Fraud, misrepresentation and non-disclosure in insurance

By Dr. Wickrema Weerasooria, Insurance Ombudsman Sri Lanka

Recently, the Sri Lanka Insurance Institute conducted two seminars on 5 and 11 September at the Auditorium of the Institute at St. Michael’s Road, Colombo on the topic of ‘Fraud, Misrepresentation and Non-Disclosure in Insurance’. Both seminars which were well-attended were conducted by Dr. Wickrema Weerasooria, the country’s Insurance Ombudsman.

Insurance Institute President Udeni Kiridena in opening the seminars said that that the topics chosen were of great practical importance to the insurance industry and Dr. Weerasooria was the unanimous choice for the speaker because he was not only a lawyer who knew this subject well but had a wide practical experience by functioning as the Insurance Ombudsman for the past over seven years.

Dr. Weerasooria, in his introductory remarks congratulated the Insurance Institute for conducting Continuing Professional Development (CPD) programs for its members and said that without a robust Institute the country’s insurance industry can never develop and aspire to global standards; that insurance unlike other financial areas was a complex area; there is little statutory or Parliamentary intervention in insurance. Hands on experience is a good but paper qualifications are also a must for insurance executives. Insurance more than Banking has been built up on industry practices which have been accepted and established by judicial decisions. Hence, any insurance executive if he or she wishes to advance in their career must do continued study and acquire Paper qualification whether they like it or not.

In that context, he was glad to see so many senior and experienced executives of the twenty two odd insurance companies participating at these seminars.

Addressing the seminar, Dr. Weerasooria said that Fraud, Misrepresentation and Non-Disclosure are all connected topics. For instance in a Non-Disclosure, there can be Fraud and Misrepresentation. Although insurance staff may look at each separately they must not lose sight of the possible connection between the three.  Of the three topics, the most serious was Fraud. It has criminal connections. However, although the term  Fraudulently is defined in our Penal Code and there are many criminal offences based on fraud, Fraud by itself has never been made a separate criminal offence like Robbery,  Theft or Cheating. Insurers should note the definition of Fraud in Section 23 of our Penal Code. “A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise”. Similarly, insurers should note the Penal Code definitions or the terms dishonestly, wrongful gain, valuable security and good faith. They are all applicable to insurance activity.

In fraud, the intention to defraud is important and the innocent party (the insurer) must be deceived. There must be a deception. Also, even if the alleged wrongdoer has committed a fraud, a court of law will not hold him liable unless the innocent party has actually suffered a loss or damage. It is often said that fraud without damage does not give rise to a cause of action.  Well-known English decisions have spoken of fraud as follows:

“Fraud is proved when it is shown that false representation has been made (1) knowingly or (2) without belief in its truth or (3) recklessly, careless whether it be true or false. To prevent a false statement being fraudulent there must, I think always be an honest belief in its truth, for one who knowingly alleges that which is false has obviously no such honest belief”. (Derry v Peak (1889) House of Lords)

In the case of Angus v Clifford (1891), the Court said:

“An action on fraudulent misrepresentation cannot be supported without proof of fraud, an intention to deceive, and it is not sufficient that there is a blundering carelessness, however gross, unless there is recklessness, by which we mean willfully shutting one’s eyes, which is, of course, fraud.”

Insurers must also appreciate that Negligence is not Fraud:. The two are different. As an English judge said;

“A man is entitled to be as negligent as he pleases towards the whole world if he owes no duty to them. Negligence, however, great, does not of itself constitute fraud”. see Le Lievere v Gould 1893))

In distinguishing between Negligence and Fraud, insurers should remember that in the main part of their business they recognise that people (insured) can be negligent or act negligently. The entire area of Liability insurance covers provided by insurance companies recognise negligence of the insured. Take Motor insurance. The insurance companies will normally pay for damages caused by the Negligence of the insured (negligent or reckless driving). Thus fraud and negligence or carelessness are clearly separate issues.  

As emphasised earlier “Fraud” by itself is not an offence under our Penal Code. However, it is an important ingredient in many activities that are basically of a criminal nature and are clearly defined offences in our Penal Code such as “cheating” (section 348), “ falsifying  accounts” (Section 467); “Forgery and Fabrication of false documents” (Sections 452-454); Criminal breach of trust” (Section 388) “Criminal misappropriation” (Section 388);  “making fraudulent deeds” (Section 409).

Alleging fraud is one thing. Proving it is another. In a criminal case, if fraud is alleged, the burden of proving it is a very heavy one. It must be proved beyond any reasonable doubt and the burden is on the person who alleges fraud (the insurer) to prove it. So one must not only be certain but have the required proof (the documents and reliable witnesses). In civil cases where fraud is in issue, the burden of proof is a little less than in a criminal case. In a recent decision our Supreme Court has said that a Civil Court when considering a charge of fraud requires a higher degree of probability than it would require in establishing negligence (Kumarasinghe v Dinadasa (2007) 2 Sri Lanka Reports p 203).

Coming to Misrepresentation, one must first define it. The established definition of a Misrepresentation is a Representation which is not true. If the incorrect representation is made innocently believing it to be true and it later turns out to be untrue or false, the law calls it an Innocent Misrepresentation; if on the other hand, the representation is made dishonestly knowing it to be untrue or even deliberately and recklessly not caring whether it is true or false – the law says it is a Fraudulent Misrepresentation. These distinctions must be clearly understood and insurance staff must examine the facts of each case carefully to see whether it was an Innocent Misrepresentation or a Fraudulent Misrepresentation.

In normal Contract Law, the courts have drawn a distinction between the consequences from a Fraudulent Misrepresentation which entitles the aggrieved or innocent party to set aside the contract and an Innocent Misrepresentation which entitles the innocent party to ask only for damages. However, in insurance law, the courts have not drawn such a distinction as regards the consequences between Fraudulent and Innocent Misrepresentation.  

The effect of misrepresentation on the insurance contract is precisely the same as that of non-disclosure. It affords the aggrieved party (normally, the insurer) a ground to avoid the contract. This is because Insurance Law has not recognised any real distinction (as contract law has done) between a “condition” and a “warranty”.  In Insurance law both terms are used synonymously and both refer to vital terms going to the root of the contract (the policy). As one English Judge has said “this is confusing and regrettable but it is too late to change this legal position.”

As opposed to a fraudulent claim which avoids the policy, an honest but exaggerated claim, does not have this effect: (Norton v Royal Fire and Life Company (1885).

To conclude, let me say that most cases of Fraud, Misrepresentation and Non-Disclosure occur at the time the Proposal Form is filed up.  However, it can also occur after the incident or event on account of which the claim is made. Insurance staff must always think of the Moral Hazards of the Insured just as much as a prudent banker thinks of the honesty and credit –worthiness of his borrower/customer.