UK: Material Alteration To The Insured Risk

At common law, an insurer faced with changed circumstances which materially alter the insured risk during the course of the policy is entitled to treat the insurance contract as automatically discharged. Earlier this year, the Commercial Court in Swiss Reinsurance Co v United India Insurance Co Ltd (2005) restated the important distinction between such a material alteration and a change in the risk which merely renders it more likely that a loss will occur, which will not entitle the insurer to terminate the contract. The Court also considered when an insured is entitled to a return of premium in these circumstances.

Swiss Re reinsured United India Insurance ("UII") in respect of a Construction All Risks (CAR) policy ("the Project Insurance") issued by UII. The Project Insurance covered the second phase of works for the Dabhol Power Project, a very substantial civil engineering project in India. This phase involved construction of two generating plants and a liquid natural gas facility on site. The physical damage section of the Project Insurance provided cover for the construction period and for a 12-month maintenance period following handover.

A dispute arose between two of the participants in the joint venture, leaving the joint venture company without the funds required to complete the construction. The contractors were not paid and therefore left the site before the project was completed (although it was almost finished).

After the contractors stopped work, Swiss Re and UII agreed that the reinsurance cover could continue for a further six months, with no premium increase, mirroring the effect of a term in the CAR policy.

When the six-month extension ended, Swiss Re informed UII that it regarded the CAR policy, and thus the reinsurance cover, as terminated. UII requested the return of the reinsurance premium attributable to the maintenance period (which UII argued had not commenced), on the basis that the policy cover was divisible into constituent parts – the construction period and the maintenance period.

Consequently, two of the issues which the court was asked to consider were:

• Was Swiss Re entitled to treat the CAR policy as at an end, on the basis that the cessation of work by the contractor constituted a material alteration to the insured risk?

• Was Swiss Re entitled to retain the entire premium?

The Court decided in accordance with established law (Kausar v Eagle Star (2000)) that to constitute a material change in risk, the change must be so great that it can properly be said by the insurers that the changed risk is something which, on the true construction of the policy, they had not agreed to cover. The Court went on to find that there had been a material alteration of risk and thus the CAR policy had been automatically terminated. The risk which UII had originally contemplated was a construction site on which contractors and subcontractors were carrying out works, and the risks which required insurance were construction risks. After cessation of the works, what was left was effectively a warehouse or repository for the various equipment and installations which had been completed at the time of cessation. In effect, the policy had ceased to be a CAR policy and what was now required for the site was property insurance. Although the two policy types had some features in common, they were nonetheless essentially different. In the circumstances, there had been a material change to the risk insured.

UII sought to argue that the insurance consisted of severable parts - cover for the construction period and cover for the maintenance period - in respect of each of which a distinct premium was paid. As such, it argued, the part of the premium which related to the maintenance period should be returned to it. The Court rejected UII’s contentions as to the severability of the premium, and held that Swiss Re would not have to return the premium because some part of the risk for which the global premium was paid had run, and premium is not recoverable in those circumstances, (see section 84 of the Marine Insurance Act 1906). It also indicated that if it had accepted UII’s arguments on severability, it would nevertheless have decided in favour of Swiss Re, because part of the risk of the maintenance liability cover under the reinsurance had run, as certain of the works packages carried out by subcontractors had been completed, and subcontractors were co-insured on the policy.

This case usefully illustrates the distinction between a CAR policy and an operational policy and emphasises that they anticipate a very different risk - notably, they would be frequently written by different underwriters. Therefore, this is an extreme example, and whether it be construction or operational property policies generally, our courts remain reluctant to allow underwriters to relinquish their liability by suggesting the risk has increased beyond that which was anticipated on presentation. Insurers receive a good deal of legal protection before the risk is underwritten by the requirements imposed by the duty of utmost good faith so as to create a "level playing field" when assessing the risk.

As soon as the risk is underwritten, however, our courts will assume that insurers have been able to assess the risk and the likelihood of that risk increasing. It is only if underwriters have inserted specific clauses (and increase in risk/hazard clauses have very little value) dealing with increase in specific risks (e.g. fire/security) or the risk has changed fundamentally, as in the Swiss Re case, that insurers will be able to deny liability. The question to ask is "Is it a different contract than the one entered into?". The dicta of Sir Frederick Pollock in Baxendale v Harvey (1859) still holds true -

"The Insurer, when it has had notice of the risk, is not entitled to any notice by reason of the increase in danger. A person who insures may light as many candles as he pleases in his house, though each additional candle increases the danger of setting the house on fire."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.