The commonly understood requirement that an insured must have an insurable interest in the subject matter of the insurance for a contract of insurance to be valid was recently placed under the judicial spotlight in the matter of Lorcom Thirteen (Pty) Ltd v Zurich Insurance Company of South Africa Limited. The judgment raises some pertinent issues for underwriters.

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The facts

The case involved a total loss claim by Lorcom (the insured) in terms of a valued hull, machinery and equipment policy of marine insurance for the fishing vessel "Buccaneer". Cover under the policy was subject, inter alia, to the Institute Fishing Vessel Clauses (20/07/87).

The underwriter declined to pay a total loss claim following the sinking of the vessel on the related grounds that the insured did not have an insurable interest in the vessel and the loss suffered did not fall within the ambit of the cover. These defences were based on the fact that the insured was not the owner of the vessel, and that it was accordingly not the party that suffered the loss covered by the policy of insurance.

While the insured was the holder of 100% of the shares in the vessel owner; and had a temporary right of use and a factual expectation (although not a legal right) to become the owner of the "Buccaneer", the underwriter argued that it did not have an insurable interest in respect of a marine policy covering the loss of hull, machinery and equipment.

The contract of insurance was subject to South African law pursuant to the agreement of the parties, although South African common law would have applied in any event absent any express agreement by virtue of section 6(1)(b) of the Admiralty Jurisdiction Regulation Act, No. 105 of 1983.

Contract of insurance or betting agreement?

The court commenced with an examination of the origins of the concept of insurable interest, and noted that its genesis is not in common law but rather in English statute, commencing with the Marine Insurance Act of 1745 and in subsequent English legislation pertaining to insurance and gaming.

The concept of insurable interest was originally introduced to combat the potential moral hazard associated with strangers to the subject matter of the insurance having an interest in the occurrence of the insured event by virtue of the contract alone. (It was feared that this might provide an unhealthy incentive for the destruction of the property or life concerned.) It was also introduced to prevent gambling under the guise of insurance.

The court found that there is no South African statute that lays down the need for an insurable interest, and that there is no justification for the importation of the statutory requirement of English law. The perceived mischief originally targeted by the insurable interest requirement is handled in South African law by the statutory regulation of gambling, and the common law in relation to unlicensed gambling agreements, which are stigmatised and discouraged as unenforceable.

In the circumstances, the court held that the proper enquiry in South African law is not whether there is an insurable interest but rather whether the contract in question ought to be regarded as an enforceable contract of insurance or an unenforceable agreement of wager.

The distinction between a contract of insurance and betting agreement lies in the fact that an insured party has a reason (apart from the contract) as to why the occurrence of the events insured against matter. The real interest of an insured (unlike that of a gambler) is that the specified event should not occur. The court expressed the view that the enquiry into whether a person has sufficient interest in the event insured against should not be an unduly technical matter, and that there may be no harm in referring to the stake as an 'insurable interest'. This is providing one does not equate the interest required to avoid categorisation as an unenforceable wager with the distinct English law requirement of insurable interest.

The court held that the presence or absence of an insurable interest is not a self-standing requirement, though it may be a relevant aspect of the proper enquiry as to whether the agreement amounts to an unenforceable wager.

The indemnity principle and insurable interest

In the case of indemnity insurance the so-called indemnity principle, which takes effect as an implied or actual contractual term, stipulates that an insured must have suffered a loss in order to be able to recover under the policy. The indemnity principle plays a role in distinguishing between genuine insurance and unenforceable wager.

Having said this, given its contractual nature the indemnity principle is susceptible to amendment or possibly even waiver by the parties to the agreement of insurance. While there is a difference between the contractual indemnity principle and the English statutory requirement that there be an insurable interest, the proximity between the concepts has often resulted in the indemnity principle being considered in the context of statutory definitions of insurable interest.

Since the parties in Lorcom approached the case from the perspective of insurable interest and not unenforceable wager, the court proceeded to consider the case law concerning insurable interest, noting that courts often approach question of insurable interest quite liberally, tending to allow the insured to recover what was promised rather than permit the underwriter to escape responsibility on the basis of what is regarded as a technical and opportunistic defence.

By way of example, the court referred to Littlejohn v Norwich Union Fire Insurance Society 1905 TH 374, where a husband married out of community of property was found to have an insurable interest in goods of his wife which constituted trading assets in a business the husband managed. Reference was also made to Refrigerated Trucking (Pty) Ltd v Zive NO (Aegis Insurance Co Ltd, Third Party) 1996 2 (T) 361, where it was found that the owner of the vehicle had an insurable interest to obtain cover in respect of third party liability incurred by drivers of its vehicles. The insurer's promise to pay to the insured an amount equal to the liability incurred by the driver was enforceable, even though the insured did not incur that liability itself and did not suffer a patrimonial loss.

Notwithstanding the generally liberal approach to the enquiry as to the existence of an insurable interest, the court found that the question of insurable interest cannot be divorced from the type and extent of recovery permitted under a policy. For example, in Manderson t/a Hillcrest Electrical v Standard General Insurance Co Ltd 1996 (3) SA 434, the genuine interest that an employer had in his employee retaining the use of his personal vehicle was found to be insufficient to give rise to an insurable interest for the purposes of a policy of insurance covering the full value of the vehicle.

Turning to the facts of the Lorcom case, the court found that a proper interpretation of the policy of insurance did not compel the insured to prove that it had suffered a patrimonial loss, but rather that there be loss or damage to the vessel. The insured merely needed to demonstrate "an interest sufficient to render enforceable a policy providing cover measured with reference to the value of the vessel."

While the court considered that the insured's temporary right of use of the "Buccaneer" was, by itself, insufficient to sustain insurance cover measured with reference to the replacement value of the vessel, the additional factual expectation that it had of becoming the owner of the vessel (in terms of a series of contracts involving its shareholder and a purchaser), gave rise to an insurable interest in such cover.

In any event, the court held that the fact that Lorcom held 100% of the shares in the vessel owner put the question of insurable interest beyond doubt, as it gave the shareholder "an interest in the company's assets sufficient to rationally sustain insurance cover expressed with reference to the underlying value of the assets." The court went on to find that this interest entitled the insured to recover the loss or diminution in the value of the insured asset, not loss in value of the shareholder's shares.

The court expressed the view that permitting a claim based on the market value of the subject matter of the insurance, without requiring proof that the insured has suffered a patrimonial loss in the same amount, would not prejudice insurers, as they had taken on the risk of paying on the basis of an actuarially assessed premium related to the likelihood of the risk eventuating. The fact that, on this basis, there may be multiple parties with an insurable interest sufficient to sustain insurance cover measured with reference to the market value of the vessel was also not regarded as inequitable, since each insured would pay premium calculated with reference to the risk.

Implications for underwriters

One important implication for underwriters in the departure from the indemnity principle evidenced by Lorcom, is the negative impact this has on the prospects of the underwriter successfully recovering monies under rights of subrogation.

The underwriter can obviously acquire no better rights against responsible third parties than those held by the insured. Thus, if one postulates a situation whereby the "Buccaneer" sank on account of the actionable negligence of a third party, it is the erstwhile owner of the "Buccaneer", not the insured, that would enjoy that right of action, and the underwriter would therefore have no prospects of a successful recovery action.

If the uninsured owner proceeded to recover its damages in a hypothetical recovery action, then the insured shareholder would have the best of both worlds, enjoying the benefit of both the payment of its claim under the policy and (indirectly) the uninsured owner's successful recovery action. It is questionable whether or not this possibility is something the underwriter would have considered when determining the amount of premium payable under the policy.

It is worth noting that there may well be different considerations applicable in relation to different policies of insurance. For example in a marine cargo policy based on the Institute Cargo Clauses the policy wording itself stipulates that in order to recover under the insurance "the Assured must have an insurable interest in the subject-matter insured at the time of the loss."

How this contractually imported requirement of an insurable interest should be interpreted in circumstances where the parties have made an express choice that South African law should apply remains to be seen. (The provisions of clause 19 of the Institute Cargo Clauses (A), provides that the insurance is subject to English law and practice.) It is certainly arguable that the English law understanding of insurable interest would play a greater role in speaking to the intention of the parities in these circumstances.

Having said this, it should be noted that even in English law a more flexible approach to the question of insurable interest has started to take root, with questions being raised regarding its on-going usefulness.

Conclusion

The Lorcom case sounds a clear warning to underwriters regarding the difficulties associated with the rejection of a claim on the basis of an alleged absence of insurable interest, or an unenforceable gamble.

Underwriters should carefully consider the true nature of the interest which a prospective insured has at the time of entering into a contract of insurance, and also the relationship that interest has to the indemnity provided under the policy, understanding that a court will not lightly render the bargain unenforceable once a claim has arisen.

This article was written by Andre Bowley l Partner at Webber Wentzel