Good faith and income protection insurance

The recent case of Taylor v Asteron Life [2019] NZHC 978 provides guidance for insurers in two respects:

  1. The High Court held that the insured’s duty of utmost good faith is an implied term in an income protection insurance contract, which requires insureds to be truthful in making claims.
  2. Where an insured breaches the duty of utmost good faith, the insurer may use remedies under the Contract and Commercial Law Act 2017, rather than be left with its remedies at common law.  This allows insurers to reclaim settlement payments that are later found to have been improperly made, as damages for breach of contract or as repayment of amounts paid under the insurance contract.

In this case the insurer was awarded full restitution of the amounts it had paid the insured under the policy.

The Facts

Mr Taylor was a self-employed insurance broker. He became ill and was unable to work from 23 December 2009. In July 2010, Mr Taylor submitted a claim under his “Income Plan” insurance policy with Asteron Life Limited (Asteron), which accepted his claim and started making payments.

In May 2014, Asteron made a number of requests of Mr Taylor to supply it with financial information. Eventually he produced some financial information, including accounts for a company called Peter J Taylor and Associates Limited (the Company). The accounts were not for his insurance broking business, though some of the commissions earned through that business were channelled through the Company. The accounts showed that the Company had made a loss. Asteron asked about the commissions disclosed in the accounts, which totalled $551,491 and had been paid into and out of the Company. Asteron explained that Mr Taylor’s insurance entitlement was subject to a deduction for prescribed income that he earned while claiming policy benefits. In September 2014, Asteron stopped making payments and advised Mr Taylor that it would not make any further payments until it could reconcile his claim.

In December 2015, Mr Taylor sued Asteron and sought:

  1. a declaration that he was entitled to receive continuing benefits under his policy; and
  2. an order directing Asteron to make payments of benefits under the policy together with payment arrears since September 2014.

Asteron counterclaimed and sought restitution of all amounts paid under Mr Taylor’s policy.

The Policy

The Policy included two categories of cover – a “Total Disability Benefit” and a “Partial Disability Benefit”.  The “Total Disability Benefit” provided “Full Pay” for a period of 60 days followed by a 75% “Pay Period” until the insured turned 65, subject to the deduction of certain specified income. Mr Taylor was entitled to work up to 10 hours per week while collecting the “Total Disability Benefit”. After a minimum period of 14 days on the “Total Disability Benefit”, Mr Taylor could drop back to the “Partial Disability Benefit” of 75% of his insured monthly income, less specified income, if he was able to work to a limited extent so that his monthly income equated to 75% or less of his insured monthly income.

Mr Taylor’s claims

Whether Mr Taylor suffered from a ‘Sickness’

The first point that the Court needed to establish was whether Mr Taylor suffered from a sickness within the meaning of the policy. Mr Taylor elected not to call expert medical evidence. This would ordinarily have made the task of proving his illness very difficult. However, because Asteron did not dispute that Mr Taylor suffered from a qualifying sickness, the Court accepted that he was potentially entitled to qualify for one of the policy benefits.

Although the Court found it difficult to identify what conditions Mr Taylor suffered from, they appeared to include a long list of illnesses and complications.

Whether Mr Taylor was “Totally Disabled” or “Partially Disabled”

Mr Taylor’s evidence was that he had not been able to work more than 10 hours per week since 2010. However, Asteron subpoenaed three of his former employees to give evidence which contradicted his account. It was supported by documentary records which confirmed that Mr Taylor was still actively involved in his business.

The Court concluded that Mr Taylor’s evidence was generally unreliable. The Court determined that Mr Taylor was able to, and did in fact, work for more than 10 hours per week, which disqualified him from receiving the Totally Disability Benefit.

The question was then whether Mr Taylor could nonetheless have claimed the Partial Disability Benefit. The primary issue was in identifying Mr Taylor’s “Monthly Earned Income” for the period during which he made claims on his policy. It was defined in the policy as “… your monthly pre-tax salary, commissions, bonuses and fringe benefits if an employee, or your monthly pre-tax earnings net of any business expenses necessarily incurred in deriving those earnings if a self-employed person.” This issue was important as Mr Taylor’s income was derived from a business that made money from his and others’ efforts. Mr Taylor had insured all of the income he derived from his business. So the Court defined “Monthly Earned Income” in the context of this claim as:

… Mr Taylor’s monthly pre-tax earnings from his business, net of any business expenses necessarily incurred in deriving those earnings. That is so whether or not the earnings are a consequence of his own efforts, or those of his employees, or not.

In determining the specified income to be deducted from his claim amount for the purposes of quantifying any Partial Disability Benefit:

The full amount of the net profit from Mr Taylor’s self-employed business gets deducted from the prescribed benefit irrespective of any arguments that it was not the product of his own endeavours, or solely his own endeavours.

Asteron called an expert accountant to calculate whether Mr Taylor was entitled to receive the “Partial Disability Benefit” i.e. whether his Monthly Earned Income was 75 per cent or less of his Monthly Insured Income. The accountant calculated Mr Taylor’s Monthly Earned Income for the 2008 – 2014 financial years, a task which was complicated by the fact that Mr Taylor had provided differing sets of the same annual accounts, one of which falsely represented that his broking business made trading losses. The evidence assumed that Mr Taylor earned his monthly income evenly across the year, and even on that assumption, the required two-thirds abatement resulted in all amounts due under the policy being fully off-set.

Consequently, the Court found that Mr Taylor’s illness had not adversely affected his income in a way covered by the policy. The Court dismissed his primary claims.

Asteron’s counterclaims

Asteron counterclaimed that it was entitled to:

  1. cancel the contract of insurance or avoid any further liability under it; and
  2. claim restitution of the amounts it had paid to Mr Taylor.

The legal framework

The Court found that the duty of good faith was an implied term of the insurance contract and its application was therefore subject to a contractual analysis. Asteron alleged that Mr Taylor “… breached his obligations of good faith under the contract by making false statements in his forms provided with his claims. It also seeks restitution of what it paid out on that basis.”

The Court acknowledged uncertainty in determining the correct legal framework for an insurer’s remedies following an insured’s breach of the duty of utmost good faith. Asteron had relied on common law principles, whereas Mr Taylor had argued that the Contract and Commercial Law Act 2017 applied. In the end, the parties agreed that that Act could be used to address all of the issues in this case and the Court proceeded on that basis.

Sections 36 to 39 apply to cancellation where a party rescinds or treats the contract as discharged for misrepresentation, repudiation, or breach. Under section 37(1)(b) and (2), Asteron was entitled to cancel the policy if Mr Taylor breached a term of the contract that was essential to Asteron, or which substantially altered the benefits and burdens of the contract.

Decision on Mr Taylor’s position

The Court found that Mr Taylor breached his obligation of good faith under the policy by making false statements about the amount of time he had spent working in the forms he provided with his claims. The Court found that Mr Taylor deliberately misrepresented to Asteron the amount of work in which he was engaged. Mr Taylor had returned to work in 2010 and worked approximately four hours a day at home or in the office and generally oversaw the overall business operation. This amounted to a breach of Mr Taylor’s duties under the contract. In addition, his income remained essentially unaffected as well as being beyond that which was agreed in the policy.

Asteron had based its claim on the representations that Mr Taylor had made regarding the number of hours that he worked and not his statements about his income. However, the Court recorded that the financial statements which Mr Taylor discovered for his business for the 2010-2012 financial years presented a serious issue. They were signed by his accountants and stated that the business had made losses of $75,301 in 2010; $38,607 in 2011 and $70,881 in 2012, over the years that Mr Taylor claimed to be incapacitated by his illness. However, Mr Taylor also discovered a second set of signed accounts which reported an operating profit of $149,025 in 2010; $163,830 in 2011; and $155,407 in 2012. The Court found that the inaccurate accounts were deliberately prepared to create the false impression that Mr Taylor made operating losses when, in reality, he was making profits.

Asteron’s restitution claim

Asteron sought “an order requiring Mr Taylor to pay back to it all the money it has paid him under the Policy given that the payments were induced by the false claims.” Notably, the restitution claims were made on the basis of Mr Taylor’s statements about his hours worked, not about his income, although the Court saw the two as closely related.

The Court applied section 42 of the Act, which allows the Court to make orders with the effect of unwinding contractual obligations that have already been performed where it is just and practicable to do so. One preliminary issue was whether Asteron had given the necessary notice of cancellation, as section 43 requires the claiming party to have cancelled. Section 41(1)(a) requires cancellation to have been made known to the other party, i.e. Mr Taylor. The Court found that the necessary notice was given in one of Asteron’s witnesses’ briefs.

Mr Taylor attempted to advance three defences: immateriality, absence of intent and change of position. The Court found that Mr Taylor’s misstatements were plainly material and deliberately false, which dealt with the first two of his defences.

In advance of the change of position defence, Mr Taylor pleaded that he had received the payments in good faith and had altered his position in reliance on their validity. He relied upon his purchase of two luxury cars, expenditure on building a holiday home, and expenditure on overseas trips (including a 12 hour flight to Hawaii which the Court found difficult to reconcile with the evidence that he suffered from extreme back pain inhibiting his ability to remain seated for work activities). To be able to rely on this defence it was necessary for Mr Taylor to have acted in good faith, which he had not, given that he had induced Asteron to make payments under the policy by making false statements in relation to the extent of his ability to work.

The Court awarded Asteron full repayment of the money it had paid with interest.

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