The Supreme Court does fraud in insurance claims and collides with the Financial Ombudsman Service | Wolters Kluwer Financial Services
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  • The Supreme Court does fraud in insurance claims and collides with the Financial Ombudsman Service

    By Adam Samuel

    Published August 09, 2016

    Fraud and insurance claims is always an emotive subject at least for insurers. On 20 July, the Supreme Court in Versloot Dredging BV v. HDI Gerling Industrie Versicherung AG concluded that the law was basically the same as the Ombudsman-world has been applying under the guise of being fair and reasonable at least as far back as 2004. While fraudulent claims and fraudulent exaggerations of claims entitle the insurer to treat itself as having been discharged from any obligations under the policy at least for the claim concerned and the future, the same is not the case where fraud has been used in support of a justified and not exaggerated claim. By four votes to one, the Supreme Court ruled that this type of “collateral” fraud had no legal impact.

    The Ombudsman position on fraud

    From the early days of the Insurance Ombudsman Bureau (IOB) in the 1980s, insurers have tried to avoid liability under general insurance policies by alleging customer fraud. The Ombudsman approach has been fairly constant for many years. The Financial Ombudsman Service (FOS) investigates these allegations.

    If a claim is found to have been made fraudulently in that the customer has lied to turn an unjustified claim into one that might be paid out, the Ombudsman will not uphold a complaint against an insurer. The IOB developed a formula that such a case was better dealt with in a court of law since it did not like finding fraud on the basis of a purely paperwork examination. Recent developments in the form of the Alternative Dispute Resolution Directive have made that approach difficult to defend. Nevertheless, FOS traditionally allows insurers to reject fraudulent claims and fraudulently exaggerated claims.

    What it does not permit is insurers to reject a claim because of a dishonest or fraudulent act used to buttress a justified claim. So, in a household contents case, insurers commonly ask for proof of ownership and policyholders sometimes create fake invoices to demonstrate which did happen but for which the paperwork has long since gone. They would be better advised to produce a photograph of them with the item concerned.

    Issue 41 of Ombudsman News, in November 2004 stated the Ombudsman’s position in these terms:

    “Where the fraudulent act or omission makes no difference to the insurer's ultimate liability under the terms of the policy, it should not entitle the insurer to 'forfeit' the policy or reject the claim. In the example given above, of the forged receipt, the claim should be paid. Indeed, it was the insurer's unreasonable insistence on strict proof that caused the policyholder to act dishonestly in the first place.

    Of course, there is nothing to prevent the insurer from:

    • giving the policyholder written notice that it intends to cancel the policy (in accordance with the policy terms), on the basis that it no longer wishes to deal with a particular policyholder; or
    • not inviting renewal of the policy.

    But at least the genuine claim should be paid.”

    It is often said that FOS’ approach to claims is different from the law and the Ombudsman News text just before the quoted comments would back that.

    The facts of the Versloot case

    The DC Mervestone was “incapacitated” and the engine was damaged beyond repair when water came into the ship because of a combination of:

    • carelessness by the crew in not closing the sea inlet valve of the emergency fire pump before using hoses to remove ice chips from the hatch covers;
    • freezing of seawater in the emergency fire system pump casing and filter;
    • contractors’ negligence in failing to seal the engine room bulkheads after passing cables through them; and
    • engine room pumping system defects (unknown at the voyage’s start by the shipowners).

    The insurer’s solicitors asked for an explanation. One of the shipowner’s managers said that he had been told that the bilge alarm had sounded but the crew had been unable to deal with it because of the rolling ship in the storm. Essentially, he was trying to speed up the claims process by diverting attention from the condition of the ship which anyway did not cause the flood or the engine failure. The comment about the bilge alarm was made once and later abandoned well before trial.

    The fraudulent claims rules

    If the whole claim is fabricated or has just been exaggerated, the common law position is that the insurer can refuse to pay the claim and can consider itself discharged from having to pay any subsequent claim from the date of the fraud. This is reflected in the Insurance Act 2015.

    The original development of a rule about fraudulent claims was linked to the notion of a continuing obligation of good faith enshrined in the Marine Insurance Act and applied by the Insurance Ombudsman Bureau with sometimes more enthusiasm than wisdom.

    The Litsion Pride was a first instance judgement that denied the claim because of the dishonest backdating of notice that a ship was entering a war zone. Even without the letter, the ship would have been covered anyway.

    The case was heavily criticised in The Star Sea by the House of Lords. It concluded that a good faith non-disclosure of an expert report on whether the shipowner had knowingly sent the ship to sea in an unseaworthy condition had no effect on the claim. When presenting claims, the insured only had to be honest. It did not have to disclose everything. Any obligation of good faith terminated anyway once legal proceedings had begun.

    The Supreme Court

    Lord Sumption who delivered the leading judgement starts from the fact that the right to have the claim paid typically dates from the moment that the loss is suffered, not the date of the claim. The rule must then be one of forfeiting the benefit of a legal right as a result of a principle of public policy, not contract law.

    It is an unusual feature of insurance law that a fraudulent claim or fraudulently exaggerated one does not need to involve any causal impact on the insurer unlike the situation when the policy is taken out. At the inception of the policy, for the insurer to succeed, the non-disclosure must have some causative impact. If the insurer knows that the claim has been fraudulently exaggerated, it has not been induced by the deceit into paying the claim. It can now refuse to pay any amounts due under the policy from the date of the fraud.

    Ultimately, Lord Sumption concluded that the fraudulent claims rule does not apply “to a lie which the true facts, once admitted or ascertained, shows to have been immaterial to the insured’s right to recover” any more than it applies to lies told during litigation. Lord Clarke who agreed with Lord Sumption described the exception to the fraudulent claims rule as “lies which are not relevant to the question whether the underwriters are liable…. or not” or “conduct… causally relevant to underwriters’ ultimate liability. As Lord Sumption put it: “the lie is dishonest but the claim is not”. The key test is whether the lie was material in the light of what has subsequently emerged not what everyone thought when it was uttered.

    For Lord Hughes, also on the same side, it is “gilding the lily”. A fraudulent or exaggerated claim by contrast provides the claimant with “something to which he is not entitled in law” unlike the situation discussed in this case. A claim is fraudulent, as Lord Hughes explains, where the customer continues with the claim or its extent after discovering that it is not justified, such as claiming that something stolen after he has found the item in a drawer. Lord Toulson accepts that a lie which speeds up the claims process is in practice “material” but agrees with the majority that it should not be regarded as such for the purposes of the fraudulent claims rule if the lies does not “go… to the existence or amount of the insured’s entitlement”.

    The majority recognises ultimately that the decision is one of public policy rather than legal principle. A lie told one day and retracted the next should not have a worse outcome than a fib during litigation. As a matter of policy a fraudulently exaggerated claim cannot be severed from the honest claim. As Lord Hobhouse explained in The Star Sea, the impact of dishonesty must match not exceed it.

    Lord Mance, whose father, Henry Mance was a Chairman of Lloyd’s of London, disagreed. He accepted that a lie told during the claims process for reasons entirely unrelated to the merits of the claim, notably to cover up personal embarrassment, would be irrelevant. Otherwise, though, a lie in “pursuit of what the insured believes or fears to be at least a questionable claim” should be treated as a fraudulent claim. He points out that many of these lies will never be discovered and nobody will ever know whether the underlying claim was bad or exaggerated.

    Some thoughts

    This was an extremely powerful Supreme Court of five judges with four having major insurance law experience. Ultimately, the decision came down to the question of where public policy needs to set the limits on the fraudulent claims rule. Lord Mance’s arguments are actually very powerful in exposing the way in which a lie may prevent the uncovering of a dishonest claim. Nevertheless, the majority’s position makes sense. If lying during litigation has no effect on a claim, then it should follow that a lie relating to something which does not affect the insured’s entitlement should not either. It is just a question of where one should place the limit about the public policy against lies being told about insurance.

    Section 12 of the Insurance Act 2015 will fit well with all this in allowing the victim of a fraudulent or fraudulently exaggerated claim to treat themselves as discharged from the date of the fraud and decline to meet the claim in any event. Pre-fraud events are unaffected. Gilding the lily of an accurate claim will not give rise to these entitlements. Although the Supreme Court did not mention the Financial Ombudsman Service, one can see from the 2004 comments in Ombudsman News how the law and what is fair and reasonable may not be as far apart as some think. The Law Commission in its preparation of the Consumer Insurance Act was clearly influenced by the Ombudsman tradition and there is an element of this in the Insurance Act. It is healthy that FOS which deals with far more cases on insurance than the courts should be affecting or reflecting a more modern version of the common law as they both move away from the old “utmost good faith” approach.

    About the author: Adam Samuel is a lawyer and compliance consultant and the author of the only major book on financial services complaint handling. He combines diploma level qualifications with the CII, a complete set of certificate level CII exams, the CISI Diploma in Compliance with merit with his background as a barrister and attorney. Formerly the second PIA Ombudsman and an IOB Ombudsman's Assistant, Adam sits on the Ethics Committee of the Institute of Financial Planning and sat for seven years on the Practice and Standards Committee of the Chartered Institute of Arbitrators of which he was also the chairman of the Arbitration Sub-Committee for four and a member for ten. Adam is a regular contributor to Wolters Kluwer Financial Services’ Compliance Resource Network.

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