Insurance Contract Law Issues Paper 2 Warranties - Law Commission

Suppose, for example, that a motor vehicle has been modified in
breach of a warranty. The breach increases the risk of a malfunction
of the vehicle’s brake system. An accident occurs which is entirely the
fault of a driver in not keeping a proper look-out. The brakes are
applied too late but function admirably. 8
6.24 The ALRC suggest that although the breach did not cause or contribute to the
loss, the insured could not prove that the breach did not increase the risk that the
loss would occur in the way it did in fact occur.
Australia
6.25 The ALRC dealt with these problems by recommending a two-part test. The
causation test would only apply to provisions that could reasonably be regarded
as capable of causing or contributing to the loss for which insurance cover was
provided. For other breaches, a proportionality test would be applied, allowing the
insurer to reduce its liability “by the amount that fairly represents the extent to
which… [its] interests were prejudiced”.
6.26 The ALRC also recommended greater protection to policyholders than the New
Zealand Act provides where the breach caused only part of the loss. Here the
insurer would still be liable for the part of the loss that was not caused by the
insured’s act. Suppose, for example, a site owner has two buildings: Building A,
where the sprinkler system has been maintained, and Building B, where it has
not. If fire spreads from Building A to Building B, the insurer would still be liable to
meet the loss to Building A.
6.27 These recommendations were enacted in section 54 of the Insurance Contracts
Act 1984:
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(1) Subject to this section, where the effect of a contract of insurance
would, but for this section, be that the insurer may refuse to pay a
claim, either in whole or in part, by reason of some act of the
insured or of some other person, being an act that occurred after
the contract was entered into but not being an act in respect of
which sub-section (2) applies, the insurer may not refuse to pay the
claim by reason only of that act but the insurer’s liability in respect
of the claim is reduced by the amount that fairly represents the
extent to which the insurer’s interests were prejudiced as a result of
that act.
(2) Subject to the succeeding provisions of this section, where the act
could reasonably be regarded as being capable of causing or
contributing to a loss in respect of which insurance cover is
provided by the contract, the insurer may refuse to pay the claim.
(3) Where the insured proves that no part of the loss that gave rise to
the claim was caused by the act, the insurer may not refuse to pay
the claim by reason only of the act.
In ALRC, Insurance Contracts (1982) at para 228.
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