Double insurance - What happens when the same risk is insured twice?

Insuring the same risk twice with different insurers is not as silly as it sounds.

In the early days of marine insurance, insureds commonly purchased more than one insurance policy to cover the same risk in order to protect themselves against insurer insolvency. 

In England, insureds placed the bulk of their marine insurance with individual underwriters through a certain coffee shop called Lloyd’s Coffee House. 

Those individual underwriters were not subject to any financial controls and insolvencies were common.

THE DOCTRINE OF CONTRIBUTION

Before you dismiss the risk of this happening in New Zealand today, I remind you of AMI and CBL, and of HIH in Australia. In the USA, AIG narrowly avoided insolvency through a government bailout.

By having more than one policy, the insured could decide which insurer to claim against and in what order. 

This was viewed as unfair to the insurer first claimed upon as it was forced to bear an unfair burden of the insured’s loss. 

The law addressed this unfairness by developing the doctrine of contribution, allowing the insurer first claimed upon to spread the claim among all the other insurers on risk.

DOUBLE INSURANCE BY ACCIDENT

It is more common these days for double insurance to occur by accident. 

A good example is a building contractor with its own comprehensive liability insurance entering into a contract with a head contractor or principal, which requires that party to arrange liability insurance for the benefit of all the parties. 

Unwittingly, the building contractor now has two liability policies.

Over time, insurers developed clauses in their policies that tried to contract out of the right of other insurers to seek contribution from them in an effort deflect the loss entirely to other insurers. Insurers commonly call these clauses ‘double insurance’ or ‘other insurance’ clauses.

Insurers have come up with ever more elaborate clauses, leading to determining which insurer bears the claim being determined in a similar way to the game of paper/scissors/rock.

THE DOUBLE INSURANCE CLAUSES

Although the exact drafting will vary, there are generally three levels of clauses.

At the lowest level, there is the rateable proportion clause. This clause says that where there is double insurance, that insurer’s policy only pays to the insured its rateable proportion of the loss. 

In the absence of both policies having any double insurance clauses, this probably would have been the outcome anyway. 

However, this clause allows the first insurer to only pay its portion and to force the insured to go to the other insurer to collect the other portion. 

That way, the first insurer avoids having to pay the claim in full and then obtain contribution from the other insurer later.

MINIMISING THE RISK

At the middle level, there is the excess clause. This clause says that where there are two policies covering the same loss, the policy with the excess clause only pays in excess of the other policy. 

In other words, the other policy goes first and only once it is exhausted does the policy with the excess clause start meeting the loss.

At the highest level is the escape clause. 

This clause often appears as an exclusion and it says that where the loss covered under a policy is covered under any other policy to any extent, there is no cover under the policy with the escape clause at all.

SCISSORS PAPER ROCK

These days it is common for all policies to have a double insurance clause. However, which level it has varies between insurers. 

This has resulted in a number of court cases where the courts have had to interpret competing clauses at different levels in order to see what the net effect of both of them is. They have also had to interpret competing clauses at the same level.

Subject to compulsory legislation, parties are free to enter into contracts on whatever terms they desire. 

The court’s task is to interpret them. As a number of the cases show, the interaction between double insurance clauses may result in the courts interpreting one policy in a way that it meets all of the loss, and the other policy in a way that it meets none of it. 

In this situation there is, in fact, no double insurance because of the interaction between the clauses.

This exercise has led to the paper/scissors/rock analogy. 

This is because generally, a rateable proportion clause is gazumped by an excess clause, and an excess clause is gazumped by an escape clause. In each case, the gazumping policy ‘wins’ and pays nothing.

LEGAL ABSURDITY

What happens when both policies have an excess clause or an escape clause? 

The courts have ruled that this leads to an absurdity whereby whichever policy is looked at, the other policy responds. In order to give the contract business sense, the courts have ruled that the clauses cancel each other out and the default common law position of each policy paying its rateable proportion applies.

A good example of the courts interpreting competing clauses occurred recently in the New South Wales Supreme Court decision of Allianz Insurance Australia Limited v Certain Underwriters at Lloyd’s of London [2019] NSWSC 453.

The Allianz insured entered into a contract with a state road authority to upgrade a road. 

Under the contract, the authority agreed to arrange a full suite of insurance policies that insured not only itself, but also all the contractors including the Allianz insured. The Allianz insured already had its own suite of insurance policies with Lloyds of London.

The underlying insurance claim involved a payment of approximately A$1M. Allianz paid this and then upon discovering the Lloyd’s of London policy, sued the syndicates involved for contribution on the basis that both policies covered the liability. 

The syndicates resisted, because in their view, properly interpreted the two policies did not create double insurance, and the claim sat entirely with Allianz.

A SENSIBLE INDUSTRY APPROACH?

While it was slightly more complicated than this, the Allianz policy had an excess clause and the Lloyd’s of London policy had an escape clause. 

The court found, after carefully interpreting the competing policy’s double insurance clause side by side, that the loss fell to be covered under the Allianz policy only. 

There was no double insurance and Allianz’s action for contribution failed. This is consistent with the usual outcome that an escape clause gazumps an excess clause.

Is this a sensible industry approach?

To anyone reading this, it should be obvious that this is a rather haphazard way of dealing with double insurance across the industry. The inevitable result must be that over time all insurers will use escape clauses.

This will be an ‘own goal’ for the industry as it will mean the legal outcome goes full circle — they are all back to paying their rateable proportion because the clauses at the same level cancel each other out.

LEGAL SCRAPS NOT A GOOD LOOK

It is interesting to see that Australia addressed this issue all the way back in 1984 when it enacted the Insurance Contracts Act. Section 45 has the effect of making all double insurance clauses in insurance policies void. This was to stop insurers trying to contractually ‘gazump’ each other. 

However, it appears that it was not drafted widely enough to apply to all insurance policies. The case considered above is an example of a situation that fell outside section 45.

Interestingly, the England and Wales reforms of insurance law in 2015 did not address this issue.

Is this something that should be fixed in New Zealand’s pending reforms? We think so. We say unseemly legal scraps between insurers as to who should end up paying the insured’s loss are not a good look for the industry.

This article first appeared on the Keegan Alexander website. It is reproduced here with permission.