Precautionary Obligations (Insurance Contracts)
by Giesela Rühl
With the conclusion of an insurance contract, the insurer promises to bear a particular risk for the policyholder. The correct assessment of this risk is therefore of elementary significance: unless he knows what risk the policyholder is presenting he cannot fulfil his task of collecting similar risks and spreading them out amongst a large number of people. What is problematic, however, is that the insured risk is often not comprised of stable factors. Events occurring after the formation of the contract may influence the probability that the risk actually materializes and can thereby upset the balance of the original contractual agreement. In particular, it can come about that the policyholder, with knowledge of his insurance, behaves negligently and increases the probability that the insured event occurs (moral hazard). To avoid situations where the policyholder’s behaviour or other events interfere with the adequacy of the premiums as against the services supplied by the insurer, legal or contractual precautionary obligations are imposed on the policyholder in all European countries. They require the policyholder to engage in or to refrain from certain conduct and are meant to reduce the probability that the insured event occurs. More generally, they are meant to uphold the contractual balance existing at the time of the formation of the contract.
2. Legal basis and nature
To date, precautionary obligations are exclusively the province of national law. There are no regulations at the European level although there were efforts to harmonize the relevant provisions in the 1970s and 1980s. However, since no agreement was reached on the details, the corresponding plans were withdrawn (internal market (insurance)). Instead of unification or harmonization of substantive insurance contract law, the European Commission is now working on a Common Frame of Reference (European private law) which may contain a chapter on insurance contracts including the precautionary obligations of the policyholder. The relevant provisions pertaining to insurance law are drawn up by the Restatement Group of European Insurance Contract Law, which published a first part, the so-called Principles of European Insurance Contract Law (PEICL) (Principles of European Insurance Contract Law (PEICL)) in 2009. However, since the Common Frame of Reference will not have binding force, the actual legal basis of the policyholder’s precautionary obligations will continue to be drawn from national law. It will only be otherwise if the PEICL—following the proposal of the Restatement Group—is elevated to the status of an optional instrument. Should that occur, the parties would be able to choose to subjugate their contract to the PEICL (choice of law by the parties). However, whether the PEICL will be structured as an optional instrument is not yet clear.
Precautionary obligations of the policyholder are usually of a contractual nature. Statutorily enshrined precautionary obligations can only be found on the Continent, in particular in Germany and Austria. Here, the policyholder is legally required to not increase the insured risk after conclusion of the insurance contract. Apart from this exception, most European legal systems leave the creation of such obligations to the contractual dealings of the parties. Their design, however, is subject to numerous statutory or other provisions which determine the role of fault and causation as well as the legal consequences of a breach. In recent years these national provisions have been reformed in numerous European states, including Belgium, Germany, the Netherlands and Sweden, to equip them for the challenges of the 21st century. In England the Law Commission has been working on proposals for the reform of insurance contract law since 2006. Alongside the rules on non-disclosure and misrepresentation (information obligations (insurance contracts)), these proposals will revamp the design of contractual precautionary obligations, which in England are better known as promissory warranties.
3. Concept and distinction from other contractual terms
Precautionary obligations appear in different European orders under different guises. In Germany, Austria and Switzerland, they are called obligations prior to the occurrence of the insured event (Obliegenheiten vor Eintritt des Versicherungsfalls). In Belgium, France and Luxembourg they are referred to as clauses de déchéance. In England, Scotland and Ireland they are variably called warranties, promissory warranties, continuing warranties or warranties as to the future. In Finland, Sweden and Denmark, the terms are duties of care (suojeluohjeet), safety prescriptions (säkerhetsföreskrifter) and safe conduct rules (sikkerhedsforholdsregeler). These last three terms perhaps best express the essence of precautionary obligations. It is, therefore, no surprise that the PEICL (Principles of European Insurance Contract Law (PEICL)) call the policyholder’s precautionary obligations ‘precautionary measures’.
Independent of their precise labelling, the policyholder’s precautionary obligations must be distinguished from clauses describing, delimiting or excluding the insured risk. These clauses determine the insurer’s obligations without reference to the policyholder’s conduct and provide which risks are covered by the policy and which not. The distinction between these clauses and precautionary obligations is usually problematic since every precautionary obligation can also be formulated as a description, limitation or exclusion of risk. For example, the insurance policy can provide that certain risks are only protected if the policyholder engages in a certain conduct. To distinguish precautionary obligations from clauses describing, delimiting or excluding the insured risk, all legal orders refuse to consider the wording or the placement of the contractual term in question and look instead to its content: if the focus is on a preventive conduct of the policyholder, the term is interpreted as a precautionary obligation. In contrast, if the focus is on the objective description of the risk, this is a pure elaboration of the risk. The distinction between the two terms is of enormous practical significance: if the clause in question is construed as a clause describing or excluding the risk, coverage is denied without any consideration of fault or causation. Where, however, the clause in question is a precautionary obligation, the coverage is denied in most legal orders only where the policyholder was at fault and where his conduct has caused or increased the damage. The determination of whether the term is a precautionary obligation or a description of the risk can be difficult at times. However, if the meaning of a contractual term remains unclear, the contra proferentem rule mandates that these terms are construed against the party that has drafted them, which is usually the insurer.
4. Design and practical operation
The policyholder’s precautionary obligations are designed differently in various European legal orders. The prevailing opinion is that differences are particularly large between the civil law and common law systems. Specifically, the precautionary obligations known in England under the notion of warranties are considered to be difficult to reconcile with the consumer-friendly rules on the Continent: in case of a breach warranties entail unravelling of the insurance contract (insurance contracts) independently of fault and causation. In fact, it is generally considered that the failure to harmonize the Member States’ insurance contract laws in the 1970s and 1980s was at least in part the result of the perceived consumer-hostile design of English law. However, in consideration of the actual operation of warranties in England, it must be doubted that this assessment is correct. In particular, in the sensitive field of consumer policies English insurance contract law has long been modified by the self-regulation of the English insurers, eg in the Statements of Insurance Practice of the Association of British Insurers (ABI) and by prescriptions of the Financial Services Authority (FSA). As a result, the practical operation of precautionary obligations to be found in England often does not differ significantly from the operation of precautionary obligations established in continental European countries.
a) Object of precautionary obligations
As a general principle, the insurer can impose any duty on the policyholder by way of a precautionary obligation. It is not required that the imposed duty is material to the insured risk. However, since the relevant terms are designed to preserve the contractual balance between performance and counter-performance and to prevent the occurrence of the insured event, in practice, almost all precautionary obligations are of some significance for the insured risk. This holds true, for example, for fire insurance (indemnity insurance) which normally requires the policyholder to maintain smoke detectors and sprinkler systems, as well as for motor insurance (compulsory insurance) which usually contains provisions requiring the policyholder to maintain the insured car in a roadworthy condition. Also, the duty to avoid an increase of risk, which is regularly part of insurance contracts if not already imposed on the policyholder by law, has a close connection to the insured risk. However, in the unlikely event that a precautionary obligation is in fact not material for the insured risk, the policyholder does not have to fear much: most legal orders provide that breach of a precautionary obligation unrelated to the risk does not have any consequences. In England, the same idea is embodied in the Statements of Insurance Practice of the ABI and the Handbook of Rules and Guidance of the FSA.
b) Review of precautionary obligations
It is not clear if and to what extent contractually created precautionary obligations are subject to the assessment of fairness under Art 3 of the Unfair Terms in Consumer Contracts Directive (Dir 13/1993) (standard contract terms). Even though the directive generally covers insurance contracts, Art (4)2 provides that contract terms defining the main subject matter of a contract or touching upon the adequacy of the price and remuneration as against the services or goods supplied are exempt from scrutiny. In view of insurance contracts, recital 19 to the directive specifies that such contractual terms are terms ‘which clearly define or circumscribe the insured risk and the insurer’s liability’. Therefore, it is sometimes argued that precautionary obligations are not assessed for their fairness. In England particularly, it is widely held that warranties are not subject to review under Art 3 of the Unfair Terms in Consumer Contracts Directive because they determine when the insurer is required to pay in case the insured event occurs. In most other countries, however, this interpretation is rejected. The reason for this is that recital 19 is phrased differently in English than in other languages. Whilst the English text mandates that the corresponding terms are not to be adjudged as unfair since they are taken into account when calculating the price of the premium to be paid, in other languages such terms are not to be adjudged as unfair to the extent that they are taken into account when calculating the price of the premium to be paid. As a result, the relevance of such contractual terms for the calculation of the premium is the reason why these terms are excluded from review in the English version, whilst it is a condition for the exclusion in other versions. It is consequently unsurprising that the exception laid down in Art 4(2) of the directive and specified in recital 19 is interpreted broadly in England, whereas it is interpreted narrowly in other countries. In fact, most European countries agree that Art 4(2) of the directive only covers terms that describe the core of the contractual agreement—meaning a brief description of the insured risk as well as the premium to be paid—but not contractually created precautionary obligations. Against this backdrop, whether said obligations are to be reviewed for their fairness under Art 3 of the Unfair Terms in Consumer Contracts Directive depends on which language version is determinative. Unfortunately, the ECJ has not yet had a chance to answer this question.
c) Consequences of breach
Legal consequences are normally attached to the breach of a contractually created precautionary obligation if the policyholder is to blame for the breach and if the breach has caused a loss. The Member States’ legal systems differ on the details, though reforms in recent years have clearly led to convergence. In particular, many countries—notably Germany and Austria—have replaced the long-standing all-or-nothing principle which entailed the unravelling of the insurance policy on the occasion of a breach with a graded system of legal consequences which take account of the policyholder’s fault as well as the causal relationship between the breach and the insurance claim. Today, pursuant to the relevant provisions as well as pursuant to Art 4:102 PEICL, the insurer is regularly discharged from liability if the policyholder acted deliberately and if the breach has caused either damage or the occurrence of the insured event or has increased the level of damage. Grossly negligent behaviour normally allows the insurer to reduce the insurance sum to be paid, whereas negligent behaviour has no effect on his duty to pay. According to most recently reformed legal schemes and Art 4:102 PEICL, the insurer may only terminate the contract in cases of intentional breach or gross negligence. Mere negligence will not absolve insurers from their responsibility.
Only common law countries provide for exceptions from the general position that fault and causation play an important role in the determination of the legal consequences of a breach of precautionary obligations. In these jurisdictions, the breach of a warranty—at least in theory—entails hefty consequences. Since warranties are categorized as conditions precedent ever since the decision of the House of Lords in The ‘Good Luck’  2 WLR 1279, a breach automatically discharges the insurer ‘from liability as of the date of the breach’. As a result, the policyholder’s fault matters just as little as the causality of the breach for a loss. On the basis of the common law, breach of a warranty therefore leads to the immediate termination of the insurance contract and to a release from liability, even if the breach is not attributable to the policyholder’s conduct and even if it did not influence the occurrence of the insured event or the scope of the loss suffered. In practice, however, the situation is not quite so dramatic: first of all, English courts take a policyholder-friendly approach when determining whether a warranty was contractually agreed upon and when determining its scope. More specifically, they limit the scope of any such provision and only impose obligations on the policyholder that are reasonable in the circumstances of the case. English courts, thus, apply similar normative considerations in the context of the scope of a warranty that courts in other countries take into account in the context of the policyholder’s fault. In addition to the English case law, the aforementioned instruments of the English insurance industry as well as the provisions of the FSA contribute to the amelioration of the situation in practice: as described above, the instruments of the English insurance industry as well as the provisions of the FSA overlay—and, in the case of consumer contracts, defang—the strict rules of the common law and thereby prevent the breach of a warranty leading to the draconian results described above. Specifically, the Statements of Insurance Practice of the ABI as well as the Handbook of Rules and Guidance of the FSA provide that the insurer will not reject a claim or invalidate a policy if the circumstances of the claim are unconnected with the breach. Since insurers are obliged to respect the relevant rules of the FSA, the strict legal consequences attached to the breach of a warranty rarely take effect. Recently, the Law Commission has advocated that the described practical operation of warranties shall become the basis of the entire English insurance contracts law. Whether the legislature will follow this suggestion and align itself with the continental trend is unforeseeable at this point. However, it is clear that the practical handling of precautionary obligations in England and on the Continent, in practice, is not vastly different from one another. Both vouchsafe the interests of the policyholder and the insurer in a balanced way and ensure that the equivalence of performance and counter-performance is maintained during the currency of the contract.
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