State of Play: Upholding fairness in an insurer's right to decline a claim - the Auto & General case

In the recent decision of ASIC v Auto & General Insurance Company Limited [2024] FCA 272 (ASIC v Auto & General), the Federal Court of Australia considered the application of the unfair contract terms (UCT) regime in the context of insurance, holding in favour of the insurer.

This is the first decision that applied the UCT regime in the Australian Securities and Investments Commission Act 2001 (ASIC Act) to insurance policies, following its amendment to include insurance contracts in April 2021. The Court was required to explore a novel question regarding the interaction between the UCT regime and the Insurance Contracts Act 1984 (ICA), particularly section 54, which precludes insurers from refusing to pay claims in certain circumstances.

In this article, we explore the judicial guidance provided by Jackman J and examine how the Court navigates the concurrent operation of the UCT regime and the ICA in the consumer protection space.

Background

Auto & General Insurance Company Limited (Auto & General) issued home and contents insurance contracts and associated product disclosure statements (PDSs) under various brands, all in substantially identical terms. The PDSs included a clause requiring insureds “to tell [Auto & General] if anything changes while you’re insured with us” (Notification Clause) during the term of the policy. If the insured failed to comply with this Notification Clause, Auto & General could take several actions detrimental to the insured, including refusing a claim and reducing the payout amount.

ASIC alleged that the Notification Clause was unfair under the UCT regime in the ASIC Act, as amended in response to the Hayne Royal Commission. Those amendments expanded consumer protection measures by including insurance contracts as subjects of the UCT regime.

ASIC’s unfairness claim was made based on several reasons. First, ASIC argued that the obligation the Notification Clause imposed was ambiguous as to what customers needed to disclose. Second, the Notification Clause allegedly suggested that Auto & General could refuse or reduce claim payments more broadly than permitted under the ICA, particularly due to section 54 of the ICA which outlines certain circumstances where the insurer may not refuse to pay claims. Accordingly, ASIC argued that the Notification Clause had the potential to “mislead the consumer as to the ambit of those rights, and to prejudice the consumer’s ability to scrutinise and challenge any refusal of their claim or cancellation of their policy” (see [104]). However, as Jackman J mentioned, ASIC did not plead misleading or deceptive conduct.

Section 12BG(1) of the ASIC Act states that a term is unfair if:

1. it would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
2. it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
3. it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied upon.

Relevantly, section 12BG(2)(b) of the ASIC Act states that in determining whether a term is unfair, the Court must consider the extent to which the term is “transparent”, which is defined within the same section as “expressed in reasonably plain language, legible, presented clearly, and readily available to any party affected by the term”.

The decision in ASIC v Auto & General

The impact of sections 13 & 54 of the ICA in applying the UCT criteria

Based on the construction of the criteria in section 12BG(1) of the ASIC Act and the relevant ICA provisions, Jackman J concluded that the term was not unfair. His Honour found that the Notification Clause did not cause a significant imbalance in the parties’ contractual rights and obligations in the light of section 54 of the ICA, given that Auto & General has the fundamental obligation to exercise its rights and powers with the utmost good faith under section 13 of the ICA.

When read in context, the Notification Clause required the insured to notify Auto & General if, during the policy term, there was any change to the information about the insured’s home or contents that the insured had disclosed to the Auto & General prior to entry into the contract (at [62]). Considering this, the Court found the Notification Clause was consistent with the underlying principles in section 54 of the ICA. While section 54 of the ICA partly acknowledges insurers’ ability to refuse payment of a claim based on certain acts or omissions by the insured, this must be exercised in conjunction with their duty to act with utmost good faith. The Court noted that, when assessing unfairness, the broader legal context must be considered.

Under the duty of utmost good faith, insurers must act with commercial decency and fairness. In the present case, this meant that Auto & General could neither opportunistically rely on breaches of the Notification Clause that haven’t caused them any loss, nor could they unjustly refuse or reduce claims. It would be a breach of this duty if Auto & General exercised its rights under the Notification Clause to the prejudice of an insured unless and to the extent that the insured’s failure to notify a change in information had prejudiced Auto & General’s interests (at [82]). Accordingly, the Court found that the substantive effect of section 54 of the ICA aligns with the intended function of the Notification Clause, making it unnecessary to contemplate how the unfairness criteria in section 12BG(1) relate to section 54 of the ICA.

Even if the conclusion that the Notification Clause has the same substantive effect as section 54 is wrong, Jackman J noted that:

"s 54 itself would operate on the term to ensure that the defendant’s powers to refuse or reduce claims would not cause a significant imbalance in the rights and obligations of the parties arising under the contract" (at [85]).

In addition, Jackman J considered that Auto & General had legitimate interests in being able to cancel any policy if it became aware the policy was outside its willingness to accept risks, in the sense that it would not have written the policy if it had been aware of the risk, and in not having to pay claims where the loss giving rise to those claims had been caused by a risk that it would not have been prepared to insure against (at [91]). Further, it was reasonably necessary to protect Auto & General’s legitimate interests for it to have powers under the contract to put itself in the position it would have been in had the insured disclosed information revealing the risk, and it had declined to grant cover, or limited the cover which it agreed to provide (at [92]).

Meaning of transparency in the UCT regime

Jackman J also provided further clarification on the role transparency plays in assessing whether a term is unfair.

His Honour said that the question of whether a term is “expressed in a manner which allows consumers readily to know and understand the parties’ rights and obligations” is an aspect of the concept of “transparent” under section 12BG(3) of the ASIC Act (at [103]).

His Honour also held that a lack of clarity and certainty is a matter which could itself be a relevant detriment within the meaning of 12BG(1)(c) (at [112]).

However, in order for a term to infringe the unfair terms regime, it must infringe all three statutory criteria, namely, that the term must cause a significant imbalance in the parties’ rights and obligations arising under the contract; not be reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term; and must cause detriment  to a party if it were to be applied or relied upon. As Jackman J emphasised, “transparency is not an independent element of unfairness as defined in s 12BG(1)” (at [104]).

His Honour emphasised that the criteria in sections 12BG(1)(a) and (b) are to be applied having regard to the proper construction of the term, not an erroneous or arguable construction of the term (at [107], [109]). His Honour then applied the reasoning of the High Court in Karpik v Carnival plc [2023] HCA 39 in holding that the greater the imbalance inherent in the term, or the less a term is regarded as reasonably necessary to protect legitimate interests, the greater the need for it to be expressed and presented clearly (at [107], [109]).

As Jackman J was of the view that, on its proper construction, there was no significant imbalance in the Notification Clause, and it was reasonably necessary to protect legitimate interests, any lack of transparency did not cause his Honour to change his view that the term was not unfair.

Concluding remarks

This decision is meaningful as it provides the first judicial guidance on applying the UCT regime to insurance contracts. Given that UCT has been a key area of interest for ASIC in recent years, this case demonstrates a broadening enforcement focus of ASIC on insurers, effectively seeking to expand the ambit of consumer protection under the UCT regime.

As a result, clearly, insurers should ensure terms are drafted fairly. But the decision reinforces that the relevant term cannot be viewed in isolation from the insurer's statutory duty to exercise its rights and powers with the utmost good faith, which should be carefully considered when drafting and applying insurance policy terms that could detrimentally affect insureds.

While ASIC has stated through its media release that it is in the process of reviewing the Federal Court's judgment, it is an open option for ASIC to appeal this decision.

To read our insights on the broader implications of this case, see our article on the "Flotation Devices" under the Insurance Contracts Act.

If you have any questions, or would like a "deep dive" workshop on the Auto & General case and its implications, get in touch with one of our experts below.