Insurable Interest and the Law

Insurable Interest and the Law Presented by: Dr Franziska Arnold-Dwyer Date: 10 September 2020 What Is An Insurable Interest? - Henley and Kemp, The Law of Insurance Broking 3rd ed (2016) - A relationship between the insured and the insured-subject matter - Insurable interest in property: • Legal interests: proprietary or contractual rights in the insured property • More controversial: economic interests in property (i.e. suffering financial loss as result of the loss of or damage to the property) - Insurable interest in life: case law-based categories • Insurable interest in own life • Automatic insurable interest in life of spouse / civil partner • Pecuniary interests (e.g. employer/employee, debtor/creditor) • NB: no automatic insurable interest in other relationships based on love and affection (e.g. children, parents, grandparents) - Insurable interest in liability: exposure to liability What Does The Doctrine Of Insurable Interest Require? Marine risks Legal basis Non-marine goods Marine Common law Insurance Act (Lynch v Dalzell 1906, s.4(1) and (1729) 4 Bro PC (2) 431) Previously also Gaming Act 1845, s.18repealed by Gambling Act 2005 Land and buildings Life and liferelated Common law (Lynch v Life Dalzell (1729) 4 Bro Assurance Act PC 431; Sadlers' 1774, ss.1-2 Company v Badcock (1743) 2 ATK 554; Western Trading Limited v Great Lakes Reinsurance (UK) Plc [2015] EWHC Life Assurance Act 1774, s.1? (Unlikely following Siu Yin Kwan v Eastern Insurance Marine risks Timing ii or expectation of acquiring an ii at the time of entering into the contract (MIA 1906, s.4(2) and ii at the time of loss (MIA 1906, s.6(1)) Effect of Contract is void lack of (MIA 1906, insurable s.4(1) and (2)) interest Illegality Yes - Marine Insurance (Gambling Policies) Act 1909, s.1 Return of Return of premium premium under MIA s.84(3)(c) if no wagering contract Non-marine goods Land and buildings Life and liferelated 103) Co Ltd [1994] 2 AC 199 (PC (HK)) ii at the time of ii at the time of loss ii at the time loss of entering into the contract (Dalby v The India and London Life Assurance Company (1854) 15 CB 365) Uncertain Uncertain whether Contract is whether whole whole contract void or void (LAA contract void or whether claims are 1774, ss.1-2) whether claims unenforceable are unenforceable Uncertain; Uncertain; probably not Yes - Harse v probably not Pearl Life Assurance Co [1904] 1 KB 558 Uncertain; Uncertain; probably probably Insurable Interest In Crisis - B Hartnett and JV Thornton, 'Insurable Interest in Property - A Socio-Economic Reevaluation of a Legal Concept (1949) Ins LJ 420: argue that the traditional rationales for insurable interest - the anti-wagering rationale and the moral hazard rationale - do not require a strict legal interest in the property - Australian Insurance Contracts Act 1984: abolishes insurable interest - Supreme Court of Canada reduces insurable interest requirement in property to economic interest (Kosmopoulos v Constitution Insurance Co [1987] 1 SCR 2) - The English Courts are increasingly reluctant to accept 'lack of insurable interest' as a technical defence (Feasey v Sun Life Assurance Co of Canada [2003] EWCA Civ 885) - Gambling Act 2005: repeals s.18 of Gaming Act 1845 and provides that gambling contracts are generally enforceable - Insurable interest is declared messy, anachronistic and redundant by leading insurance law academics (Rawlings and Lowry (2003), Merkin (2006), Clarke (2011), Davey (2014)) - Law Commission proposes that the requirement for an insurable interest in relation to indemnity insurance should be abolished (2008) - Yet, the insurance industry came out fighting to retain insurable interest No strong insured-side appetite for abolition Insurable interest reforms? - Abolition of doctrine - Clarifying definition / widening categories of insurable interest - Tidying up the statute book and codifying complex case law - Do nothing and let the courts carry on with incremental development Re-Assessment Of The Role Of Insurable Interest In The 21st Century - Key issues relevant to its role and reforms: 1. The rationales for insurable interest in modern English insurance law and practice 2. The tension between the doctrine of insurable interest's role as a definitional characteristic of contracts of insurance and its role as a validity requirement 3. To what extent, and how, insurers should take greater responsibility in ascertaining whether a prospective policyholder has an insurable interest Rationales For Insurable Interest 1. Anti-wagering rationale 2. Moral hazard rationale 3. Interconnectedness rationale The Anti-Wagering Rationale: Obsolete? - Traditional anti-wagering rationale: the doctrine of insurable interest serves as a dividing line between insurance and gambling (LAA1774, MIA 1906) - Professors Lowry and Rawlings: gaming has become a legitimate activity and, in so far as regulation is required, such regulation should be a matter of public law, not contract law - Professor Clarke: preventing gambling under the guise of insurance is no longer a sound reason for the requirement of an insurable interest since gambling is now widespread and has been legalized by the GA 2005 The Anti-Wagering Rationale: Wager Policies - Gambling has become 'mainstream leisure activity' (Gambling Commission Annual Report 2018/19) - - Gambling is permitted: • Privately • Commercially: licensed premises with licensed operators • No need/benefit to gamble 'under the guise of insurance' • Higher transaction costs and more documentation to place insurance • More complex claims process under insurance contracts The Anti-Wagering Rationale: Insurers Must Not Gamble - Existence of an insurable interest distinguishes an insurance contract from other contracts of speculation: • Gambling contracts (Carlill v Carbolic Smoke Ball Company [1892] 2 QB 484) • Credit default swaps (Potts Opinion for ISDA 1997; Lord Mance in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd [2011] UKSC 38 [135]) - Distinction relevant to regulation of insurance business: • Policyholder protection (ICOBS, FOS Scheme, FSCS, Insurers (Reorganizations and Winding Up) Regulations 2004 apply to insurance but not to gambling contracts) • Refrain from mis-selling products that are unsuitable and under which policyholder is not eligible to claim (FCA Handbook ICOBS) • Gambling by insurers can undermine their financial stability (AIG, Langley J in Measey v Sun Life Assurance • [2002 EWHC 868) • Internal contagion restriction: no business other than insurance business (PRA Rulebook SII Firms: Conditions Governing Business, 9.1) • Capital requirements: rules on valuation of assets and liabilities, calculation of SCR and quality of capital held (PRA Rulebook, SII Firms) - multiple exposure risk • Investment of assets in accordance with 'prudent person principle' (PRA Rulebook, SII Firms: Investments, 2.1.) - Distinction relevant for accounting and tax purposes The Anti-Wagering Rationale: CDS Case Study - CDS ≠ insurance contracts because 1) payment under CDS not dependent on loss; and 2) CDS not dependent on an insurable interest (1997 Potts Opinion, 2000 NYSID Opinion, Belmont Park Investments v BNY Corp Trustee Services [2013] UKSC 38 [135]) - Case study of CDS highlighted a number of negative implications to which insurance contracts without an insurable interest could become susceptible: • Enterprise) • potential devaluing effect of shorting on the underlying asset (European sovereign debt crisis 2009) potential social cost of gambling by financial institutions (AIG and RBS - bail-outs with taxpayers' money) • Creation of multiple exposure risk endangering the financial stability of the relevant financial institutions and created systemic risk risk (2011 Report of the US Financial Crisis Inquiry Commission: CDS transactions in relation to US sub-prime mortgage collateralized debt obligations were major contributor to Financial Crisis 2008) - Counter-measures applicable to CDS: • 2019 ISDA 'Narrowly Tailored Credit Events Protocol' (2019) • Enhanced reporting obligations under EU EMIR Regulation (2012), EU Market Abuse Regulation (2014), MiFID II (2014) and US Dodd-Frank Act • EU Short Selling Regulations (2012) The Moral Hazard Rationale: Ineffective And Inappropriate? - Traditional moral hazard rationale: the absence of an insurable interest can tempt an insured to bring about the loss in order to gain financially, whereas the presence of an insurable interest minimizes the incentive to do so (MIA 1746, Sadlers' Company v Badcock (1743) 2 ATK 554) - Professor Davey: empirical research does not support the deterrent effect of insurable interest in relation to life insurance: evidence from homicide statistics that spouses murder for life insurance benefits - Professor Clarke: the doctrine of insurable interest, which is an insurance contract law doctrine rooted in common law and statute, is not an appropriate medium to control moral hazard - J. Loshin: the doctrine of insurable interest creates reverse moral hazard - insurers are incentivized to accept insureds with no, or ambiguous, interests in the knowledge that the contract is not enforceable in the absence of a valid insurable interest The Moral Hazard Rationale: Deterrent Effect - Deterrent effect: some homicides could have been / can be prevented if life insurance would have been / will be refused for lack of insurable interest • Historical example: the 1880s burial club murders by the 'Black Widows of Liverpool' - homicides motivated by financial gain from the proceeds of life insurance unsupported by an insurable interest • Recent example: in 2017 London couple 'bought' boy for adoption from a destitute family in India, took out life insurance for £150,000 with Indian insurer and then arranged boy's murder - Probability theory: the greater the number of policyholders without an insurable interest, the greater the circle of people who might benefit from the destruction of the insured subject-matter without suffering any financial prejudice from its loss, and the greater the likelihood that one or more of them might be tempted to act to bring about the destruction of the insured property. The Moral Hazard Rationale: 'Skin In The Game' - Doctrine of insurable interest should be re-evaluated as a mechanism for aligning the interests of the insured and the insurer: i.e. the preservation of the insured subject-matter - If the insured has 'skin in the game': • s/he is likely to take greater care to protect the insured subject-matter from loss or damage ('endowment effect') • s/he is likely to have access and control to the insured property allowing the insured to perform contractual risk mitigation obligations under the insurance policy - Insurance contracts operate more efficiently if the insured has 'skin in the game' - Parallel development: US and EU risk retention measures applicable to securitizations The Moral Hazard Rationale: STOLI - Stranger-originated life insurance (STOLI): investment schemes facilitated or instigated by a third-party investor pursuant to which a person, in whose life the investor has no insurable interest, takes out life insurance, with the premium payments being funded by the investor, and with the intention that the policy be assigned to the investor shortly after the policy has been issued. Prevalent in the US until legislative intervention. - Widely criticized for: • Creepiness - a stranger is wishing you to die! • Against human dignity: condoning attitudes that people's lives can be treated as an investment asset and as an object of speculation • Data breaches as result of on-selling and securitizations • Abuses and fraudulent sales practices which can compromise the insured's life future insurability • Disrupting life insurance pricing which depends on % of policies lapsing or being surrendered (without pay- out)