 has not caused difficulty in its application to‘occurrence’ insurance policies, such as motor vehicle policies. That is, policies thatprovide cover for claims arising from incidents that occur during the policy period.

There has, however, been much judicial consideration of the application of section 54in relation to ‘claims made’ and ‘claims made and notified’ policies of insurance1.

‘Claims made’ and ‘claims made and notified’ policies both indemnify insureds forclaims which are made against them by a third party and notified to the insurer duringthe period of cover. These policies also indemnify potential future claims arising froma fact or circumstance that the insured becomes aware of during the period of cover,provided that the fact or circumstance is notified to the insurer during the period ofcover. Many policies contain a ‘deeming provision’ which provides that where aninsured notifies facts or circumstances which might give rise to a claim to the insurerduring the policy period, any claim which ultimately eventuates from those facts andcircumstances will be treated as a claim under that policy. Subsection 40(3)2 of the

1 ‘Claims made’ and ‘claims made and notified’ policies include, professional indemnity,directors and officers, errors and omissions and medical malpractice insurance.

2 ‘Where the insured gave notice in writing to the insurer of facts that might give rise to aclaim against the insured as soon as was reasonably practicable after the insured becameaware of those facts but before the insurance cover provided by the contract expired, theinsurer is not relieved of liability under the contract in respect of the claim, when made, byreason only that it was made after the expiration of the period of the insurance coverprovided by the contract’: subsection 40(3).

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IC Act stipulates that insurers are required to offer the circumstance or occurrencenotified element regardless of whether it is provided for in the contract.

Given that professional indemnity claims (and similar types of claims) can often bemade a long period after the event or circumstance giving rise to the claim, insurershave not traditionally covered such risks under ‘occurrence’ policies. This is becauseinsurers find it difficult to account for their liabilities when they are not notified of theincident that may lead to a potential claim several years later. Such a result can lead toinsurers having to set aside excessive reserves or worse, having insufficient reserves tocover claims.

From the insurer's point of view there are a number of advantages in providing coversuch as professional indemnity or medical malpractice on the basis of claims made or‘claims made and notified’ policies. These include:

• eliminating the so-called "long tail" of unascertained policy obligations. In otherwords, at the end of the policy period, the insurers should know exactly the claimswhich they will need to cover (whether those claims have been notified to them asclaims or circumstances which may give rise to a claim). This is important forinsurers in terms of calculating their liabilities and the reserves that they should setaside for the purpose of meeting those liabilities;

• potentially avoiding the difficulty of ascertaining which of several successivepolicies should respond to a claim, where the work giving rise to the claim mayhave spanned more than one insurance period; and

• the extent of insurance cover available at the time of notification of the claim (orcircumstances which might give rise to a claim) being the amount which has beennegotiated prior to the outset of the policy period based on present day claimsexperience rather than historical information.

Recent judicial interpretation of subsection 54(1) of the IC Act has excused the insuredfrom the consequences of a failure to notify claims or circumstances which might giverise to a claim during the period of cover (even where the decision not to notify wasdeliberate) so that coverage is still available for such losses for an indeterminate periodafter the policy has expired. In simple terms it has been said that the result converts thepolicy into an ‘occurrence trigger contract’, subject to the need for insurers to providefor ‘incurred but not reported claims’ as in traditional accident-based liabilityinsurance.3

3 There is still some uncertainty flowing from the various cases as to whether the latenotification of circumstances which might give rise to a claim in a claims made and notifiedpolicy which does not include any provisions relating to the notification of circumstanceswhich might give rise to a claim, can be the subject of relief under section 54.

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SUMMARY OF CASES

Below is a brief discussion of some of the cases that have interpreted section 54 overthe last decade. The varying interpretations have been clarified in the most recent case,Australian Hospital Care (see below).

Primary cases

East End Real Estate Pty Ltd v C E Heath Casualty and General Insurance Limited(1992) 25 NSWLR 400.

In relation to the ‘claims made’ element of indemnity policies, provided the claim ismade during the period of the policy, it is not necessary for an insured to notify theinsurer of a claim until indemnification is sought.

This case saw the NSW Court of Appeal consider a ‘claims made and notified’professional indemnity policy. The Court held that subject to any prejudice the insurermight have suffered, subsection 54(1) allowed the insured to make a claim against theinsurer even though they did not notify the insurer of the claim until after expiry of thepolicy. The Court rejected the submission that section 54 was to be confined toconditions, warranties and exclusion clauses rather than extending the scope of thecover.

FAI General Insurance Company Ltd v Australian Hospital Care Pty Ltd (2001) 204CLR 641

In relation to the ‘notified’ element of indemnity policies, there is no need for theinsured to notify the insurer of an occurrence that may lead to a claim in the future.Section 54 operates to remedy the insured’s failure to comply with the scope of thecontract.

The High Court decision in the Australian Hospital Care case has clarified theuncertainty that has existed in relation to the ambit of section 54 by endorsing East Endand Antico and essentially overruling Perry (see case summary below). Further, thereasoning in both Greentree and Permanent Trustee v FAI4 was rejected, even though thefinal decision was found to be correct (see case summary below).

4 Permanent Trustee Australia Ltd v FAI General Insurance Co Ltd (1998) 153 ALR 529.

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The Australian Hospital Care case considered a ‘claims made and notified’ policy. Theinsured (AHC) was contacted by the solicitor of a patient, who indicated that his clientwas considering legal action due to the possible negligence of a doctor. Followinginvestigation into the matter, both the insured and the patient were satisfied that therewere no grounds for complaint so the insured did not notify the insurer of thisoccurrence. Despite these events, the patient did end up taking legal action and theinsured sought to rely on section 54 in order to be indemnified from the claim.

The High Court held that the effect of section 54 was that despite an insured beingaware during the policy period of incidents that may lead to a future claim,non-disclosure of these incidents until after the period of that particular policy hence possibly avoiding a premium increase for the next policy period is not aground upon which the insurer can refuse to pay the claim.

Other cases

FAI General Insurance Company Limited v Perry (1993) 30 NSWLR 89

The insured held a ‘claims made and notified’ policy. Despite becoming aware of apotential claim within the period of the policy, the insured did not notify the insurer.The insured unsuccessfully attempted to rely on subsection 54(1), by submitting thathis failure to notify the insurer of these facts was an ‘omission’ under paragraph54(6)(a). Although the NSW Court of Appeal found that the concept of omission didnot include the insured’s failure through inaction to exercise some right that existsunder the policy, the practical result of the decision has been overturned by theAustralian Hospital Care case.

Antico v C E Heath Casualty & General Insurance Limited (1997) 188 CLR 652.

This involved an insured who proceeded to defend claims made against him withoutseeking the consent of the insurer. The issue was whether a failure to obtain theconsent from the insurer was an omission for the purposes of section 54.

The High Court approved the East End case (see above) and stated that the legislationwas expressed broadly enough that an omission could include a failure to exercise a‘right, choice or liberty’ that the insured enjoyed under a contract of insurance.

Greentree & Anor v FAI General Insurance Co Ltd (1998) 44 NSWLR 706

This case involved the negligent design of a building, which was only discovered by athird party after the expiry of the policy. The NSW Court of Appeal held thatsection 54 could not be invoked, where the effect of doing so was to alter the basicterms of the contract of insurance. It was found that this would destroy the necessarycausal connection between the policy terms and the insurer’s refusal to pay the claim,upon which the application of subsection 54(1) depends.

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Gosford City Council v GIO General Limited [2002] NSWSC 511 and [2003] NSWCA 34

This case involved a ‘claims made’ policy that did not include a provision to treat thenotification of circumstances as a claim during the policy period. The New SouthWales Court of Appeal held that section 54 would not apply to provide relief to aninsured, who fails to notify circumstances that may give rise to a claim during thepolicy period (that is, the insured failed to invoke section 40(3)). The circumstances ofthat decision depended on the particular wording of the policy.

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PART C: CURRENT OPERATION OF SECTION 54 DOES IT STRIKE AN APPROPRIATE BALANCE?

We are seeking submissions on the operation of section 54 with respect to ‘claimsmade’ and ‘claims made and notified’ policies. The following questions areprovided to assist the framing of submissions but are not intended to limit theirscope. Any elaboration of reasoning behind answers to the below questions wouldbe appreciated.

Does section 54 provide an appropriate balance between the rights and obligations ofinsurers and the insured? If not, what changes will promote a better balance? Areamendments needed to other provisions (eg section 40)?

Does section 54 work fairly with respect to ‘claims made’ and ‘claims made andnotified’ insurance policies?

Does the current operation of section 54 affect the market for the provision ofinsurance?

OPTIONS FOR REFORM

For the purpose of stimulating discussion, some broad options are canvassed below.The options below are intended to be a guide only, and are not intended to limitsubmission content.

Option 1:Retain section 54 in its current form.

Option 2:Amend section 54 (and possibly section 40) to overcome the judicialinterpretation in the Australian Hospital Care case.

For ‘claims made’ or ‘claims made and notified’ policies:

• Notification by an insured to the insurer, of facts or circumstances which mightgive rise to a claim, outside the period of cover, would be excluded from the reliefprovided under section 54.

For ‘claims made and notified’ policies:

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• Section 54 would still provide relief to an insured in respect of a claim made againstthe insured during the period of cover, but notified to the insurer outside thatperiod.

Option 3:Amend section 54 (and possibly section 40) so as to overcome thejudicial interpretation in East End and the Australian Hospital Care case.

• Notification by an insured to the insurer, of facts or circumstances which mightgive rise to a claim, outside the period of cover, would be excluded from the reliefprovided under section 54.

• Section 54 would no longer provide relief to an insured in respect of a claim madeagainst the insured during the period of cover, but notified to the insurer outsidethat period.

Option 4:Divide section 54 into two separate provisions.

• The first section would reflect the operation of section 54 in its current form,however, the operation of this section would be limited to ‘occurrence’ policies.

• A variation of section 54 would be drafted to operate in relation to ‘claims made’and ‘claims made and notified’ policies. This new section could be drafted, takinginto consideration the proposals raised in ‘Option 2 and 3.’

• Regulations could prescribe the application of each section above to insurancetypes that may not fall within the specified categories.

OTHER ISSUES FOR CONSIDERATION

Submissions may also wish to consider consequential implications associated with anyof the options and additional matters that may warrant investigation. These mayinclude:

• whether there is a need for an extended reporting period, so that an insured whobecomes aware of a circumstance close to the expiry of their policy period is notexcluded from cover if he or she does not comply with notification requirementsprior to the cut off date; and

• whether there is a need for run off cover, where an insured (for example, a solepractitioner) dies or retires.

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We request that submissions on section 54 be provided by no later than15 October 2003. If possible, submissions should be sent by e-mail toicareview@treasury.gov.au. Alternatively submissions can be mailed or faxed to:

SecretaryInsurance Contracts Act ReviewC/- Department of the TreasuryLangton CrescentPARKES ACT 2600

Fax: 02 6263 2770

Contacts in the Secretariat:Mr Michael Rosser – Tel: 02 6263 3962Ms Angela McGrath – Tel: 02 6263 3094

For further information on how to make a submission, please see the ‘MakingSubmissions’ link on the Review’s website, icareview.treasury.gov.au.

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ATTACHMENT A

REVIEW OF THE INSURANCE CONTRACTS ACT 1984

TERMS OF REFERENCE

The review of the operation of the Insurance Contracts Act 1984 (the Act) is to beconducted having regard to the following:

(1) Whether the rights and obligations of insurers and insureds (including personsseeking insurance) under the Act continue to be appropriate, including in lightof:

(a) product, regulatory and other developments in the financial servicesindustry (particularly the insurance sector) since the Act was enacted; and

(b) Judicial interpretation of the Act.

(2) Whether any amendments to the Act are required to take account of the mattersset out in item 1, and whether there are any deficiencies in the Act, such asaspects of the relationship between insurers and insureds that are notadequately covered;

(3) Whether any amendments are warranted in order to remove ambiguity andmore clearly express the intent of the Act; and

(4) Any other matters relating to the Act which the reviewers consider itappropriate to examine.

A written report on the findings of the review is to be provided to the Government by31 May 2004.

Given concerns that section 54 of the Act may be adversely impacting on the cost andavailability of professional indemnity and similar types of insurance, a preliminaryreport on urgent issues relating to that section is to be provided to the Government by31 October 2003, in order that any resultant legislative amendments can beimplemented at the earliest available opportunity.

Ian CampbellParliamentary Secretary to the Treasurer10 September 2003

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ATTACHMENT B

BACKGROUND AND THE CURRENT STATUTORYFRAMEWORK

The IC Act had its origins in 1976 with the Attorney-General expressing concern withthe lack of uniformity between the insurance laws of the Territories and the States, therelative bargaining power between the insurer and the insured and the fairness ofnegotiating and contracting of insurance. As a consequence he asked the AustralianLaw Reform Commission (ALRC) to report on:

(1) the adequacy of the law governing contracts of insurance (excluding marineinsurance, workers compensation and compulsory third party insurance) havingregard to the interests of insurer, insured and the public;

(2) what, if any, legislative or other measures were required to ensure a fair balancebetween the interests of the insurer and the insured; and

(3) any other related matter.

In response, the ALRC produced two reports. ALRC 16, entitled ‘Insurance Agents andBrokers’, dealt with the regulation of insurance intermediaries. ALRC 205, entitled‘Insurance Contracts’, dealt with contracts of insurance, contract terms and remediesand the information insurers must make available to an insured.

ALRC 20 Report

The ALRC 20 Report (the Report) proposed wide-ranging reforms to the field ofinsurance by attempting to enhance uniformity between the laws of the States andTerritories, balance the relative bargaining power between the insurer and the insuredand make the negotiating and contracting of insurance fairer. The Report includeddraft legislation to implement these designs which formed the basis of the IC Act.

5 The Law Reform Commission, Insurance Contracts Report No. 20 (1982).http://www.austlii.edu.au/au/other/alrc/publications/reports/20/.

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Specifically, the Report recommended that an insurer should not be entitled toterminate a contract if the insured is in breach of it, but rather be entitled to reduce theclaim in proportion to the prejudice it has suffered as a result of the breach.6 As aresult, a very similar version of the current section 54 of the IC Act was drafted tosatisfy two of the Report recommendations as outlined below.7

Recommendation 36: Obligations during the period of cover.8

Many contracts of general insurance and some contracts of life insurance containterms which have the effect of placing obligations on the insured in order toprotect the insurer against increases in the risk during the period of cover.

Legislation should provide that, whatever the form of the relevant terms, thepenalty placed on the insured for a failure to comply with an obligation imposedby the contract should be the same (para. 229). Where an insured has breachedsuch an obligation, an insurer should only be entitled to reduce a claim by anamount that fairly represents the extent to which its interests have beenprejudiced by the relevant conduct.

However, an insured should be entitled to recover if he proves, in respect ofconduct which might, in principle, have contributed to a loss, that it did not do soin the particular circumstances of the case. Where the insured is able to prove thatthe conduct caused only a part of the loss, he should not be disentitled fromrecovering that part of the loss which was not caused by the conduct (para. 228, cl.54(1)-(3), 54(5), 55).

Finally, an insured should not be disentitled from recovery where he proves thatcompliance with the relevant obligation was not reasonably possible in all thecircumstances or where non-compliance was necessary to protect life or property(para. 230, cl. 54(4)).

Recommendation 37: Remedies for breaches of conditions subsequent.9

The recommendations made in relation to those terms designed to protect theinsurer against an increase in the risk during the period of cover should applyequally to those terms which place obligations on the insured in order to protectthe interests of the insurer after a loss has occurred (para. 241-2, cl. 54-5).

6 Ibid at page xxii.7 Ibid at Appendix A, page 267.8 Ibid at page xxxi.9 Ibid at page xxxii.

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To illustrate the recommendations, the Report contains three examples where thesection would apply. 10

A motor vehicle policy contains a term by which the insured warrants that thevehicle will be maintained in a roadworthy condition. As a result of a brakefailure, the vehicle, while being driven by the insured, collides with anothervehicle. The driver of the other vehicle was 50% to blame for the accident. Theinsured’s conduct in allowing the vehicle to become unroadworthy couldreasonably be supposed to cause or contribute to a loss, hence sub-cl. (2) applies.The insured is able to prove that he was, at most, 50% to blame for the accident.Hence the insurer is entitled to deduct only 50% of the claim (sub-cl. (3)).

If the vehicle was damaged while parked, the insured could recover the fullamount of his loss (sub-cl. (1)).

A’s motor vehicle policy contains a term which excludes the insurer’s liability ifthe driver of the vehicle is unlicensed. While driving the car, A is involved in anaccident. He was unlicensed at the time, having forgotten to renew his licence,which expired 2 weeks previously. A’s conduct could not reasonably besupposed to be of a type which could contribute to an accident, so sub-cl. (1)only applies. Since the insurer could not have been prejudiced by A’s drivingthe car without a licence, it is liable for the full amount of the claim.

CURRENT DRAFTING OF SECTION 54

As mentioned above, the current section 54 (set out below) is substantially the same asthe provision in the Draft Insurance Contracts Bill 1982 as developed by the ALRC.

54 Insurer may not refuse to pay claims in certain circumstances

(1) Subject to this section, where the effect of a contract of insurance would, but forthis section, be that the insurer may refuse to pay a claim, either in whole or inpart, by reason of some act of the insured or of some other person, being an actthat occurred after the contract was entered into but not being an act in respectof which subsection (2) applies, the insurer may not refuse to pay the claim byreason only of that act but the insurer’s liability in respect of the claim is reducedby the amount that fairly represents the extent to which the insurer’s interestswere prejudiced as a result of that act.

10 Ibid at Appendix A, page 290.

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54 Insurer may not refuse to pay claims in certain circumstances (continued)

(2) Subject to the succeeding provisions of this section, where the act couldreasonably be regarded as being capable of causing or contributing to a loss inrespect of which insurance cover is provided by the contract, the insurer mayrefuse to pay the claim.

(3) Where the insured proves that no part of the loss that gave rise to the claim wascaused by the act, the insurer may not refuse to pay the claim by reason only ofthe act.

(4) Where the insured proves that some part of the loss that gave rise to the claimwas not caused by the act, the insurer may not refuse to pay the claim, so far asit concerns that part of the loss, by reason only of the act.

(5) Where:

(a) the act was necessary to protect the safety of a person or to preserveproperty; or

(b) it was not reasonably possible for the insured or other person not to dothe act;

the insurer may not refuse to pay the claim by reason only of the act.

(6) A reference in this section to an act includes a reference to:

(a) an omission; and

(b) an act or omission that has the effect of altering the state or condition ofthe subject-matter of the contract or of allowing the state or condition ofthat subject-matter to alter.

The Explanatory Memorandum to the Insurance Contracts Bill 1984 (Cth) furtherelaborates the rationale for section 54. At paragraph 182, it states that:

The existing law is unsatisfactory in that the parties’ rights are determined by theform in which the contract is drafted rather than by reference to the harm caused.The present law can also operate inequitably in that breach of the term may leadto termination of the contract regardless of whether or not the insurer sufferedany prejudice as a result of the insured’s breach. The proposed law willconcentrate on the substance and effect of the term and ensure that a more

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equitable result is achieved between the insurer and the insured (ALRC paras.228-230 and 241-242).

The total extract from the Explanatory Memorandum relating to section 54 is atAttachment C.

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ATTACHMENT C

EXPLANATORY MEMORANDUM TO CLAUSE 54 OF THEINSURANCE CONTRACTS BILL 1984 (CTH)

Clause 54 Insurer may not refuse to pay claims in certaincircumstances177. Present Law Any of the following types of terms may be presently used byinsurers to protect themselves against an increase in risk during the period of coverand to ensure that their interests are protected once a loss occurs:

(1) ‘continuing’ or ‘promissory’ warranties whereby the insured warrants that acertain state of affairs will continue to exist or that certain matters or events willor will not exist or occur during the currency of the contract. If the warranty isbreached the terms may provide that it is entitled only to reject that claim butnot avoid the contract. Others may permit the insurer to avoid the contractentirely and claim damages;

(2) terms framed as obligations to be performed by the insured e.g. that he will takeall reasonable precautions for the safety and protection of the property. A breachwill have similar results to those specified in (1); and

(3) ‘temporal exclusions’ whereby cover is suspended during the existence ofspecified facts or circumstances which increase the risk e.g. in a motor vehiclepolicy, liability may be excluded if the driver is under the influence ofintoxicating liquor; and

(4) conditions whereby an insured is required to give details of claims or commenceproceedings within a certain time.

178. The effect of these terms has been modified in some jurisdictions in Australia:

(1) New South Wales – s.18 of the Insurance Act 1902 (NSW) permits a court toexcuse a breach of a term or a condition by the insured which has not prejudicedthe insurer. The section is only applicable where the term is the subject of a courtaction but the precise meaning and effect of the section has caused difficulties.

(2) New South Wales and Victoria – in so far as they relate to a limited range ofinsurance contracts, s.138 of the Consumer Credit Act (1981) (NSW) and s.138 ofthe Credit Act (1981) (Vic) will, if they came into force, render such termsineffective where the relevant loss was not caused or contributed to by theinsured.

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179. Proposed Law – Clause 54 affects contracts which permit an insurer to refuse topay a claim, either in whole or in part because the insured or a third party has donesome act after the contract was entered into. Provided that the act could not reasonablybe regarded as being capable of causing or contributing to a loss in respect of whichcover is provided, the insurer may not refuse to pay all or part of the claim. It may,however, reduce its liability by an amount that fairly represents the extent of which theinsurer’s interests were prejudiced as a result of that act (clause 54(1)).

180. Where the act could reasonably be regarded as being capable of causing orcontributing to a loss, in respect of which cover is provided, the insurer may refuse topay the claim (clause 54(2)). If the insured proves that no part of the loss was eithercaused by, or contributed to, the loss, then the insurer may not refuse to pay the claimby reason only of the act (clause 54(3)). If he proves that part of the loss was not causedby the act, the insurer may not refuse to pay that part of the claim (clause 54(4)).Should the insured prove that the act was necessary to protect the safety of a person orto preserve property or that it was not reasonably possible for the insured or someother person to do the act, the insurer may not refuse the claim by reason only of theact (clause 54(4)).

181. The clause also applied to an omission as well as an act and to an act or omissionaltering the state or condition of the subject matter of the contract (clause 54(6)).

182. Rationale The existing law is unsatisfactory in that the parties’ rights aredetermined by the form in which the contract is drafted rather than by reference to theharm caused. The present law can also operate inequitably in that breach of the termmay lead to termination of the contract regardless of whether or not the insurersuffered any prejudice as a result of the insured’s breach. The proposed law willconcentrate on the substance and effect of the term and ensure that a more equitableresult is achieved between the insurer and the insured (ALRC paras. 228-230 and241-242).