How to deal with fraudulent insurance claims: prevention is better than cure – A Practical Guide

When insurers are faced with a claim that they believe is in some respect fraudulent, they need to consider four issues:

1. The onus is on them to prove the fraud;
2. What needs to be proved may be determined by the wording of the policy, and the law applicable to the insurance agreement;
3. Absent any appropriate wording, the underwriter may well be faced with paying that portion of the claim that is not shown to be fraudulent;
4. Can the insurance contract be terminated and, if so, must any premiums be returned? 

Many marine policies underwritten in South Africa may be subject to English law and practice – so recent developments in English law should be of interest to local brokers and insurers.  In this regard, England has recently passed the Insurance Act 2015.  This Act deals with fraudulent claims although the legislature left certain nuances to be developed by the courts.  Such assistance has not been long in coming - in the recent Supreme Court decision, Versloot Dredging v HDI Gerling Industrie Versicherung AG [2016] UKSC45 (the “DC Merwestone” case), the severity of the common law was lessened.

English Common Law

Notwithstanding a fairly muddled line of judicial precedent, the English common law provided for the forfeiture of a claim tainted with any fraud.  This forfeiture rule of “fraud unravels all” applied to the following three instances:

1. Where the whole claim is fabricated;
2. Where there is a genuine claim but the amount is exaggerated; and
3. Where there is a genuine claim with the correct value but the supporting information may have been dishonestly embellished (the so called “fraudulent device”). 

English Statutory Law

The Insurance Act 2015  has confirmed and therefore replaced the common law, to a degree.  It holds that where there is a fraudulent claim by an insured the insurer may:

1. Notify the insured that it is treating the policy as terminated;
2. Refuse all liability in respect of events occurring after the time of the fraudulent act; and
3. Need not return the premiums paid under the contract.

But what about the position where the claim is genuine, but was embellished by a fraudulent device?

English Developments

In the DC Merwestone case, where a fraudulent device was employed by the insured, two courts decided that the insurers were entitled to regard the insurers claim as forfeited.  But the Supreme Court reversed that decision holding that a claim which is supported by a fraudulent narrative will not be subject to the forfeiture rule if the claim itself was valid and that the lie had no bearing on the validity of the claim. 

The owners of the DC Merwestone claimed under their hull policy for loss suffered following the flooding of the engine room.  Initially, the cause of the flooding was not clear, and the claim was supported by a fraudulent embellishment that the crew of the ship had ignored a bilge alarm in order to expedite the payment of the claim.  It was subsequently established that the cause of the flooding was due to a combination of the negligence of both the crew and independent contractors as well as the unseaworthiness of the vessel .  The claim was therefore valid.  The underwriters however resisted indemnifying the insured based on the fraudulent embellishment which they argued led to the claim being forfeited under the common law. 

In reviewing the facts, the court held that the lie which was told had no effect on what was otherwise a valid claim.  The lie was termed a “collateral lie” which the majority found would not invoke the forfeiture rule.  In telling such a lie “the insured is trying to obtain no more than what the law regards as his entitlement and the lie is irrelevant to the existence or amount of that entitlement.”  The court further held that applying the common law rule to collateral lies “is disproportionately harsh to the insured and goes further than any legitimate commercial interest the insurer can justify.” 

The decision has applied social justice but left the insurance industry somewhat disgruntled. 
Insurers can protect themselves by including specific forfeiture clauses in their contracts, which any prudent policy should already contain.  Whilst some may regard this as unfair, the effect of fraudulent claims, of any degree, increases premiums which are filtered down to all insureds, whether honest or not.

South African Common Law

The South African common law position is quite different from that of English law .  Our civil law is not punitive in nature therefore an unfounded or totally fraudulent claim, where the loss never occurred or is self-imposed, can be rejected.  A valid claim, either supported by a fraudulent means or which has been exaggerated, may not be rejected and the insurer will be obliged to pay out the valid portion.  Examples of both being a claim where documents or information have been falsified or where the value or incident is embellished.

This was confirmed in Schoeman v Constantia Insurance Co. Ltd. where the court found that there is no compelling social need to adapt the harsh penal approach previously applied in English law.  The fact that insurers can easily protect themselves by inserting express terms against fraud within their contracts has left no reason for the courts to develop the common law to be any harsher on the fraudulent insured.

It should also be noted that where the insurer suffers any loss as a result of any type of fraud, then those losses can be recovered in the normal course through a delictual action against the fraudulent insured.  The insured further runs the risk of criminal prosecution.  In other words, even when the fraud is immaterial to the outcome of the claim, if fraud has been committed there are civil and criminal remedies available to the insurer. 

What can insurers do?

The insurers can avoid liability through the appropriate drafting of a suitable fraud clause in their policies.  Properly worded, the clause should allow insurers to reject outright fraudulent claims and those claims tainted by fraud.  It should also allow the insurer to terminate the policy and reject any subsequent valid claim brought under the policy.  Whilst premiums are not required to be returned when the policy is terminated due to fraud, insurers should still include such a term within the clause.

Our courts have been generally accepting of the clauses; even when complete forfeiture of a claim is out of proportion to the impact the fraud may cause the insurer.  However, the academics have cautioned against this approach especially where there is a valid claim accompanied by fraudulent devices – the result may appear to a court to be punitive, and the clause may not be enforced.

Therefore, despite not following the harsh English forfeiture rule, contractually the insurer is protected and the South African position on fraudulent claims results in being similar to that of the current English law under their Insurance Act.  Following the DV Merwestone decision we may see more of a move toward a legislative reform due to the “softening” of the English rule.  If insurers have included suitable fraud clauses then they are well protected until a matter concerning fraudulent devices comes to the fore in order to challenge the wide application by the courts or the legislature.    

This article first appeared on Southern Africa Shipping News