Misrepresentation, Non-Disclosure and Breach ... - Law Commission

“Moral hazard” and the need for precautions
1.62 The law of warranties is designed to guard against a second danger associated
with insurance. This is that a policyholder who has insured a risk may fail to take
proper precautions by, for example, leaving doors unlocked, or fires unattended.
This is said to be a form of “moral hazard”. 32 The law has therefore taken a very
strict approach to warranties.
1.63 In considering our proposals, we have tried to balance the need to encourage
policyholders to take precautions and their reasonable expectations of cover.
Again, we have been highly influenced by accepted market practice. In the
consumer area, our proposals are designed to match the law to what is already
required by the FSA and expected by the FOS. For businesses, our proposals
attempt to match the default rules to current market practice, while allowing
parties to negotiate an alternative solution if they wish.
Suspicions of fraud
1.64 We have heard one argument for the current law that we do not think is
legitimate. It is sometimes suggested that harsh rules may not be reasonable in
themselves but are useful where an insurer suspects but cannot prove fraud.
1.65 The following example emerged from our survey of ombudsman decisions:
A policyholder claimed for the loss of a valuable diamond ring
shortly after insuring it. The insurer went through every detail of her
case. They eventually avoided the policy on the grounds that she
had failed to mention a previous loss. The proposal form had asked
if she had “suffered loss, damage or liability during the last five
years, whether insured or not”. Some time earlier, the
policyholder’s young son had spilled candle wax on the carpet. She
phoned the insurer to ask if she could claim, but was told that
accidental damage was not covered. A few months later she
redecorated the room and replaced the carpet. The insurer said
she should have disclosed this uninsured loss. The ombudsman
ruled that the phrase “suffered loss” could not be intended to
include all damage to a home caused by young children (Case 11).
1.66 We do not believe that a reputable insurer would really worry about a failure to
mention spilt candle-wax. It may well be that some other suspicion or concern
was at play here – though as no other concern was mentioned, it is difficult to be
certain. It seems fair to assume that the insurer’s attitude was this: if it suspects
but cannot prove that the insured was lying about the loss of a ring, it should be
entitled to avoid the policy on other grounds, even if those grounds have little
merit in their own right.
32 Moral hazard is opportunism characterised by an informed person’s taking advantage of a
less-informed person through an unobserved action. A more obvious form of moral hazard
is making a claim for a loss, which has not in fact been suffered in the hope that the insurer
will not notice, or be able to prove, the fraud. That issue will be dealt with in our second
consultation paper.
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