Reflections on sound marine insurance legislation

The Supreme Court of the UK recently concluded the Versloot Dredging case, rendering a victory to the insured by a vote of four to one. This ruling has dealt a significant blow to the fraudulent devices rule, such that, in future, an insurer could still be required to pay indemnities even if the insured has committed fraud. In the case, the vessel in question gave rise to a claim of more than €3 million (US$3.3 million) due to engine damage suffered as a result of flooding of the engine room. In the course of the claim, the insured gave an erroneous account of the details at the time of the occurrence of the incident. Subsequently, having ascertained that the insured lied, the insurer refused to pay indemnities, following which the insured instituted a legal action.

Opinions of the courts. On the basis of the finding that the loss was caused by covered risks, both the court at first instance and the court of appeal rendered rulings supporting the insurer. The courts held that in insurance fraud there is one type, called fraudulent devices, which means that the insured genuinely suffered a loss but, during the claim procedure, he exaggerated the facts or provided grossly false statements.

Notwithstanding the fact that the claim itself is lawful, it is in essence still fraudulent and likewise breaches the requirement of continuing utmost good faith. The intent of the fraudulent devices rule is to prevent fraud by the insured. The background to this rule is consideration of the overall interests of the marine insurance industry, and the court does not have more ample grounds from which to deviate.

However, the Supreme Court held that, first, the status of lies varies at different stages of insurance. At the time of entry into the insurance contract, full and truthful disclosure by the insured is of utmost importance to the insurer’s assessment of the risks, but when the claim is filed, the statements of the insured are not of utmost importance in the insurer deciding whether or not to pay out the indemnities; rather it is more incumbent upon it to rely on its own judgment. Accordingly, when the claim is filed, the insurer’s right of termination should be strictly restricted, particularly where the claim is lawful and valid.

Second, a fraudulently exaggerated claim and a lawful claim supported by collateral lies should be differentiated. A collateral lie means a lie that turns out, when the facts are found, to have no relevance to the insured’s right to recover. The latter does not satisfy the requirement of materiality.

Finally, even if the insured is indemnified, there is no need to worry that he or she will act in a reckless fashion in future, as the insurer is fully within its rights to increase the premiums or terminate the insurance contract early, after paying out the indemnities. In promoting the sound development of the insurance industry, insurance law should lean more toward controlling the risk of breaching the duty of good faith before the fact, rather than achieving the foregoing goal after the fact, by increasing the penalties for fraud.

But it has even been acknowledged by the originator of fraudulent devices, Lord Mance, that “collateral lies” can distort the entire claim process because revealing the fraud and determining its intent undoubtedly results in the expenditure of a great deal of time and money. Furthermore, there are defects in the UK Supreme Court’s substantive judgment criteria.

Current legislation in China. Article 242 of China’s Maritime Law specifies that, “The insurer shall not be liable for indemnifying losses willfully caused by the insured”. However, this applies only in situations where the insured deliberately fabricates or devises an insured event, and this provision is not applicable in the event that the insured uses a fraudulent device. The Insurance Law and Contract Law are commonly applied in judicial practice to deal with insurance fraud cases.

The third paragraph of article 27 of the Insurance Law specifies that, “If the proposer, insured or beneficiary, following the occurrence of an insured event, fabricates a false cause for the event, or exaggerates the extent of the losses with forged or altered relevant supporting documents, materials or other evidence, the insurer shall not be liable to pay the indemnities or insurance monies for the portion that is fraudulently claimed”. Notwithstanding the fact that this provision may cover instances of fraudulent devices, pursuant to this provision, the insured is still entitled, after the fraud, to the portion that was not fraudulently claimed.

More stringent legislation. In the field of marine insurance, vessels are perennially out to sea, and once an event occurs, no one but the insured has access to first hand information. Furthermore, preservation of evidence is difficult, and its truthfulness is even more suspect. Accordingly, insurers are more reliant on the statements of the insured. Given humans’ propensity to seek gains and avoid harm, instances of the insured using fraudulent devices to obtain greater indemnities are not rare.

The establishment of the insurance fraud system should be focused on the overall interests of the marine insurance industry. Development of China’s marine insurance industry still lags behind the UK. Good faith can reduce the cost of social transactions and promote social welfare. From this perspective, with a view to promoting the sound development of the marine insurance industry in China, it is necessary to take relatively stringent means to reduce the number of insurance fraud cases and, by virtue of this, to alert the insured to potential risks.

In light of the Versloot Dredging case, the author would like to put forward two recommendations for improving marine insurance legislation in China in future. First, beefing up chapter 12 of the Maritime Law. As the law code for shipping in China, a major shipping nation, the provisions of the Maritime Law on the important issue of insurance fraud are overly simple, harming China’s image as a major shipping nation. Revising the Maritime Law would be the most direct and effective means of rectifying this situation.

Second, revising the third paragraph of article 27 of the Insurance Law to read, “… thereby affecting indemnification by the insurer, the insurer shall not be liable to pay the indemnities or insurance monies”. The reasons for striking the “portion that is fraudulently claimed” are given above; and “affecting indemnification by the insurer” is added to avoid abuse of fraudulent devices by insurers. This provision would apply only in instances of deliberate acts by the insured, and the burden of proof would fall on the insurer. Accordingly, both parties’ rights and obligations would be relatively balanced.

Mervyn Chen is a senior partner at Wintell & Co