1. Relation to the PICC
C1 Article 3.2 lays down the exclusive remedies for breach of the duty of pre-contractual disclosure. As a consequence, if a reinsured breaches this duty, the reinsurer is not entitled to avoid the contract for mistake pursuant to Article 3.2.2 PICC or for fraud pursuant to Article 3.2.5 PICC.
C2 Damages pursuant to an application by analogy of Chapter 7, Section 4 PICC (cf. Article 7.4.1 Comment 3 PICC) may only be claimed in accordance with Article 3.2. Thus, the reinsurer does not have a choice between claiming damages and adjusting or avoiding the contract, as the case may be. The reinsurer is bound to exercise the remedies as set forth in paragraphs (1) to (3) and may only claim such damages which are not cured by the exercise of these remedies. This will usually be reliance damages (see Comment 38).
2. Structure of the provision
C3 Article 3.2 is designed in a threefold structure. Paragraphs (1) and (2) determine the consequences of a breach of the pre-contractual duty of disclosure in cases where the reinsurer would have entered into the contract, albeit on different terms and conditions. In principle, paragraphs (1) and (2) allow for an adjustment, whereas paragraph (3) allows for the avoidance of the contract. Paragraph (4) grants additional damages which are not already covered by paragraphs (1) to (3).
3. Determining breach of the duty of disclosure as set forth in Article 2.2.1
C4 Exercise of the remedies enumerated in Article 3.2 requires a breach of the duty of disclosure established in Article 2.2.1. This requirement is met if the prospective reinsured fails to provide the reinsurer with all information, known or reasonably ought to be known, that is material to the risks to be assumed by the reinsurer. Breach of the duty is determined pursuant to Article 2.2.1 and the Comments thereto.
4. Remedies in general
C5 Article 3.2 sets forth remedies exclusively for breaches of the pre-contractual duty of disclosure. The Article mentions non-disclosure but does not explicitly refer to misrepresentation. This is because non-disclosure under the PRICL includes the concept of misrepresentation.
C6 As described in Comments 22 et seq. to Article 2.2.1, the reinsured may have breached a disclosure duty not covered by Article 2.2.1, i.e. to provide an appropriate answer to the reinsurer’s inquiries for additional information. Any breach of such duty is not to be treated as a breach of the duty of disclosure under Article 3.2 either. The same applies to breaches of other pre-contractual duties, which may relate to the duty of utmost good faith (Article 2.1.2) and the duty of confidentiality (Article 2.1.3).
C7 Article 3.2 is based on the assumption that both parties to the contract have an interest in upholding it despite the breach. The PRICL, therefore, adopts an approach that seeks to uphold the contract. Accordingly, adjustment is the favoured remedy, and avoidance is the remedy of last resort, available only where strict requirements are met (paragraph (3)).
C8 Article 3.2 seeks to provide the reinsurer with remedies which are proportionate to the gravity of the breach and its consequences. The Article balances the interests of the parties and also reflects modern developments in insurance and reinsurance, as demonstrated, e.g. by the UK Insurance Act 2015, Schedule 1.
C9 The reinsurer may unilaterally exercise the remedies granted, notably the adjustment of the contract; the reinsurer bears the burden of proving their availability.
C10 In accordance with the principle of good faith under Article 1.7 PICC and the principle of utmost good faith under Article 2.1.2, a reinsurer entitled to a remedy under Article 3.2 may be restricted in exercising such right. For example, a reinsurer may not be able to adjust the contract pursuant to paragraphs (1) and (2) or to avoid it pursuant to paragraph (3) if it has not pursued that right within a reasonable time. Generally speaking, the concept of inconsistent behaviour (venire contra factum proprium; cf. Article 1.8 PICC) applies to the exercise of such remedies. For example, a reinsurer may not exercise a remedy if the breach was caused by its own act or omission or if the reinsurer was aware of the undisclosed information (cf. Article 7.1.2 PICC (Interference by the other party)).
C11 Questions concerning limitation are governed by Chapter 10 PICC. In particular, the maximum limitation period of ten years under Article 10.2(2) PICC applies where the reinsurer remains unaware of the breach. In contrast, the principle of utmost good faith generally requires the reinsurer to exercise its remedy within a reasonable time after becoming aware of the non-disclosure. The reinsurer is then not allowed to rely on the general limitation period of three years pursuant to Article 10.2(1) PICC.
5. Right to adjust the contract
a. Deterrent effect
C12 Traditionally, reinsurers could avoid the contract for the reinsureds’ breach of its pre-contractual disclosure duty, thereby obtaining a full discharge from their obligations. While the severity of this remedy had a strong deterrent effect, contract avoidance often proved to be a disproportionate remedy.
C13 Contract adjustment under paragraphs (1) and (2) reflects a more proportionate approach. However, it raises the question arises of whether adjustment provides sufficient motivation for the reinsured to make full disclosure. The concern is that the remedy of adjustment allows the non-disclosing reinsured to be no worse off than it would have been had it made proper disclosure.
C14 This concern is overstated. In cases of fraud or where the reinsurer demonstrates that it would not have entered into the contract at all, the remedy of avoidance remains available. Furthermore, in cases of adjustment, the reinsured will be worse off in many situations. For example, if the reinsurer adjusts the contract by inserting an exclusion clause, losses which occurred in the past and are subject to the exclusion clause will not be covered at all. Moreover, where the reinsurer has received an inadequate premium relative to the risk, the amount to be paid will be reduced proportionately and lead to the effect that the reinsured is only partially covered. This provides sufficient incentive for the reinsured to comply with its duty of disclosure.
Illustration
I1. Reinsured A, a life insurer, failed to inform Reinsurer B that it sells policies exclusively through marketing to members of the American Association of Retired Persons (AARP). The minimum age for AARP membership is 55. Forty of the policyholders are killed when a terrorist bomb destroys the high-rise apartment building in which they reside. All held high-limit life insurance policies issued by Reinsured A, resulting in payments of USD 40 million by Reinsured A to beneficiaries. Reinsurer B discovers the failure to disclose the information regarding the age group at which policies were targeted, a material omission in view of the increased mortality associated with age. An objectively reasonable and prudent reinsurer would have demanded a higher premium as a condition of entering into the contract of reinsurance. Reinsured A nonetheless seeks payment by Reinsurer B by arguing that the deaths of the insured persons were not related to their age but were caused by murder. Although Reinsured A is correct that the loss in question was caused by terrorism and crime rather than age-related mortality, Reinsured A’s breach of its duty of disclosure entitles Reinsurer B to adjust the contract.
b. Paragraph (1): Different terms and conditions other than the premium
C15 Paragraph (1) establishes a right to retroactively adjust the contract where the reinsurer demonstrates that it would have entered into the contract only on different terms and conditions. As a consequence, such terms and conditions form part of the contract retroactively.
C16 The formula “terms and conditions” as mentioned in paragraph (1) is used as a synonym for any kind of contract clause. It is used in a broad sense. The wording would even cover the premium arrangement. However, the premium is expressly excluded from the scope of application of paragraph (1) because it is directly addressed in paragraph (2). The differentiation made between premium and other terms and conditions is consistent with UK Insurance Act 2015, Schedule 1.
C17 One of the situations addressed by paragraph (1) is that in which the reinsurer would have excluded a risk had it known the undisclosed information. In such cases, the reinsurer has the option of retroactively inserting such an exclusion into the contract. This exclusion would become part of the contract and may release the reinsurer from providing coverage for a risk initially insured under the contract.
Illustration
I2. Reinsured A fails to disclose the information that it insures large asbestos manufacturers. Reinsurer B would never have entered into the contract without an asbestos exclusion. When Reinsurer B is presented with asbestos claims, it is entitled to insert an asbestos exclusion retroactively.
C18 In another scenario, a reinsurer may have been willing to accept the risk but only at a lower limit had it been aware of the undisclosed information. In such cases, the reinsurer would be able to adjust the contract by reducing its liability to the limit it would have covered.
Illustration
I3. Reinsured A purchases a USD 500 million coverage from Reinsurer B. Reinsured A fails to disclose the information that a considerable portion of its property policies covers risks located in Florida, a state in which hurricane losses are common. Reinsurer B’s underwriting guidelines provide a maximum cover limit of USD 100 million where the risk involves Florida property. Upon discovering the true facts, Reinsurer B is entitled to limit its cover to USD 100 million in accordance with its underwriting guidelines.
c. Paragraph (2): Higher premium
C19 Paragraph (2) addresses remedies available to the reinsurer in case it would have entered into the contract on a higher premium had it known the undisclosed information. The reinsurer’s rights to reduce the amount to be paid on a claim (subparagraph (a)) and to adjust the premium (subparagraph (b)) protect its interest in receiving a premium adequate to the risk. At the same time, paragraph (2) allows the contract to be upheld, which is in both parties’ interest.
C20 The remedy to proportionally reduce the amount to be paid under subparagraph (a) relates to any claim arising from a loss that occurred before the reinsurer became aware of the breach. This applies irrespective of how such loss will be allocated under an allocation clause in the contract. For example, if a loss occurring before the reinsurer became aware of the non-disclosure is allocated to a period following such awareness, the amount to be paid may nevertheless be reduced proportionately. In turn, if a loss occurring after the reinsurer became aware of the non-disclosure is allocated to a period prior to such awareness, the amount to be paid is not reduced. The reinsured may respond to this situation by accepting to pay the higher premium even retroactively (second sentence of paragraph (2)). This is dealt with in Comment 24 below.
C21 In determining the proportionate reduction, the reinsurer must use the ratio of the premium actually charged to the higher premium that would have been charged had the reinsurer been correctly informed.
Illustration
I4. Reinsured A issues automobile liability policies and states that it has 100,000 policies in force. In fact, it has 200,000 policies in force. Reinsured A contracts with Reinsurer B which charges USD 10 million for the coverage but would have charged USD 20 million had it known the actual facts. Reinsurer B is entitled to reduce the amount to be paid on claims by 50 percent.
C22 Subparagraph (b) grants the reinsurer the right to claim the premium it would have charged had it known the undisclosed information. This higher premium applies to the remaining contract period. Correspondingly, all claims arising from a loss that occurred after the reinsurer became aware of the breach are covered as provided in the contract. This applies irrespective of whether the reinsurer actually adjusts the premium.
C23 This approach deviates from the solution set out in the UK Insurance Act 2015. Subparagraph (b) operates prospectively as from the moment the reinsurer becomes aware of the non-disclosure. From that moment on, it puts the parties in the position they would have been in had they contracted on the basis of full disclosure. By contrast, the UK Insurance Act 2015 only provides for a proportionate reduction in the amount to be paid on claims (cf. Schedule 1, paragraph 6). Where the breach was deliberate or reckless, the UK Act provides the reinsurer with an additional right to avoid the contract (cf. Schedule 1, paragraph 2).
C24 The second sentence of paragraph (2) grants the reinsured the right to pay the higher premium retroactively to the formation of the contract. This right is exercised by notifying the reinsurer within a reasonable time after the premium adjustment. As a consequence, the reinsured is entitled to coverage as provided in the contract but only for losses of which it was not aware prior to notification. The rule in the second sentence of paragraph (2) anticipates situations in which contracts of reinsurance involve long-tail risks.
C25 “Reasonable” refers to the period of time that is necessary for the reinsured to give notice as soon as circumstances permit. The time necessary to give notice for the reinsured will include an appropriate time to assess the situation.
C26 The reinsured’s right to pay the premium retroactively depends on the actions taken by the reinsurer. Where the reinsurer does not exercise the right to adjust the premium, the reinsured’s corresponding right will not arise.
6. Paragraph (3): Right to avoid the contract
a. Avoidance in general
C27 As mentioned before, it is the aim of the PRICL to uphold the contract wherever possible. Therefore, the reinsurer’s entitlement to avoid the contract is restricted to extraordinary cases. For the same reason, the requirements for this remedy must be interpreted strictly.
C28 There are only two situations in which paragraph (3) permits avoidance: if the reinsured has acted fraudulently, or if the reinsurer would not have entered into the contract at all had it known the undisclosed information.
C29 Where the contract is avoided pursuant to paragraph (3), the reinsurer is not entitled to retain the premium received. However, parties may have agreed on the reinsurer being entitled to retain the premium or, in order to reach a similar result, on a liquidated damages or penalty clause. Such clauses are subject to a reduction to a reasonable amount pursuant to Article 7.4.13(2) PICC as well as to the general principle of utmost good faith under Article 2.1.2. Moreover, prohibitions on penalty clauses imposed under national law may be classified by a court or an arbitral tribunal as constituting internationally overriding mandatory rules, which take precedence over the PRICL pursuant to Article 1.1.5.
Examples of such prohibitions under national law are presented in Axa Gen Insurers Ltd v Gottlieb [2005] EWCA Civ 112, [2005] Lloyd’s Rep IR 369; Schoeman v Constantia, 2003 6 SA 313 (SCA); Pearl Assurance Co v Union Government [1934] AC 570 (PC).
C30 Avoidance under paragraph (3) requires notice being given pursuant to Articles 3.2.11 and 3.2.12 PICC. In line with Article 3.2.14 PICC, avoidance affects the validity of the contract retroactively, i.e. back to the point in time when the contract was formed. The legal consequence is that each party may claim restitution of whatever it has supplied under the contract. Restitution is governed by Article 3.2.15 PICC. The reinsurer may not avoid the contract if it impliedly or expressly confirmed the contract pursuant to Article 3.2.9 PICC.
b. Subparagraph (a): Alternative 1 – Fraudulent breach
C31 The first situation in which the reinsurer is entitled to avoid the contract, is where the reinsured has fraudulently not disclosed material information. A non-disclosure is fraudulent if it is intended to mislead the reinsurer and to gain an advantage to the reinsurer’s detriment. The reinsured will usually intend to gain the advantage of a contract that the reinsurer would either not have entered into at all or that it would have only entered into on different terms and conditions. Avoidance does not, however, require the reinsured to actually gain the intended advantage.
Illustration
I5. Reinsured A fears that Reinsurer B might not enter into the contract if Reinsured A insures more than 100,000 property units in Florida. In fact, Reinsured A insures 150,000 units in Florida but tells Reinsurer B that the number is 90,000 units expecting Reinsurer B to enter into the contract on that basis. Reinsurer B is actually willing to contract with an insurer that covers 200,000 units in Florida. While Reinsured A’s fraudulent non-disclosure concerned material information (the number of units insured in Florida) the non-disclosure did not affect Reinsurer B’s decision to enter into the contract. Nevertheless, Reinsurer B has the right to avoid the contract.
c. Subparagraph (b): Alternative 2 – Non-disclosure causing formation of the contract
C32 The second situation in which the reinsurer is entitled to avoid the contract, is where it would not have entered into the contract at all had it known the undisclosed information. This requirement would be met, for example, where a reinsurer categorically refuses to cover the non-disclosed risk.
Illustration
I6. Reinsurer B’s retrocessionaires exclude coverage for pollution risks. Therefore, Reinsurer B never reinsures pollution risks. Reinsured A insures a large amount of pollution risks but negligently does not disclose this to Reinsurer B. Reinsured A and Reinsurer B enter into a contract. Reinsurer B is entitled to avoid the contract.
C33 In determining whether the reinsurer would not have entered into the contract at all, a subjective standard must be applied. This approach differs from the objective standard that must be applied with respect to the question of whether undisclosed information was material. Thus, under Article 3.2, the reinsurer is only entitled to avoid the contract, if the non-disclosure induced the actual reinsurer to conclude the contract of reinsurance at all. In other words, it is required that the actual reinsurer would not have entered into the contract at all. To judge this, the relevant point in time will be the moment of contract formation.
C34 The reinsurer may establish its subjective assessment of materiality through documents (such as internal underwriting guidelines, internal memoranda or e-mails), testimony, past practices or other admissible evidence and must do so by a preponderance of the evidence. However, mere far-fetched contentions do not serve as credible evidence. The credibility of the evidence may be supported by objective criteria. The reinsurer may, for example, argue that a reasonable person in its position would not have entered into the contract at all.
Illustrations
I7. Reinsured A, a Directors’ & Officers’ (D&O) liability insurer, is seeking to enter into a contract of reinsurance with Reinsurer B and fails to disclose that a majority of the directors on the board of Reinsured A are not “independent” as the term is generally understood in the relevant industry. The clear norm among reinsurers is to refuse to cover companies that lack a majority of independent directors on the board, but Reinsurer B has no prohibition on this and there is evidence that Reinsurer B does not consider this important in assessing risk. Although objective criteria support the allegation that the actual Reinsurer B would not have entered into the contract of reinsurance at all, Reinsurer B would have concluded such contract even if the information had been disclosed. Consequently, Reinsurer B is not entitled to avoid the contract.
I8. The contract between Reinsured A and Reinsurer B is up for renewal. During the contract term, the top managers of Reinsured A have been convicted of wire fraud. Because an objectively reasonable reinsurer would consider this information in determining whether to continue to do business with Reinsured A, the information is material. This remains the case even some evidence suggests that Reinsurer B has historically attached less weight to the criminal justice difficulties of insurance executives than is a reasonable reinsurer. However, if there is sufficient evidence that Reinsurer B is not at all concerned with the criminal records of a reinsured’s personnel, the criminal convictions of Reinsured A’s managers do not entitle Reinsurer B to avoid the contract.
C35 There is a difference between the prospective reinsured’s duty of disclosure and the reinsurer’s remedy of avoidance. The test for the remedy of avoidance under paragraph (3)(b) is subjective, whereas the test for materiality under in Article 2.2.1 is objective (see Article 2.2.1 Comments 9 et seq.). Regarding the duty to disclose, this is because a prospective reinsured is usually not expected to know the subjective views of the reinsurer, whereas it is expected to know the views of a reasonable reinsurer. In contrast, since the remedy of avoidance is aimed at protecting the specific reinsurer’s freedom to contract, it can only be judged on the basis of a subjective standard: what the specific reinsurer would have decided.
C36 Exercise of the remedy avoids the contract in its entirety.
7. Paragraph (4): Right to claim damages
C37 Notwithstanding an adjustment (paragraphs (1) and (2)) or an avoidance (paragraph (3)) of the contract, the reinsurer may have incurred harm. Paragraph (4) entitles the reinsurer to claim damages for such additional harm. Exercising the remedy of avoidance or adjustment is a prerequisite to the claim for damages pursuant to paragraph (4).
Illustrations
I9. Reinsured A fraudulently breaches its pre-contractual duty of disclosure towards Reinsurer B. Reinsurer B may avoid the contract pursuant to paragraph (3)(a). Avoidance should put Reinsurer B in the position it would be in had it not entered into the contract. However, Reinsurer B may have incurred costs when negotiating the contract and these losses cannot be recovered by avoidance. In this case, Reinsurer B is entitled to claim damages in the amount of the negotiation costs.
I10. Reinsurer B adjusts the premium pursuant to paragraph (2)(b). For that purpose, it has to re-evaluate the risk, which may require Reinsurer B to incur costs, e.g. by obtaining a revised expert opinion where the original one formed the basis of the initial premium calculation. Reinsurer B is entitled to compensation for these additional costs.
C38 All aspects not covered by paragraph (4) are subject to Chapter 7, Section 4 PICC which applies to pre-contractual duties by analogy (see Article 7.4.1 Comment 3 PICC). In cases of pre-contractual non-disclosure, full compensation pursuant to Article 7.4.2 PICC will usually result in “reliance damage” being awarded. Interest must be paid in case of delay in the payment of a sum of money in accordance with Article 7.4.9 PICC. Furthermore, the requirement of a causal link between the breach and the harm incurred (Article 7.4.2(1) PICC), the foreseeability of the harm at the time of contract formation (Article 7.4.4 PICC), etc. apply.