Peter Hamilton: When lying to insurers is allowed

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About 18 months ago I wrote about how an insurance claim, valid in every respect, can be rejected if the insured has sought to embellish the facts with a lie in the course of making the claim. Such fraud has become known as a fraudulent device.

I illustrated the point by reference to a Court of Appeal decision in a case called Versloot Dredging vs HDI Gerling Versicherung, in which the court had upheld the rule on fraudulent devices for two main reasons.

First, it shared the same basis as the rule relating to fraudulent claims generally, which is the obligation owed by the insured of the utmost good faith.

Secondly, it shared the same public policy justification, namely the deterrence of dishonesty, where total honesty is essential because the insured knows all the facts and the insurance company needs to be able to rely on its insured.

In an earlier House of Lords case, Lord Hobhouse said: “The fraudulent insured must not be allowed to think, ‘If the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing.’”

And in yet another case, Lord Justice Millett said the rule was “necessary and salutary” to counter the “widespread belief that insurance companies are fair game and that defrauding them is not morally reprehensible”.

The reason for returning to this subject is that in July, the Supreme Court heard a further appeal in the Versloot case and has modified the rule on fraudulent devices in favour of the insured.

A small cargo ship was loading scrap metal in a port in Lithuania in the middle of winter. It was freezing cold. In order to open the hatch covers, the crew used an emergency fire pump to blast away ice from the covers before opening them. Afterwards, they failed to drain the seawater from the pump or to close the sea inlet valve to it. The water in the pumping system froze and damaged it.

The result was that after the ship left port, seawater entered the ship. Because of a past failure of contractors to seal the engine room bulkheads securely, the seawater flooded the engine room and destroyed the engine. The engine was replaced at a cost of over €3m.

The subsequent claim by the owners under their insurance contract was in all respects a good one and should have succeeded but for what the owners’ manager had said to the underwriters in the course of making the claim.

He recklessly made the untrue statement that the master and/or the crew had reported that the bilge alarm was heard by the crew some nine hours before the time they had in fact heard it, but had not investigated it because it appeared to be caused by the rolling of the ship in heavy seas.

The aim of the statement was to indicate fault on the part of the crew and not on the part of the owners. That was a fraudulent device.

The general rule on fraudulent claims is simple. The insurer is not liable to pay them. That is clear if the fraud consists of making a claim for a loss that the insured knows to be non-existent or exaggerated.

But what should the rule be if the loss is genuine and not exaggerated, but the claimant has told a lie to improve his chances of the claim being met or to speed up the claims process? In the Versloot case, the lie was irrelevant to the merits of the claim. Lord Sumption summed up the view of  most of the justices when he said:

“…although a lie uttered in support of a claim need not have any adverse impact on the insurer, I consider that it must at least go to the recoverability of the claim on the true facts. By that test, the fraudulent claims rule applies to a wholly fabricated claim. It applies to an exaggerated claim. It applies even to the genuine part of an exaggerated claim if the whole is to be regarded as a single claim, as it must be. But it does not apply to a lie which the true facts, once admitted or ascertained, show to have been immaterial to the insured’s right to recover… The extension of the fraudulent claims rule to lies which are found to be irrelevant to the recoverability of the claim is a step too far. It is disproportionately harsh to the insured and goes further than any legitimate commercial interest of the insurer can justify… In my opinion, it is not the law.”

The appeal was allowed and the insured recovered its loss from the insurer. Thus, if the collateral lie is shown to have been immaterial to the insured’s right to recover or was not relevant to the merits of the claim, the collateral lie should be disregarded and not operate to deprive the insured of what was otherwise a valid claim.

Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of moneymatterslegal.co.uk