Do you have to deny cover on the spot, or can you wait?

You're a life insurer and you discover your insured has not complied with his or her duty of disclosure. You'd like to avoid the contract, using section 29(3) of the Insurance Contract Act. Do you have to show that you would have denied cover on the spot if the insured had made full disclosure? Or can you still avoid the policy even if your hypothetical strategy would have been to get more information about the risk, and ultimately not have covered on any terms?

This has been a controversial issue but this week in Davis v Westpac Life Insurance Services Ltd [2007] NSWCA 175 the NSW Court of Appeal gave us some clarity and came down on the side of the sensible life insurer.

Mr Davis' non-disclosure

On 28 August 2001 Mr Davis applied for life insurance. Between that time and the day that the policy came into effect, 12 November, he was referred to a specialist who said that Mr Davis needed to be tested for sleep apnoea. At no time did Mr Davis tell the insurer about his medical appointments or that he had suspected sleep apnoea. The test was run after the policy came into effect, and revealed that he suffered 94 respiratory events an hour which were mainly apnoeas.

After Mr Davis made a claim on his policy, the insurer avoided the contract on the basis of the non-disclosure.

The question for the NSW Court of Appeal was this: Could it?

At trial, the insurer said that if it had known of Mr Davis' problems, including the 94 events per hour, it would have postponed entering the contract for a year to see what happened with his sleep apnoea. Mr Davis said it couldn't do that and then rely on section 29(3): the insurer had to establish that it would not have entered into a policy on any terms with the insured as at the date the policy was entered into.

Avoiding a contract of life insurance - what must an insurer prove?

The NSW Court of Appeal disagreed. It said that an insurer can still avoid a contract of life insurance even if it can't prove it would have denied cover on the spot if the insured had made full disclosure. It held:

• If an insurer is trying to show that it would not have been prepared to enter into a contract of life insurance with the insured on any terms if the duty of disclosure had been complied with, what can it take into account? The Court said it could consider information it would have obtained if the insured had complied with the duty and it had then made some further inquiries
• The only relevant time period is three years after entry into the policy.
• If, during the three year period, the insurer becomes aware of facts which reveal that the insured had not complied with the duty of disclosure (and/or made a misrepresentation), but needs further information before determining what its attitude to acceptance of the risk would have been, it can consider the results of those consequent inquiries. If, after making those inquiries, it determines it would not have been prepared to enter into any policy, it can avoid the policy.

So what should life insurers do now?

Life insurers should now review their claims handling practices and manuals to ensure they comply.