Article by Gareth Thomas and Tommy Tong

‘Moral Hazard’

Brotherton v Aseguradora Colseguros
(Transcript 22nd May 2003, Court of Appeal (Eng))

Arising from the judgment of Colman J. in Strive Shipping Corp. v Hellenic Mutual War Risks Association (The ‘Grecia Express’) [2002] EWHC 203, there has been much debate about the extent to which an insured can mitigate his failure prior to the inception of an insurance policy to disclose allegations of misconduct by demonstrating later that the allegations were false. That debate may have been laid to rest by the Judgment of the Court of Appeal in Brotherton.


In Brotherton, the claimant reinsurers are seeking to avoid their policy of reinsurance with the defendants, who insured a Columbian state-owned bank under a bankers blanket bond policy, which covered, amongst other things, losses caused by the dishonest or fraudulent acts of bank employees. The basis of their avoidance was the failure by the defendants to disclose news bulletins and newspaper articles carrying reports of allegations of misconduct on the part of the president of the bank, which had led to his suspension and arrest. In short, the reinsurers alleged that the defendants had failed to disclose a ‘moral hazard’ of their insured.

The defendants had sought leave to call evidence at the trial to prove that all the undisclosed allegations made against the president had either been dropped or disproved. They did so in reliance on the reasoning of Colman J. in The ‘Grecia Express’, in which he held that "… I do not consider that failure to disclose allegations which on the evidence before the Court are proved to have been false entitles underwriters to avoid the policy".


At first instance, Moore-Bick J., consistent with his earlier judgment in Drake Insurance v Provident Insurance, rejected this reasoning and struck out that part of the defence which raised these issues, thereby preventing the defendants from calling evidence as to the president’s innocence of the allegations at trial.

Unanimously, the Court of Appeal upheld the decision. Giving the leading judgment, Mance LJ, who had left the point open in ICCI v Royal Hotel [1998] LRLR 151, held that it would be an unsound step to introduce a principle of law which would enable an insured either not to disclose allegations which a prudent insurer would regard as material or subsequently resist avoidance by insisting on a trial in circumstances where, if the insurers never found out about the allegations the insured would face no difficulties in obtaining payment for his losses, however directly relevant the allegations were to the perils insured and the losses which occurred, but if the insurers did find out, they would be put to the trouble, expense and risk of litigation, in circumstances where they would never have been exposed had the insured acted in good faith and made proper disclosure.


This Judgment reinforces the principle that the concept of materiality in nondisclosure cases is directed to the exercise of underwriting judgment (i.e. whether to insure the risk at all and, if so, on what terms) at the time of the contract, and that information which comes to light after the contract is made can have no bearing on that judgment. The effect of the judgment, if it is followed, will be to reduce the cost of litigating ‘moral hazard’ cases such as this, and further reinforce the obligation of the prospective insured to disclose all matters material to the risk to the insurer prior to inception.


The Duty To Report "As Soon As Possible"

Fong Wing Shing Construction Co. Ltd. v Assurance Generales de France (HK) Ltd.
(HCA 5465/2001, transcript 28th May 2003 – Gill DJ)


The plaintiff was insured under a Contractors All Risks policy by the defendant. The policy covered, amongst other things, liability arising out of bodily injury. The plaintiff sub-contracted work to another company, Judea. In July 1998, a worker employed by another employer to paint part of the building away from the works being carried out by Judea was apparently injured. In June 2000, the injured worker sued the plaintiff for his injuries and the plaintiff notified the defendant insurer of the claim.

As is almost universal in such policies, the plaintiff’s policy required it, as a condition precedent to the insurer’s liability, to notify insurers of any occurrence which might give rise to claim under the policy, in this case "as soon as possible".

The evidence from the project manager and site foreman, both employees of Judea, was that they had had no knowledge of any accident during the whole period of the works. The first anyone connected with the works had heard of the injury was in 2000. The judge accepted this evidence, but the insurer argued that in any event they were entitled to reject the claim for breach of the condition precedent.


The Deputy Judge distinguished this case from those where the insured or his personal representative were aware that the insured event had taken place, but were not aware of the existence of the policy and therefore the right to make a claim until sometime later. In such cases the insurer was entitled to reject the claim for breach of the condition precedent (see Vireselst’s Administratrix v Motor Union Insurance Co. Ltd. [1925] 2 KB 137). He decided that, in circumstances where the insured had no knowledge of the accident until the time it reported it and that lack of knowledge was through no want of diligence on the part of the insured, the notification could not have been made earlier. He therefore held that the condition precedent had not been breached; the occurrence had been notified as soon as possible.


The decision is obviously a sensible one on the facts of the case, but it remains to be seen what the position would be in a case where the insured had failed to obtain knowledge of an occurrence through want of diligence. Presumably, if it had been possible through proper diligence to have learned about the accident earlier, then the Deputy Judge would have held that the occurrence had not been notified "as soon as possible". In that sense, the case reinforces the need for constructors to make sure they have in place adequate systems to monitor and record activity on site and to report incidents upwards to those responsible for notifying potential claims to insurers.


Employees Compensation Insurers Insolvency Scheme

On 21 February 2003, the Employees Compensation Insurers Insolvency Bureau ("ECIIB") was established by the insurance industry of Hong Kong and, on the same day, the ECIIB and the Insurance Authority entered into an agreement on the establishment of the Employees Compensation Insurer Insolvency Scheme (the "Insolvency Scheme").

The purpose of the Insolvency Scheme is to take over from the Employees Compensation Assistance Scheme ("ECAS") the responsibility of meeting the liabilities arising from employees compensation insurance policies in the event of the insolvency of the relevant insurers.

Commencing from 1 April 2003, the Insolvency Scheme will collect contributions from employees compensation insurers in Hong Kong. Starting from the effective date which is expected to take place on 1 April 2004, the responsibility of meeting liabilities arising from employees compensation insurance policies in the event of the insolvency of the relevant insurer will vest in the Insolvency Scheme. The scope of the Insolvency Scheme and the claims and settlement procedures will largely follow the relevant provisions under ECAS.

The purpose of the establishment of the ECIIB and the Insolvency Scheme is to relieve the financial burden of the existing ECAS, in particular from the sudden strain on the cash flow of the ECAS arising from the insolvency of an employees compensation insurer.


Insurance Companies Ordinance (Amendment of Part 8 of Third Schedule) Regulation 2003

The Insurance Companies Ordinance (Amendment of Part 8 of Third Schedule) Regulation 2003 (the "Amendment Regulation") was gazetted on 14 January 2003 and came into operation on 3 April 2003.

The Amendment Regulation amends the Third Schedule of the Insurance Companies Ordinance (the "Ordinance") in the following ways:

Definition of Hong Kong long term insurance business
The Amendment Regulation adds a definition of "Hong Kong long term insurance business" to Part 1 of The Third Schedule to the Ordinance, and specifies that the revenue account to be prepared in a prescribed form (Form HKL1) and submitted by a long term insurer in accordance with the Ordinance must be audited. The purposes of this Amendment Regulation are to provide a clear delineation of what insurance business of a long term insurer constitutes Hong Kong long term insurance business and to ensure the integrity of information relating to such business to be submitted to the Insurance Authority of Hong Kong ("IA") by a long term insurer.

Preparation of revenue account, valuation summary and valuation
balance sheet by an insurer authorised to carry on long term business
The Amendment Regulation also imposes a duty on a long term insurer to submit annually to the IA a revenue account (via form HKL1), a valuation summary (via form HKL2) and a valuation balance sheet (via form HKL3) for its Hong Kong long term insurance business. These forms are similar to those which are required to be submitted by an insurer of long term business in support of any actuarial valuations under Part 7 of the Third Schedule.

The revenue account, valuation summary and valuation balance sheet are required to be certified by the chief executive and two directors of a long term insurer.

Under the Amendment Regulations, long term insurers are required to submit the revenue account, valuation summary and valuation balance sheet commencing with the financial year ending on or after 31 December 2003. Pursuant to section 20(1A) of the Ordinance, such submission shall be made within 4 months after the end of the relevant financial year.


The Code on Investment-Linked Assurance Schemes

In April 2003, the Securities and Futures Commission ("SFC") issued the Code on Investment- Linked Assurance Schemes ("Code") pursuant to the Securities and Futures Ordinance ("SFO"), which replaced the Code on Investment-Linked Assurance Schemes ("Old Code") issued by the SFC in 1998 and amended in June 1999 issued under the now repealed Protection of Investors Ordinance ("PIO").

The Code was issued pursuant to the SFO which became effective on 1 April 2003. The Code contains changes which are consequential to the enactment of SFO and the repeal of, amongst others, the PIO and Securities and Futures Commission Ordinance.

Apart from the consequential changes, under the Code, an applicant applying for the authorisation of a collective investment scheme that is an investment-linked assurance scheme is now required to nominate an individual as an approved person for the purposes of being served by the SFC with notices and decisions for the scheme and the issue of any related advertisement, invitation or document.

Further, the Code also alters the minimum requirements for the information to be included in the illustration document which an applicant is required to prepare in respect of each of its proposed investment. The changes are the alteration of the assumptions on the rate of return applied to illustrate the expected surrender values and the introduction of a new set of prescribe statements which are required to be disclosed in an illustration document.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.