Limitations Doctrine Insurable

The limitations of doctrine of insurable interest in English law

Introduction

Sea travel is important to international trade and commerce for many reasons. While it is often considered to be a slow form of transport, it also has significant benefits. It is much cheaper for a merchant to ship goods by sea than by air, and the quantities that can be shipped in one batch may also be significantly higher. However, the drawback of sea travel is that it carries many risks which other forms of transport (either by air, road or rail) may not have. Weather and sea conditions play an integral part in a successful shipment and voyage, however many parties are now turning to contracts of marine insurance in an attempt to minimise any losses that they might incur as a result of force majeure. Whether it is the merchant of goods, or the ship owner, or even a mortgagee, many insurance policies are now commercially available to parties to protect their interests and investments.

As a consequence of the development of the need for marine insurance, the law in this area has developed rapidly, yet the fundamental principles lie in the common law from cases and legislation from the early twentieth century, and even earlier than that. The question is then, has marine insurance law developed to the extent that it can now legitimately and efficiently limit the operation of its fundamental principles in certain circumstances? This is the question that this paper will seek to answer, with specific reference to the doctrine of insurable interest. As will be discussed, the doctrine of insurable interest is of fundamental importance to not only marine insurance, but contracts of insurance generally.

In general terms, the doctrine of insurable interest refers to the need for the party seeking to rely on the insurance to have a clear and substantive interest in the subject matter of the insurance at the time the loss was suffered. The intention is to protect insurers from fraudulent and unfair insurance claims, which would otherwise make the marine insurance industry a commercial graveyard. This paper will explore the limitations of the doctrine insofar as it relates to English law. In doing so, it is important to have regard for the fundamental principles of marine insurance law, including indemnity and how it relates to the doctrine.

This paper will divide itself into four key chapters so as to give appropriate consideration to each element in order to be able to adequately address the proposition. Firstly, it will provide a very brief overview of marine insurance law. It is important to understand this area in general terms so as to have a sound understanding of its aims and objectives, and how these relate to the application of the doctrine of insurable interest. It will then move on to discuss one of the fundamental principles of marine insurance law; that is, the contract of insurance as one of indemnity. A party takes out insurance so as they can be indemnified (whether whole or in part) by another party should any agreed contingency occur. Following this, the paper will discuss the doctrine in more significant detail. It is important to understand the common law roots of the doctrine and how it has operated and developed over time into a fundamental principle of marine insurance law. Finally, this paper will discuss the limitations (if any) and conclude that these limitations are insignificant to the overall importance of the doctrine to marine insurance law. While the law may be at times unclear and ambiguous, this does not mean to say that the doctrine does not operate in some form on all marine insurance contracts. A party must have an interest in the subject matter of the insurance policy in order to be able to rely on the indemnity provided by it, and it is important to bear this in mind as this paper moves through the various discussion topics.

Marine Insurance Law Generally

It is no great surprise that sea travel carries inherent risks. However, in relation to international trade, sea travel appears to be the most efficient and cost-effective form of transportation. The reasons for this are quite diverse, however while sea travel takes longer, the cost benefit analysis indicates that sea travel is the preferred method of shipment for goods and trade. However, as discussed, sea travel carries risks. In order to minimise the loss which may arise as a result of any of these risks actually materialising, it is common for parties to take out contracts of marine insurance. These contracts are diverse in the risks which they each cover, however they all serve one significant purpose: to indemnify (whether in part or in full) the insured party against loss arising as a result of the risks associated sea travel. One particular author summarises the common transaction of a merchant engaging a shipowner to carry goods particularly well:
The transaction described may also be expressed in the following form:

• A contract of indemnity;
• Made in good faith (in uberrima fide);
• Referring to defined proportion;
• Of a genuine interest in a named object;
• Being against contingencies definitely expressed, to which the object is actually exposed;
• And in return for a fixed and determined consideration.

The above passage demonstrates that there are six key factors which must be present in a contract of marine insurance. The first is the notion of indemnity, which will be discussed in more detail in the subsequent chapter of this paper. The second key factor is the need to make the contract in good faith; this is a concept which is not uncommon in contract law in any case. The third and fourth factors are that the contract must refer to a defined proportion of a genuine interest in a named object. This means that the insured party must be able to demonstrate that they have an interest in the goods being insured, and this interest must be definite. It must also be a need to quantify and define the value of the object being insured. These principles will be discussed in further detail in subsequent chapters of this paper. The fifth element is that the contract of insurance or protect against contingencies which are ‘definitely expressed’; this is a matter of fact as a general rule, and can be answered by reference to the agreement between the parties. For example, a particular contract of insurance may not insure against certain risks, whereas any insurance contract taken out with another insurer may insure against these particular risks. The final element must be that a ‘fixed and determined consideration’ must be present in any contract of marine insurance. This means that the parties must specify the value of the goods being insured, or alternatively what will be paid by the insurer for these goods in the event that the contingency or contingencies provided for within the contract occur. The presence of all six of these elements would, according to policy in this particular area of law, constitute a valid contract of marine insurance. This would, in turn, make such a contract of marine insurance enforceable against either party, namely that the insured party could enforce the contract against the insurer to pay a certain amount if they refuse to, or that the insurer may rely on the terms of the contract so as to defeat their liability if same can be disputed.

In terms of modern insurance practice, it is not uncommon for insurance companies to use standard form insurance contracts in relation to insuring parties against risks associated with sea voyage. As one author puts it:

… in the last twenty-five years many marine insurance countries have adopted the plan of keeping in stock skeleton formed the policy, adapted from the common form to suit the requirements of different subjects of insurance, such as ship for voyage, ship for time, freight; and for goods several forms of varying according to the conditions on which the goods are meant to be insured. This system offers two practical advantages: it removed from the policy on any interest all clauses that do not affect that interest, and it reduces to a minimum the risk of error in the somewhat mechanical work of writing out policies and affixing the proper marginal clauses.

The above passage recognises the development of standard form insurance contracts and their ability to be tailored to suit specific insurance matters. It also highlights that standard form insurance contracts ensure that all relevant risks are covered on all matters, and that certain terms are not excluded by error or omission. This is important from the insurer’s perspective in the sense that it ensures that the insurer is afforded maximum protection under the terms of the insurance contract, without derogating from the rights of the insured party. It maintains the overall philosophy of a contract of insurance having its groundings in contract law, and the parties are still free to negotiate whatever terms in the policy that they see fit. Therefore the concept of freedom of contract is maintained.

In summary, it is clear that marine insurance is of paramount importance to parties who regularly deal with trading and shipment of goods by sea. It ensures that the financial loss to the merchant in the event that goods are lost or damaged at sea is minimised, making marine insurance invaluable to this party. Furthermore is also important to bear in mind the rights of the insurer, namely that it deserves to be protected against unfair contract terms and also having to make financial payment in respect of losses which are claimed which cannot be substantiated. The concept of good faith remains fundamental to insurance contracts, as does the other five elements discussed earlier in this chapter. Provided all these elements are present, there is no reason why an insurance contract is not enforceable in English jurisdiction. This paper will now turn to discussing the issues of indemnity, as well as the concept of insurable interest, in more significant detail.

Insurance as a Contract of Indemnity

The concept of indemnity is fundamental to marine insurance contracts. It is embodied in section 1 of the Marine Insurance Act 1906, which states that “a contract of marine insurance is a contract whereby the insurer undertakes to indemnify the assured, in manner and to the extent thereby agreed, against marine losses, that is to say, the losses incident to marine adventure”. Therefore, in the fundamental definition of a contract of marine insurance, concept of indemnity is recognised as being of paramount importance in this particular area of law. Perhaps the most widely recognised comment on the concept of indemnity in insurance contracts generally is the judgement of Lord Wright in the case of Rickards v Forestal Land, Timber and Railways Co, which states:

… the object both of the legislature and the courts has been to give effect to the idea of indemnity, which is the basic principle of insurance, and to apply in the diverse convocations of fact and law in respect of which it has to operate…

In addition to the above, it is also being held that:
… the contract of insurance… is a contract of indemnity, and of indemnity only, in his contract means that the insured, in case of a loss against which the policy has been made, shall be fully indemnified, but shall never be more than fully indemnified…

Essentially, in light of the above, it can be successfully argued that a contract of insurance always has the concept of indemnity at its foundations. It is always the intention of a contract of insurance, particularly marine insurance, and in the event of a loss occurring which the policy seeks to cover, the insurer must honour its obligations under the terms of the contract and indemnify the insured against these losses.

The challenge that indemnity faces in the eyes of the law is whether or not a contract of insurance is intended to be a contract of full indemnity. For example, if an insured party suffers a loss which is expressly covered under the terms of the contract, is the insurer liable to fully indemnify the insured party against this loss, or is partial indemnification sufficient? The courts have considered this concept at length and arrive at the conclusion that a contract of insurance can also be a contract for partial indemnity. For example, in the case of British and Foreign Insurance Co Ltd v Wilson Shipping Co Ltd, it was held that “in practice, contracts of insurance by no means always result in a complete indemnity, but indemnity is always the basis of the contract…”. Consider also the judgement of Patteson J in Irving v Manning, where it was held that “a policy of assurance is not a perfect contract of indemnity”. As one author puts it:
Ideally, an assured should be compensated only to the extent of his loss. In practice, however, this is not always easy to attain. But having said that, the principle [of partial indemnity] is always at hand it may be invoked whenever judges feel that justice may be better served by its application rather than by strict and literal adherence to rules. It is fair to say that judges have in the past important principle of indemnity as a fall-back whenever the main ground of their decisions needed further support or reinforcement.

The above passage demonstrates that there is scope for application of the concept of partial indemnity; however it follows as a general rule that a contract of insurance should indemnify an insured party to the extent of his loss provided that this is expressly covered in the contract. As the main basis of marine insurance is the law of contract, this is often a matter that can only be determined by reference to the terms of the agreement between the parties. For example, the insurer may have agreed with the insured party to limit its liability in respect of a particular contingency occurring. This might mean that instead of paying, say £1 million, the insurer may only have to pay £250,000 to the insured party in respect of its loss.

One particular author sums up the concept of indemnity in quite a succinct manner. In particular and in addition, the author identifies the process by which an insurance contract is enforced:

Thus, the insurance policy as a contract of indemnity, the latter forming a basic principle of insurance law in the sense that the assured can only recoup the loss occurred. Before the act of indemnification, the loss has to be primarily identified and then measured or quantified. These are two acts that take place separately. Upon identification of losses and their valuation, the other party may claim that the losses are either misconceived, or wrongly measured or quantified, or that they do not fall into the defendant’s liability due a specific reason, such as the fact that they might not be covered by the terms of the relevant policy.

The above passage demonstrates that there is neither the loss to be quantified before an insurance contract can be enforced. This generally goes without saying, as the need to show damages is fundamental in any claim to breach of contract or enforcement of any contract. After the loss has been established, it may be that the insurer seeks to rely upon certain provisions of the agreement so as to dispute the loss or alternatively that it has a defence to the loss by way of an agreed limitation of liability clause in the insurance contract. It demonstrates that there is a need not only for the insured party to demonstrate its loss and substantiate its claim, but also for the insurer to show proof as to why it should not indemnify the insured party against loss pursuant to the terms of the insurance contract.

In summary, it is clear that the concept of indemnity is fundamental to any contract of insurance. In the context of marine insurance, indemnity lies at the heart of any contract between an insurer and an insured party. There is a general presumption that, provided the loss can be substantiated and is within the terms of the insurance policy, the insurer must indemnify the insured party to the extent of its loss. There are certain occasions where partial indemnification may be acceptable, however it is generally presumed that full indemnification of loss will be provided to the insured party unless the insurer can otherwise demonstrate that they should not be the case. Therefore, there is a reverse onus of proof on the insurer to demonstrate a defence to liability, and the insured party can generally rely on the terms of the contract provided that its loss can be substantiated. Often the substantiation of loss is not difficult and is a matter of fact, as evidence normally exists of the insured party’s loss particularly where a marine adventure is involved.

The Doctrine of Insurable Interest

The doctrine of insurable interest is an important principle to the concept of marine insurance law. It essentially provides that there must be a relationship between the person who benefits from the insurance and the insured property. This ensures that the person who seeks indemnity from a contract of insurance has a genuine interest in the property and, in theory, prevents a person from fraudulently claiming against a contract of insurance. There are a number of requirements which need to be satisfied in order for the principle of insurable interest to be proven. The first requirement arises from the indemnity principle, and section 5(1) of the Marine Insurance Act 1906 states:
…every person has an insurable interest who is interested in a marine adventure…
In order to find a more comprehensive definition of ‘insurable interest’ one must resort to the common-law, where it was stated that an insurable interest is:
…a right in the property or a right derivable out of some contract about the property, which in either case may be lost upon some contingency affecting the possession or enjoyment of the property.

Furthermore:

In particular a person is interested in a marine adventure where he stands in any legal or equitable relation to the adventure or to any insurable property at risk therein, in consequence of which he may benefit by the safety or due arrival of insurable property, or maybe prejudice by its loss, or by damage thereto, or by the detention thereof, or may incur liability in respect thereof.

Essentially the main first test is that a person must have an interest in the insurable goods in order to any contract of insurance to be valid. Therefore it is important to establish who may have such an interest in order to determine the limits of the doctrine. It has been said that persons who have an insurable interest can be broadly divided into three categories:

The persons who may stand in ‘any legal or equitable relationship to the adventure or to any insurable property at risk therein’ may be broadly divided into three main categories, the most obvious of which is the owner of the insurable property, whether it be ship, goods or freight. The second class covers persons who have lent money, in any emergency or otherwise, on the security of the ship and/or on her cargo; and, lastly, an insurer whose position clearly falls within the wording of the section. Besides these three categories there are also other parties who, though they are not specifically mentioned in the [Marine Insurance] Act, a generally recognised in the law of marine insurance to have an insurable interest: agents, carriers, lien holders, pawnors and pawnees; trustees and executors; captors; and, basically, any person who is to profit from a marine adventure.

The above passage demonstrates the various persons who may have an insurable interest in a marine adventure. It is clear that it is not limited merely to the owner of the goods, but also to those parties which may have other types of interest in the goods, such as mortgagees and the like.

Another issue which needs to be looked at this point it is the requirement that the marine adventure is lawful. In the event that the marine adventure is not lawful, no contract of marine insurance is deemed ever to be created. The Act expressly states:
… every lawful marine adventure may be the subject of a contract of marine insurance.

Therefore it is an implied term of every contract of marine insurance that the adventure which is being insured is undertaken lawfully. An example of animal for marine adventure may be where a party trade with an alien enemy which, as a general rule, makes any contract to protect such conduct void ab initio.
The final, and perhaps most important, test which need to be satisfied to establish an insurable interest is the time at which the interest must attach. At law, the insurable interest must attach at the time at the time of the loss in order for the contract to be enforceable and the right of indemnity obtained. The relevant legislative provisions in relation to this requirement read as follows:

(1) The assured must be interested in the subject-matter insured at the time of the loss though he need not be interested when the insurance is effected:
Provided that where the subject-matter is insured “lost or not lost,” the assured may recover although he may not have acquired his interest until after the loss, unless at the time of effecting the contract of insurance the assured was aware of the loss, and the insurer was not.
(2) Where the assured has no interest at the time of the loss, he cannot acquire interest by any act or election after he is aware of the loss.
The above provisions essentially demonstrate that any person who takes the contract of marine insurance must have an interest in the subject matter of the contract at the time of any loss, in order to rely on the indemnity provided by the contract. It is not sufficient to have an expectation or hope of an interest at the time of loss, and thus only a definite interest is sufficient at law. In addition, the interest must attach at definite at the time of loss in order to be sufficient.

In summary, this chapter has tended to provide a basic overview of the doctrine of insurable interest insofar as it relates to marine insurance law. It is in no way intended to be an exhaustive analysis of this otherwise conjugated area of law; however the main purpose was to provide a solid grounding in this particular concept before determining the limits thereof. In short, three key criteria must be present and satisfied in order for insurable interest to exist, namely a substantive interest, a legal marine adventure and the presence of the substantive interest at the time of the loss. This ‘three pronged’ test relies upon statutory regulation by way of the Marine Insurance Act 1906, as well as elaborations made at common law. The doctrine of insurable interest runs contemporaneously with the notion of an insurance contract as a contract of indemnity, given that an insurable interest must exist in order for the indemnity provided by an insurance contract to be relied upon by the insured.

Limits of the Doctrine

Given that this paper has discuss the various concepts relating to indemnity an insurable interest in previous chapters, is now important to turn to the salient issue of this paper: what are the limits of the doctrine of insurable interest? Recent reforms in relation to marine insurance law have indicated that there is a tendency now to shift in favour of a new definition of the doctrine of insurable interest. Specifically, the Marine Insurance (Gambling Policies) Act 2005 came into force on 1 September 2007 and now expressly provides that it is a criminal offence for a person to take it a marine insurance contract without having some form of insurable interest in the subject matter concern. The relevant provision of the Act reads:

[a person would need to show] a bona fide interest, direct or indirect, either in the safe arrival of the ship in relation to which the contract is made or in the safety or preservation of the subject matter insured, or a bona fide expectation of acquiring such an interest.

However it is important to note that the above provision only makes it a criminal offence for a person to take out a marine insurance contract without having some form of insurable interest, and is not necessarily affect the enforceability of such a contract. Rather, while an alternative version of the doctrine of insurable interest exists, it is not affect the validity of the doctrine in so far as enforceability of an insurance contract is concerned. Take, for example, the statements made by the Law Commission on this very issue:

5.40 For insurance of goods, statute no longer demands that the insured must have an insurable interest in the subject matter in order for the insurance contract to be enforceable. However, the indemnity principle applies and therefore an interest for the purposes of the indemnity principle must be demonstrated at the time of loss in order to have a valid claim.
5.41 For insurance on land and buildings it is likely that the position is as for goods.
5.42 For marine insurance, the position is unclear. Some argue that statute no longer demands that the insured must have an insurable interest in the subject matter at the time of the loss in order for the insurance contract to be enforceable.
Whatever the answer to this, it remains a criminal offence to take out marine insurance without an interest. The indemnity principle certainly applies and therefore an interest for the purposes of the indemnity principle must be demonstrated at the time of loss.
5.43 For liability insurance, the position is as for goods.
5.44 For both goods and marine insurance it is necessary for the contract to list the names of those parties who are interested in the insurance. For land and buildings it is likely that it is unnecessary to list the names of those interested. For liability insurance it is unnecessary to list the names of those interested.

The above passage demonstrates that the position regarding insurable interest, particularly in relation to marine insurance, remains unclear. Aside from a few key requirements as discussed in previous chapters of this paper, there are no rigid rules in place regarding insurable interest and its requirement in insurance contracts. Essentially the position of the doctrine differs depending upon the type of insurance being discussed; however having regard for marine insurance, what is clear is that the law is somewhat ambiguous on this particular issue. Some argue that the doctrine of insurable interest is required in contracts of marine insurance, and some argue that it is not.

The ambiguity which exists in relation to the doctrine of insurable interest and marine insurance law has perhaps led to the English and Scottish Law Commissions instigating a review in this particular area. The Law Commissions conducted extensive research on the doctrine of insurable interest and its applicability in the modern context, and have proposed ways of moving insurance law forward having regard to the ambiguity in relation to insurable interest. They expressly quoted the report of the Financial Services Authority, who stated:

The Scoping Paper [previously released by the English and Scottish Law Commissions] suggests that there may be a regulatory interest in maintaining requirements for insurable interest “to separate those who are using insurance to order their affairs prudently from those who are merely gambling”. The FSA doubts there is a strong regulatory interest in the use to which insurance (or any other financial instrument) is put. The FSA guidance in chapter PERG 6 of the FSA’s Handbook of rules and guidance makes clear that the purpose for which a policyholder buys a contract of insurance is not relevant to the identification of a contract of insurance.

The above passage by the FSA indicates that their belief is the intent behind which a person purchases a contract of insurance should not be relevant to whether the contract is actually enforceable at law. This is a direct reference to the fact that the Law Commission previously released a paper which recommended that the insurance laws be refined and reformed to the extent that they distinguish between a person who is purchasing a policy to insure a genuine insurable interest as opposed to a person who is purchasing policy merely to ‘gamble’. The notion behind this is that a person who purchases an insurance policy for a purpose other than to cover a genuine insurable interest is intending to fraudulently claim against that policy, and hence the criminal sanctions for such conduct are a proactive approach to prevent this.

The question that the Law Commissions then had to adjudicate on was whether the doctrine of insurable interest was necessary in terms of identifying insurance and distinguishing it from other forms of contract. The short answer to this question is arguably yes, as the traditional definition of a contract of insurance is found by reference to the common law:

That I think is the first requirement in a contract of insurance. It must be a contract whereby for some consideration you secure to yourself some benefit, usually but not necessarily the payment of a sum of money, upon the happening of some event.

Then the next thing that is necessary is that the event should be one which involves some amount of uncertainty. There must be either uncertainty whether the event will ever happen or not, or if the event is one which must happen at some time there must be uncertainty as to the time at which it will happen.

The remaining essential is… that the insurance must be against something. A contract which would otherwise be a mere wager may become an insurance by reason of the assured having an interest in the subject matter – that is to say, the uncertain event which is necessary to make the contract amount to an insurance must be an event which is prima facie adverse to the interest of the assured.

This demonstrates that a contract must insure the assured’s interest in the subject matter of the insurance contract, which is consistent with the previously discussed concepts of indemnity and insurable interest. However, the remaining issue is whether statutory reform would be necessary to clarify this issue. The Law Commissions referred to an authoritative work by MacGillivray, who states:

A contract of insurance is one whereby one party promises in return for a money consideration to pay to the other party a sum of money or provide him with some corresponding benefit, upon the occurrence of one or more specified events.

A specified event “must be of a character more or less adverse to the interest of the person effecting the insurance”.

Another well accepted definition of a contract of insurance does not require an insurable interest, but requires an “uncertain and adverse event”, which is markedly different from an insurable interest:

An insurance contract is commonly described as a contract whereby a person usually but not always in business as such, agrees to pay money (or provide a corresponding benefit) on the occurrence of an uncertain and adverse event, in return for a money consideration.

The above two passages demonstrate that the doctrine of insurable interest is crucial to contracts of insurance in general, let alone marine insurance. However, the existing common law definitions and scholarly articles which exist on this issue appear to indicate that there is little need for statutory reform, as the Marine Insuranc