Utmost good faith: The basis of all insurance contracts

The importance of management’s duty of disclosure, and the consequences of non-disclosure and misrepresentation cannot be understated.

In a world full of commercial uncertainty, organisations should undertake prudent steps to ensure that their D&O coverage is as effective as possible.

Luckily, this can be as simple as understanding the concept of utmost good faith in an insurance context, and being aware of the disclosure requirements when applying for coverage.

And while making appropriate disclosure can be tedious at times, its relevance should not be understated as a failure to do so, often finds itself in the centre of coverage disputes.

Arranging insurance with utmost good faith

The parties to an insurance contract, i.e. the insurer and the policyholder, are bound by the legal doctrine of uberrima fides, a latin phrase meaning ‘utmost good faith’.

Acting with utmost good faith means that all parties are under a strict duty to deal fully and frankly with each other, disclosing all ‘material facts’ during the application process.

Because an insurance company decides to issue coverage based on the information provided by an organisation, directors and officers must reveal the exact nature and potential of the risks intended to be transferred to the insurer.

After all, the management of an organisation knows their business better than anyone else.

The issue of non-disclosure and misrepresentation should be treated seriously by D&O policyholders, as it is frequently the main offender in contentious and disputed claims.

Management’s duty of disclosure

As a part of the application process executives are required to complete an insurance proposal, which contains a range of questions prepared by the insurer to capture the information necessary to measure D&O exposures.

To fulfil their duty of disclosure, management must answer all questions accurately, honestly and to the best of their knowledge, disclosing all relevant ‘material facts’.

In general terms, a material fact is a piece of information which would influence an underwriter when deciding whether to accept an organisation’s risk. And if so, assist in determining the terms and conditions that will apply to the coverage put forth.

In the context of directors and officers liability insurance, this includes details regarding the organisation’s type of operations, its size, previous mergers & acquisitions, the experience of its leaders, along with any details of past claims, whether or not they were covered by insurance.

Continuous disclosure is essential

Satisfying a duty of disclosure isn’t just a once off occurrence. An organisation and its executives are wholly responsible for keeping underwriters advised of accurate information throughout the entire application process.

If information alters between the time of application and the policy being issued, insurers should be notified of any changes to ensure the duty of utmost good faith is maintained.

Due to the serious implication of non-disclosure, it is in management’s best interest to promote transparency and continuous disclosure of all relevant information.

---

---

Consequences of non-disclosure and misrepresentation

If a company or its executives fail to disclose, or misrepresent a material fact, and this induces an underwriter to accept the risk, it can have significant consequences for which a range of legal remedies are available to the insurer.

1. Avoid the insurance contract

If the non-disclosure or misrepresentation was made fraudulently, the insurer may avoid the contract. This means that the insurer is entitled to treat the policy as if it never existed, and the policy will be cancelled effective from the date of inception.

2. Reduce liability of a claim

If the insurer cannot avoid the contract, it may attempt to reduce its liability to an amount that would place it in the position it would have been, if the disclosure had been made correctly. For example, an underwriter may argue that had the material fact been disclosed, a particular sub-limit or exclusion would have applied, thereby reducing the insurers liability.

3. No affect on coverage

Full coverage may apply if the non-disclosure or misrepresentation would have not affected the underwriter’s decision to accept the risk for the same premium, terms, and conditions.

Ensuring that correct disclosure is made

So, when applying for D&O coverage how does an management know what details are relevant to an insurer?

While there is no definitive list of suggested disclosures, the insurance proposal supplied by underwriters provide a useful guide as to the nature of information required.

However, despite an insurers best effort to ask the appropriate questions, the proposal may not address all the disclosure requirements. Therefore, it is important that applicants apply common sense and seek advice from a qualified broker, to ensure they submit an acceptable level of detail.

For example, some questions may only allow a yes or no answer. If this does not adequately address the question, executives should consider providing additional detail for underwriter’s consideration in an attaching document.

To disclose or not to disclose?

For directors and officers in doubt as to whether to disclose something to an insurer or not, as a general rule, the best option is to be conservative and disclose.

It may take a little more time and effort to find out the relevant facts and figures, but it could save you a lot of headache in the long run.

From a risk management perspective, the relative costs involved in making adequate disclosure is insignificant, compared with potential consequences of a having a policy rescinded due to non-disclosure.

A final word on changing insurers

As a final caveat for organisations considering changing insurers at renewal. Management should pay special attention the ensure that all information is disclosed to their new insurer, including details from operations, activities and claim occurring in past policy periods.