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

Section 3 Economic incentives in insurance markets
Table 5: Illustrative workings of an insurance market with misrepresentation
with different remedies
Number of policies
written
Premium that should
have been charged
Premium actually
charged
Income from pool of
policies
Scenario 1.
Misrepresentation
followed by
payment of claim
and receipt of
additional premium
Scenario 2.
Misrepresentation
followed by
avoidance of
claim
Scenario 3.
Misrepresentation
followed by
proportionality
50 50 50
£400 £400 £400
£200 £200 £200
£10,000 £10,000 £10,000
Number of claims 2 2 2
Cost per claim £9,800
Initial £10,000 claim
less additional
premium of £200
£200
Both claims
rejected –
premiums
returned
£5,000
Reduced from
£10,000
proportionally
Cost of claims for pool £19,600 £400 £10,000
Economic Profit - £9,600 + £9,600 £0
3.2 Conclusions
We have presented three simple illustrative scenarios of alternative outcomes
in an insurance market depending on the options available and possible
responses by firms to claims. It is a very simple theoretical example and does
not reflect the proposal being considered by the Law Commission. Despite
this, the illustration suggests that the ability to completely avoid a policy for
reasons of negligent non-disclosure or misrepresentation (the current strict
law) may provide a measure of over-compensation to some insurers.
Specifically, the ability to refuse a claim for reasons of non-disclosure or
misrepresentation may not encourage some insurers to ask clear
understandable questions. In an extreme case it allows insurers to make a
greater profit from wrong answers than from right ones.
London Economics
June 2007 14