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The lives of others

A consultation on life insurance law has revealed concerns over restrictions on taking out cover

Not so much tax planning but an area of development in relation to the law on an important financial product – life insurance. Any fundamental change in the law needs to be at least considered when building tax planning solutions.

The Law Commission for England and Wales and the Scottish Law Commission issued a scoping paper and press release in January 2006 seeking views from the industry and consumer groups on areas that “deserve scrutiny”.

Although the whole of insurance law is being reviewed, I will be focusing on the possible changes to the law of life insurance and I am grateful to my colleague, Barbara Gardener, for the continuing research and consideration she is carrying out on this subject.

It is true that the base rules regarding insurable interest are enshrined in the Life Assurance Act 1774 but life insurance companies have moved with the times.

For example, some companies have dispensed with the need for insurable interest to be proved in connection with single-premium bonds which provide only minimal life cover.

Other companies, for example, recognise insurable interest between a couple engaged to be married.

Any review of the law in this area is to be welcomed as it would offer the oppor-tunity for the rules to be updated which should make for consistency.

The main points under-lying the initial announce-ment of consultation were as follows:

  • The Law Commission for England and Wales and the Scottish Law Commission sought views from the industry and consumer groups on “areas that deserve scrutiny”.
  • Some laws governing insurance contracts directly contradicted industry rules and best practice causing confusion for consumers and businesses, it said.
  • Insurance legislation has long been criticised for being out of date. A Law Commission report considered the issue 20 years ago but was never implemented.

A particular problem is the non-disclosure of facts to insurers, which, by law, can invalidate a policy. As an example, one couple who took out a critical-illness policy inadvertently failed to notify the insurer of the wife’s reduced hearing caused by ear infections.

After she contracted fatal leukaemia, the insurer exercised its legal right to reject the claim because the policy was invalid since the hearing loss had not been disclosed, even though it was unconnected with the illness that triggered the claim.

By law, a married couple can insure each other’s life but there is doubt over whether non-married cohabiting couples have the same right. Some insurers issue policies to cohabitees while others believe such policies are illegal under the 1774 Life Assurance Act.

In the joint scoping paper, the following was stated:

“2.2: The doctrine of insurable interest restricts the availability of valid insurance to those who can show a particular type of interest in the life, property or liability to be insured. This is a complex area of law, which relies heavily on old case law and archaic statutes, notably the Life Assurance Act 1774.2.3: There appear to be two objectives behind the development of the doctrine:(1) The prevention of gambling under the guise of insurance.(2) The deterrence of moral hazard.2.4: Preventing gambling under the guise of insurance may still be a strong argument for retaining restrictions on the ability to insure. From a regulatory perspective, it may be thought desirable to separate those who are using insurance to order their affairs prudently from those who are merely gambling.

A doctrine of insurable interest is probably a more effective and convenient way of enforcing such a separation than through, say, a statutory definition of insurance.2.9: If we are to look at insurable interest, we believe we should do so across all types of insurance and all categories of policyholder.

In addition, we are conscious that there are two other areas which may achieve part of the objectives of insurable interest and which will therefore need to be given at least some consideration.

First, the principle of indemnity, which operate to prevent a claim being successful if a loss has not been suffered. Second, the definition of insurance, which could restrict insurers’ ability to offer cover where there is no interest.”

As a background to all this, the primary source of law is the Life Assurance Act 1774. Section 1 of the act bans the making of insurances where there is no interest, and renders any policy issued in such circumstances null and void. It is clear from subsequent case law that such a policy is therefore illegal. Case law has also established that the interest need exist only at the time the policy is effected.

There are three classes of interest which satisfy the requirements of section 1 of the act:

1: Natural affection. One has an unlimited insurable interest in one’s own life and that of one’s spouse.

2: Potential financial loss. There is an open class where one can insure a life in which one has a pecuniary interest, provided (in England and Wales) that one also has a legal or equitable interest.

3: Statutory interest. Section 253 of the Civil Partnership Act 2004 gives each person in a civil partnership an insurable interest in the life of the other, and section 11 of the Married Women’s Property Act 1882 confirms the right of a woman to insure her own life or that of her husband.

The commission said that it had been suggested to them that the class of “natural affection” is too restricted.

For example, the mere fact of cohabitation does not give cohabitees the right to insure the lives of their partners.

Similarly, consultees felt that the test of potential loss was too demanding – in particular, that unlike some other jurisdictions “a mere chance or expectation” is not sufficient.”

More on this next week.

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