The Principle of Utmost Good Faith in Insurance

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Utmost good faith is a key principle of insurance. It imposes an obligation on the insured and the insurer to disclose all material facts at inception.

The principle of utmost good faith applies as contracts of insurance are different from commercial contracts, whereby in the latter, the seller can withhold information which is not requested by the buyer and would be making a good deal without misleading the buyer. The principle of caveat emptor (let the buyer beware) may be suitable for commercial contracts but not for insurance contracts, as insurance contracts are intangible and depend solely on the sharing of all material facts between the proposer (person requesting insurance cover) and the insurer (insurance company). A material fact is defined by the Marine Insurance Act of 1906 as:

“would influence the judgement of a prudent insurer in fixing the premium or determining whether he will take the risk”

[Source: http://www.jus.uio.no/lm/england.marine.insurance.act.1906/plain.txt]

Both parties must deal openly with faith and trust due to the imperfect knowledge that each party has about the other party’s side. If a person goes to insure a property in an area susceptible to flood, the insured would know all about this risk, but the insurer would not, as it would be impossible for him to visit and analyse in detail each and every risk underwritten. On the other hand, the insured would not know everything about the cover provided by the insurer and any conditions or exclusions that apply, unless the insurer discloses this information in the policy. The duty of utmost good faith applies at inception in the negotiation stage, and ends when the contract is formed, unless conditions in the policy stipulate otherwise.

Even here, there are facts which need not be disclosed, which are facts which lessen the risk (eg: having an alarm system installed), facts already known by the insurer (eg: common knowledge, law), and facts unknown by the insured (eg: having an illegal fireworks factory operating close to the premises). Facts which always need to be disclosed are previous claims and losses, refusal of cover by other insurers, character and integrity of the insured, and all fact relating to the subject matter, especially those which increase the risk. The case of Schoolman vs Hall (1951) shows that failure to disclose facts about the insured may lead to claim repudiation, where in this case, an act of dishonesty fifteen years earlier was held to be material when taking out a jewellery insurance policy. In a proposal form, the insured is asked to sign the declaration, which is the statement that all material facts have been disclosed by the insured. 

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