Nearly all of the leading texts and reporters on insurance law commence with a history of the development of insurance.  Some authors devote a whole chapter to it, others a mere paragraph or two. Insurance has a colourful history, which makes interesting reading, but more importantly it provides a historical context for a number of the principles that apply to insurance as we know it today.

History of Insurance

The origins of insurance are purported to date back thousand of years to a time when the transference of risk was incorporated into commercial arrangements effected by the Babylonians, Phoenicians, Greeks and Romans. For example, maritime loans were provided at higher rate of interest, freeing the borrower from liability to repay the loan in the event that the ship or cargo was lost.[1] The birth of the modern insurance contract is attributed to Italian merchants in the 14^th Century who fostered the development of marine insurance.  A contract entered into in 1385 insured a ship and cargo against loss arising:

from Acts of God, of the sea, of fire, of jettison, of confiscation by princes or cities or any other person, of reprisal, mishap, or any other impediment.[2]

During the 16^th Century England marine insurance was developing with merchants assuming small amounts of mercantile risk.  Sums insured were generally inadequate but early in the 1700’s a soundly-based marine insurance industry had formed in no small measure as a result of the activities of Mr Edward Lloyd.  Lloyd established a coffee house in 1688 which became the gathering place for the commercial community and in particular those involved in the shipping and mercantile industry.  The coffee house became a popular place for the arrangement of marine insurance.  In the early 18^th Century a practice developed whereby a merchant wanting insurance would pass around to other merchants gathered in the coffee house a slip of paper on which was written details of the ship, cargo, voyage and amount of insurance sought.  The slip was initialled by those who were willing to accept a proportion of the risk set out above on the slip. When the entire amount of the insurance sought was underwritten, the insurance contract was complete (and hence the use of the term “underwriter” which remains with us today).[3] Lloyds of London has long since vacated the coffee house and is now a statutory corporation, but its business is still conducted in a similar way with the individual members (and not the corporation) underwriting the risk, albeit that underwriters now band together in professionally managed syndicates in order to curtail their personal exposure.[4]

These early underwriters expanded their activities outside of marine insurance and by the 18^th Century “…subscription books were opened for ‘an insurance office for horses dying natural deaths, stolen or disabled’ and for ‘Assurance of Female Chastity’.” [5]

Fire insurance operated as early as 1591 in Hamburg and in England since the 1630’s.  Ironically, it was the Great Fire of London in 1666 which was the catalyst for the establishment and a growth of a fire insurance business in England.  After the Great Fire, controls were introduced to regulate the materials from which houses could be constructed, their proximity to one another and the availability of basic fire fighting equipment.  Management of the risk of fire was an essential element in making fire insurance sustainable and attractive to underwriters.[6]

Life insurance too was linked with the development of marine insurance with merchant-underwriters frequently prepared to insure the life of the captain of a ship during a sea voyage.  However, in England it was not until the end of the 17^th Century that life insurance schemes were proposed and established.[7] This was frequently conducted by mutual societies who shared member contributions amongst the descendents of members who had died.  Life insurance as we know it today was not possible until more accurate mortality statistics and actuarial analysis became available allowing calculation of premium based on age of entry and lifestyle factors.[8]

Reinsurance, which is the insurance of contractual liabilities incurred by others under contracts of direct insurance, developed in response to increasing demands upon underwriters.  This was again in the area of marine insurance where underwriters sought to reinsure themselves against the most hazardous parts of the voyage.  The catastrophic nature of marine insurance (whereby frequently the entire ship was lost) leant itself to the distribution of that risk among a number of underwriters.[9]

The history of insurance in Australia can be traced to the foundation of the colony of New South Wales in 1788 however the growth of local insurance institutions did not occur until the mid 1800’s; for example the Australian Mutual Provident Society (AMP) held its first meeting in Sydney on 31 August 1848.  Professor Tarr cites the following extract from the AMP’s prospectus issued in 1856 which sets out the aims of the Society:

The Society was established for the purpose of guarding against all contingences of human life which can happen to its members.  Before its institution, those objects were attainable to a limited extent in some of the Australasian colonies by the extension to them of several respectable British companies. The founders of this Institution, however, argued that in the first place all profits on insurance business transacted in the colonies by English offices accrued to British shareholders and, secondly, …a Society of Mutual Assurers in the Colonies must be able to offer to all persons becoming members much more favourable terms… The Australian Mutual Provident Society was accordingly established with a view to affording facilities to assureds of every class – from the poor man, who could save his 10 or 20 shillings a quarter, to the prosperous merchant or wealthy squatter.[10]

From these humble beginnings grew the large Australian insurance industry which we know today, offering a seemingly endless array of insurance products through numerous insurance companies and brokers.  As at 1 October 2009, 106 insurers are authorised to provide general insurance under Section 122 of the Insurance Act 1973 (Cth).  Thirty-two companies are registered to provide life insurance pursuant to the Life Insurance Act 1995 (Cth) and 19 friendly societies are registered under that Act and provide mainly health insurance or other specialised insurance aimed at member needs.[11]

Legislation was required to manage the insurance industry and in England this dates back as far as the Marine Insurance Act 1745 and the Life Insurance Act 1774.  While most of this Imperial legislation was adopted by the Australian colonies, it has now largely been supplanted by comprehensive State and Commonwealth legislation.  Section 52(xiv) of the Federal Constitution provides the Commonwealth with power to make laws with respect to “Insurance, other than State insurance; also State insurance extending beyond the limits of the State concerned…”   Life insurance became regulated by the Life Insurance Act 1945 (Cth) (now the Life Insurance Act 1995); and general insurance is regulated by the Insurance Act 1973 (Cth).

The Insurance Contracts Act 1984 (Cth) commenced operation in 1986 such as to regulate – in broad terms – the contractual relationship between insurer and insureds.  The Insurance (Agents and Brokers) Act 1984 (Cth) regulated the conduct of financial service providers, including insurers and insurance brokers, but this has now been repealed and replaced by equivalent provisions in Chapter 7 of the Corporations Act 2001 (Cth).  The financial service reform regime embodied in the Financial Services Reform Act 2001 (Cth)  (and the Corporations Act 2001) governs the licensing and conduct of general insurance providers and intermediaries, and financial services and financial product disclosure to retail customers of general insurance products.

There is, of course, other State and Federal legislation in relation to health insurance, workers compensation, and mandatory professional indemnity cover for medical practitioners, solicitors, financial service providers etc.

Characteristics of Insurance

What is it that distinguishes insurance contracts from other forms of commercial contract?

The late Professor Sutton described a contract of insurance as follows:

It is a contract whereby one person, the insurer, agrees in return for money or other consideration called the premium, to pay to another person, the assured, a sum of money or its equivalent on the happening of a specified event.  The event must involve some element of uncertainty – there must be either some uncertainty as to whether the event will ever happen or not, or if the event is one which is bound to occur, as in the case of life insurance payable on death, then there must be uncertainty as to the time at which it will happen.[12]

A commonly cited definition of the contract of insurance is Channell J’s “three-point test” in Prudential Insurance Co v Inland Revenue Commissioners[13] which can be paraphrased as follows:

(1)         for some consideration (usually payment of a premium), the insured secures a benefit (usually a sum of money) upon the happening of an event;

(2)         the event should involve some amount of uncertainty; whether it will ever happen or, if the event is bound to happen at some time, as to when it will happen, and

(3)         the insured must have an interest in the subject matter of the insurance so that the occurrence of the uncertain event adversely affects the interest of the insured.

In summary,[14] the essential elements of an insurance contract are:

There must be a binding contract. There must be an offer (usually a proposal made by the insured or its broker); acceptance (usually upon issue of the policy of insurance); and consideration (usually payment of a premium).

1. The insurer must have the obligation to pay money or its equivalent. The insurer will usually be required to pay a sum of money on the happening of a certain event or to pay for the repair of a motor vehicle or the rebuilding of a home or settlement of legal proceedings etc.
2. The insured must be legally entitled to receive the benefit of the contract. It is not sufficient if payment under the contract is discretionary; for example, in the case of an association which may, at its absolute discretion, make a payment to a member on the occurrence of a particular event.
3. There must generally be some element of uncertainty as to whether the specified future event will occur however, in the case of life insurance, for example, it is not a matter of if death will occur but when, and so the element of uncertainty remains.
4. Traditionally one of the elements of a contract of insurance is that the insured must have an interest in the subject matter of the insurance. For example, ownership of a motor vehicle or house, etc.  If there is no interest at all, then the insured is unlikely to suffer any loss in the event that something adverse happens to the item insured and the contract is more likely to be in the nature of a wager or bet than in the nature of insurance.  More will be said about the need for an “insurable interest” later in this discussion under the heading “The Principle of Indemnity”.

The Principal of Indemnity

Application of the Principle of Indemnity

The main purpose of arranging insurance is to obtain financial protection (or an indemnity) against the adverse consequences of a specific event.[15] The provision of an indemnity has therefore come to be regarded as the cornerstone of all insurances; but in our view this oversimplifies the position.  In the literature it

is acknowledged that, in spite of the importance of indemnity and its critical role in insurance, it is not “the controlling principle in insurance law”.[16] The reason for this is that not all insurance contracts are founded upon an obligation to indemnify the insured.

Professor Sutton identifies two broad categories of insurance:

• indemnity insurance – which provides an indemnity against loss, with the measure of the loss being the measurement of the payment, within the limits of the policy (such as motor vehicle insurance or professional malpractice insurance), and
• contingency insurance – which provides for payment on the happening of a specific event (such as death or sickness) and payment is for an amount stated in the policy.[17]

Holders of life, sickness and accident insurance policies receive payment of a defined sum of money on the happening of a specified event (for example, a trauma insurance policy may pay the insured $40,000 if he or she is diagnosed with cancer). The amount recoverable is not a measure of the insured’s actual loss.  Such insurance falls within the category of “contingency insurance”.

On the other hand, house insurance, car insurance, liability insurance and professional indemnity insurance (indeed all forms of insurance apart from life, sickness and personal accident insurance) oblige the insurer to reimburse the insured in respect of his or her actual loss.[18] Such insurance falls within the category of “indemnity insurance”.

In 1979 Vice Chancellor Sir Robert Megarry succinctly explained the distinction as follows:

“Indemnity insurance provides an indemnity against loss, as in a fire policy or a marine policy on a vessel. Within the limits of the policy the measure of the loss is the measure of the payment. Contingency insurance provides no indemnity but instead a payment upon a contingent event, as in a life policy or a personal injury policy. The contractual sum is paid if a life ends or the limb is lost, irrespective of the value of the life or the limb.”[19]

While indemnity may not be the controlling principle in insurance law, it is none the less an important factor that must be given due consideration when determining an insured’s entitlements under a contract of insurance.

Aspects of the Principle of Indemnity

There are four main aspects to the principle of indemnity:[20]

The insured should have an interest in the property insured

As stated earlier, one of the elements of a contract of insurance is that the insured must have an interest in the subject matter of the insurance.  If there is no interest at all, then the insured is unlikely to suffer any loss in the event that something adverse happens to the insured property and the insured will have no entitlement to indemnity.  However the extent to which an insurable interest is a pre-requisite to the entry into a contract of insurance now depends upon whether the policy is one which attracts the operation of the Insurance Contracts Act 1984 (Cth) (“ICA”).[21]

Section 19 of the ICA provides that a person has an insurable interest in his own life and in the life of his spouse; a parent has an insurable interest in the life of a child who is under 18 years of age; and a person who suffers an economic loss as a result of the death of another person has an insurable interest in their life.

Sections 16 and 18 of the ICA provide that an insurable interest is no longer required at the time the contact was entered into.  For general insurance policies, the effect of those sections is to require an interest at the time of loss. However under section 17 of the ICA an insured is able to recover under a contract of general insurance if he suffers a “pecuniary or economic loss” as a result of damage or destruction of the insured property, irrespective of whether or not he has an interest in law or in equity (an insurable interest) at the time of the loss.  Hence the previous position – that the insured must have a legal interest in the property either at the inception of the policy or (at least) at the date of loss – has been displaced.[22]

In summary; the effect of the ICA is therefore to extend the scope of general insurance to those who do not necessarily have an interest in the subject property at the time the contract of insurance was made or at the time of the loss. Take for example, a beneficiary under a trust or a will, who has no legal right to property but, nevertheless, has an expectation that he or she will inherit it or be vested with it in due course.[23]

Insured’s entitlement for reimbursement of actual loss suffered

The amount which the insured recovers under the policy will depend upon the value of his or her interest in the subject matter of the policy; however this will be subject to the maximum limit of cover specified in the policy.  Where property is damaged, the measure of indemnity will generally be the cost of repair, less an allowance for betterment.[24] Market value may sometimes be a suitable measure of the loss, but it will not adequately indemnify the insured in all cases.  For example, in Randall v Atlantica Insurance Company Limited[25], the subject matter of the policy was a 33 foot fibreglass yacht, built specifically to the insured’s specification and which he had no intention of selling.  Carruthers J in the New South Wales Supreme Court, considered that the amount recoverable should be based on the cost of reinstatement (but not exceeding the sum insured) even though this exceeded market value.

A similar situation arose in Spina and Spina v Mutual Acceptance (Insurance) Ltd[26] where a house occupied by the insured but extremely run down was destroyed by fire. The house itself added little or nothing to the value of the property (ie the property would have sold for “land value”) and the cost of rebuilding the house was far greater than the economic loss suffered by the insured.  Macrossan J of the Supreme Court of Queensland determined that the loss to the insured was not the difference between the pre-fire and post-fire value of the property but rather the loss to the insured of a favoured dwelling.  His Honour expressed the view that:

… it does not follow that a house owner who has an indemnity policy will, in these circumstances, necessarily suffer no loss or very little if his house is destroyed by fire … it will frequently be the case that an insured with the benefit of an indemnity policy will be entitled to reinstatement costs rather than mere difference in market value before and after the event which has caused the damage. House properties used for the purpose of residence are not to be seen as mere market commodities for which reference to market values will always provide an accurate measure of the amount of the loss under a contract of indemnity.[27]

Naturally, disputes occur in relation to the determination of the proper amount of the insured’s loss and, hence, the insured’s entitlement for reimbursement under the policy.  In order to bring about a measure of certainty for both the insurer and insured, many policies provide “new for old” cover or “replacement value” as opposed to “market value”.

In respect of liability insurance, for example, professional indemnity insurance or public liability insurance, the actual loss is the insured’s liability in law to third parties, subject again to the limit of indemnity provided by the policy. In addition, liability insurers almost invariably meet the insured’s costs of defending the action; the result being a complete indemnity of the insured by the insurer in respect of a third party claim (subject to any excess).

The case of Falcon Investments Corp (NZ) Ltd v State Insurance General Manager[28] emphasises that it is the actual loss to the insured which is to be indemnified.  In that case the insured intended to redevelop a site involving the demolition of an old house and the erection of a block of flats on the land. Demolition was not to occur for one year and in the meantime the house was to be let. While tenanted the house was ultimately so badly damaged by fire as to render it incapable of repair. While there was no question that the fire had markedly reduced the value of the house, the loss suffered by the insured was held to be loss of the 12 months rent it would have received before the house was demolished less the saving in demolition costs resulting from the fire (and other incidentals which we will not go into).

The insured is not entitled to make a profit

It is a fundamental principle of indemnity that an insured cannot make a profit and, hence, cannot be paid more than the amount of his or her actual loss. The fact that property may have been over-insured and premiums paid calculated on a higher than actual value, does not entitle the insured to recover the full sum insured. Instead, the insured is entitled to be indemnified only for the value of the property as at the date of the loss.[29]

Anything that reduces the loss reduces the indemnity that is payable under the policy

It follows that anything that the insured receives that reduces or diminishes the loss also reduces the amount the insurer is liable to pay.

One consequence of this principle is that the insured cannot make a profit where multiple policies have been issued in respect of the same risk (“double insurance”). In spite of the fact of double insurance – more than one policy covering the same risk – the insured cannot recover more than the amount of the loss.

Similarly, where an insured suffers loss of property as a result of an act of a third party wrongdoer and successfully recoups his loss under a policy of insurance, he is not entitled to pursue the wrongdoer for the same loss. Instead, the insurer is entitled to exercise its rights of subrogation and step into the shoes of the insured and proceed against the third party wrongdoer in the insured’s name.

Conclusion

As will be apparent from this brief overview of General Insurance, insurance has developed into a very sophisticated industry since its humble beginnings in 14^th Century Europe. Despite this, many of the principles that formed while insurance was in its infancy continue to apply today.  Perhaps the greatest advances in insurance have been in our lifetime; and have been born out of the broader social movement towards increased consumer rights and access to information. The late 20^th Century has seen the advent of plain English policy wordings; the development of a greater range of insurance products; and a raft of legislative intervention aimed at providing greater transparency for consumers and guaranteeing cover for a broader range of insureds and claimants.

Revised October 2009

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