Source: Insurance, Banking & Negotiable Instruments Law Teaching Material
There are certain fundamental principles (or characteristics) more or less common to all classes of insurance business.
The general rule of ‘caveat emptor‘ (let the buyer beware), which applies to ordinary trade contracts, does not apply to insurance contracts. Insurance contracts are contracts of utmost good faith or uberrimae fidei. Accordingly, it is the inherent duty of both parties to a contract of insurance to make full and fair disclosure of all material facts relating to the subject matter of the proposed insurance. It is so because insurance shifts risk from one party to another. A material fact for this purpose is a fact, which would affect the judgment of a prudent insurer in considering whether he would enter into a contract at all or enter into it at one premium rate or another. For example, in life insurance suffering from a disease like asthma or diabetes is a material fact whereas having occasionally a headache is not a material fact.
Although the duty of utmost good faith applies also to the insurer, for example, he must not urge the proposer to effect an insurance which he knows is not legal or has run off safely, but this duty rests highly on the insured because he knows or is expected to know more about the subjectmatter. The proposer must disclose all material facts truly and fully. There should not be any false statement or half-truths or any silence on a material fact. This applies to all material facts whether considered by him as material or not and whether known to him or not. The proposer is expected to know every circumstance, which in the ordinary course of business ought to be known by him. He cannot rely on his own inefficiency or neglect.
The duty to make a full and true disclosure continues until the contract is concluded, i.e., until the proposal of the insured is accepted by the insurer, whether the policy is then issued or not and it is not a continuing obligation. Thus, any material fact coming to his knowledge after the conclusion of the contract need not be disclosed. However, the duty to disclose revives with every renewal of the old policy or alterations in the existing policy.
In case of life insurance, Section 45 of the Insurance Act of India makes an important provision in this connection. The Section lays down that no policy of life insurance, shall, after the expiry of two years from the date on which it was effected, be called in to question by an insurer on the ground that the statement made was inaccurate or false, unless the insurer shows that such statement was on a material fact or suppressed facts which it was material to disclose and that it was fraudulently made by the policy-holder.
However, the following types of facts are not required to be disclosed by the proposer, i.e., the non-disclosure of them shall not be fatal to the contract:
Any fact that diminishes the risk
(i) Any fact that is known or presumed to be known to the insurer
(ii) Any fact which is of public knowledge or which relates to the law of the country
(iii) Any fact as to which information is waived by the insurer.
If the principle of utmost good faith is not observed by either party, the contract becomes void able at the option of the party not at fault, irrespective of whether the non-disclosure was intentional or innocent. Of course, in case of innocent misrepresentation the premium is refundable on the avoidance of the contract.
This principle consists of the following elements under the Ethiopian law; from the point of view of the insured, the principle of utmost good faith requires the insured;
A) To disclose to the insurer, at the time of the conclusion of the contract, all facts related to the object, liability or person to be insured and of which he is aware and which he thinks will help the insurer to fully understand the risks it undertakes to insure (Art 667). The insured is required to disclose facts which may influence the decision of the insurer to enter into the contract or not or if it decides to enter into the contract if it would affect the amount of premium it would charge (Art 668(1))
B) To notify the insurer of changes that may occur after the conclusion of the contract. The insured must notify the insurer of changes in facts and circumstances surrounding the object or liability insured if such changes are capable of increasing the probability of occurrence of the insured risks. The test of materiality is also applicable here as the insured has to notify of changes if they are of such a nature or importance that, had they existed at the time of the conclusion of the contract and had the insurer known them, they would have influenced the decision of the insurer to enter into the contract or not and the level of premium it would have imposed. /Art 669/1/. For instance, where the insured changes the purpose or use of his house from residence to a business purpose, let us say, distribution of gases /fuel. The insured has to notify the insurer of such change within fifteen days from the date he changed the purpose of the house and started the business, because the house is more exposed to risk of fire than when it was being used for residence.
The notification of increase of risks has to be made within 15 days from the date of occurrences of such change, which increased the risk, where such change or occurrence is the result of the act of the insured. However, where such change resulted from the act of a third party, the insured is required to notify the insurer of such change within 15 days from the day when he became of aware such change.
Failure to comply with these elements of the principle of utmost good faith may have one of the following effects depending on the motive of the insured person. If the insured concealed material facts or made false statements there in intentionally with the motive to benefit from a lower rate /amount of premium, the contract will have no effect and the insurer shall retain the premium. Failure to notify the increase of risks according to Art 669(1) internationally and with similar motive shall have the same effect.
However, if the failure to comply with these obligations is not intentional or fraudulent, i.e., if it is not a result of a motive to benefit from lower rates of premium, the policy shall remain
in force. However, the insurer may terminate the contract by giving a notice of 30 days or maintain it by increasing the premium where insurer discovers the existence of such concealment or false statement or failure to notify increase of the risk before the materialization of the risk. However, if such concealment, false statement or failure to notify increase of risks is discovered after the risk has materialized, the insurer shall not have the obligation to compensate the insured. Rather it shall pay a reduced amount of money which shall be determined by taking into account the amount of premium actually paid and the premium that should have been paid had the insured not concealed facts or made false statements or failed to notify increase of risks.
C) To refrain from any fraudulent act aimed at making a net profit or obtaining undeserved benefit out of a contract of insurance. For instance, the insured must refrain from intentional /fraudulent over-insurance of the object, which occurs where on the date of conclusion of the contract, the sum insured/amount of guarantee provided in the policy exceeds the value of the object /Art. 680/1// or where the insured purchases several insurance policies from several insurers in respect of the same object, covering the same types of risks and the sum insured or amount of guarantee provided by the policies exceed the actual value of the object. Over insurance where it is intentional or fraudulent may result in the termination of the contract by the court upon the application of the insurer to this effect and in addition, the insurer may be entitled to payment of compensation for any damage the insurer might have suffered because of the violation of the duty to act in good faith.
However, if over insurance was not the result of intentional act of the insured to make a net profit from the insurance or insurances, the contract shall remain in force but only to the extent of the actual value of the object. In other words, the amount of guarantee /sum insured provided in the policy shall be reduced to the actual value of the object. (Art 680 (2) & Art 681(2).
D) To refrain from purchasing an insurance policy in respect of goods or objects which are already lost or damaged or destroyed or in respect of goods or objects which are no longer exposed to a risk with the motive of receiving compensation for the loss or damage sustained before the conclusion of the contract.
For instance, a person who purchases a motor insurance policy in respect of his motor vehicle which was already lost or damaged or totally destroyed at the time of the contract violates the principle of utmost good faith if he was aware of such facts and purchased the policy with the intention of receiving compensation for the already lost or damaged or destroyed property. In such cases, the insurer is entitled to retain all premium paid and may further claim payment of compensation for expenses it might have incurred. /Art 682/2/
Similarly, an insurer which sells a marine insurance policy or inland marine insurance policy (policies that cover risks which may arise during transportation) in respect of goods which are already transported and are stored in a warehouse and of which it is aware to benefit from the premium paid, violates this principle. In such cases, the insured is entitled to the refund of the premium he has paid and to claim compensation for the damages he might have suffered.