Financial Services

University Degree Business and Administrative studies

150 FIN 1636972

Simon Horsman 1636938

150 FIN Coursework

Insurance

Explain the terms “Uberrimae fidei” and “Adverse Selection” and how they interact to shape the world of UK insurance.

The definition for Uberrimae fidei is “All contracts of insurance are subject to 'utmost good faith' in that applicants for insurance are obliged to disclose any detail which may be of importance to the insurers whether or not it is requested.”

uberrimae fidei is part of a good faith contract, not only part of an insurance contract but other forms of commercial agreements. We have this contract because the innocent party will be unaffected by any fraud, misrepresentation or deliberate non disclosure of materials and facts. If any sort of fraud does occur from the other party, the contract becomes void; therefore it will no long be valid.

Andrew Tulloch suggested “Absence of good faith should give rise to the power of the aggrieved party to claim damages”. He also implied that the party that breached “the good faith” (uberrimae fidei) should result in a loss or fraud. This may happen if the risk of loss or claim results in prejudice against the innocent party.

The principle of uberrimae fidei (good faith) originated from England through marines insurance practices. All transactions should be made by up most good faith, however not all facts are need to be discussed with both parties. Under common law doctrine “Common Law doctrine of caveat emptor, the seller is under no obligation to notify all the defects of the goods to the buyer, but the buyer is the one who is under an obligation to inspect the goods to be purchased.”

Therefore in an insurance policy, facts that are relevant to both parties are discussed. Such as the risks on both parties, any influences that the insurer will judge to accept or reject the risk. The materials that are within knowledge of both parties are discussed. The limitation under the English law suggests the information disclosed is regarded as the material. However what the party doesn’t have knowledge about, there is no obligation on the disclosure to tell that party what it doesn’t know.

Uberrimae fidei is also an international contract, this suggest that rules of up most good will is applied in all countries for an insurance policy. The governing principal of uberrimae fidei is also based in Malaysia, it is a contract based on the principles of fraud and misrepresentation. Likewise the contract is similar to the one that is originated in England. “Contracts Act 1950, the Insurance Act 1996, the Road Traffic Ordinance 1950, and the Road Transport Act 1987.”.

The insurance act of Malaysia 1996 suggests that if insurer proves that the materials given are inaccurate or false. The policy becomes void. Therefore it can no longer be enforced. Breaching the duty of uberrimae fidei is by misrepresenting the facts and materials by either party. If any fact that causes risk to either side of the party which is misrepresented is also seen as breach to the insurance policy. The non- disclosure or misrepresented fact that might influence judgement of an insurer of taking a right decision will result in breach of uberrimae fidei.

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Adverse selection (or anti-selection) is defined as the market failure which is often associated with insurance in which people with greater risks are the ones who seek out insurance, in order to get low risk people, the company needs to lower rates and therefore needs a lot of customers. Particularly, insurance will often not be profitable when buyers have better information about their risk of claiming than does the seller. When adverse selection occurs there is a greater risk people who are aware that they are more likely to claim then the average person, are more likely to buy the insurance, and other customers who are below the average risk group will find that it is too expensive to buy. One way to reduce adverse selection is to make the purchase of insurance compulsory, so that those for whom insurance priced for average risk is unattractive are not able to opt out, furthermore to avoid adverse selection insurance companies must reduce the likelihood for claiming large claims by limiting its coverage or by changing the rates of premiums.

Research on asymmetric information has shown that implications of adverse selection, which can be a consequence of asymmetric information. It has been questioned whether asymmetric information is a practically important feature for insurance markets. There is very little evidence of adverse selection on the amount of payment in the event that the insured risk occurs, however there is convincing evidence of adverse selection on other aspects of the contract. Therefore when testing adverse selection it is important to look at multiple features of insurance contracts when testing for adverse selection.

Moral hazard is another important point. Moral hazard can be defined as an individual who take on more risk knowing that they are covered by insurance. Many tests for asymmetric information cannot distinguish between adverse selection and moral hazard, as the policy suggestions are quite different.

Not only in an insurance contract but also in all commercial agreements, each party must act with up most good faith. This is because fraud, misrepresentation or intentional non-disclosure of material facts in a contract would make it invalid. Insurance contracts are known as having up most good faith therefore insurance parties should act with up most good faith. Lord Mansfield made an observation “good faith is the governing principle applicable to all contracts of insurance…to mislead the underwriter into believing the circumstance does not exist. Keeping back of that information is fraud and that policy is void”.

It is not necessary however those parties should disclose every fact and matter affecting the transaction to each other; the seller is under no obligation to notify all the defects of the goods to the buyer, the buyer is under obligation to inspect the goods. Similarly in insurance policies, neither party has to disclose information to one another. The most important facts to be disclosed are ones, which have a bearing on the insurance. If the client fails to disclose material affecting the policy, and insurance company is able to prove an infringement of uberrimae fidei, the policy then becomes void.

The extent of adverse selection is affected by the reason why the person chooses to buy the product; most likely it is compulsory or is offered to the individual via their employer.

The degree of which adverse selection occurs is affected by many factors this includes sex, wealth, occupation, current health situation, this is important as low health is more likely to mean they would claim, also important is income and the level of policy in which they have applied for. As time goes on individuals are able to better speculate what their health status will be like for the coming years, therefore the level of adverse selection declines. Other factors such as the type of policy also affects adverse selection, such as policy holders who hold short term life insurance policies are likely to have a higher level of adverse selection, in comparison to those that hold a whole life insurance policy.

The most common theory of adverse selection suggests that individuals are divided into two groups these are those of high risk levels and those in the opposite of low risk levels. Furthermore adverse selection occurs when the individual’s beliefs about their death and their true mortality rates are related. If this does not occur then there is a regular difference between policy holders and the population mortality rates and thus no adverse selection occurs.

However there are many empirical evidences that are in conflict with the definition of adverse selection within the UK insurance market. A study conducted by Hemingway (1990) conducted a study in a hospital found that the percent of individuals insured within helmet wearing and non helmet wearing motorcyclists is 73% of helmeted and 59% of those did not wear helmets. Also he found that within car drivers 40% who were wearing seatbelts had insurance whereas 33% of those that did not wear seat belts purchased insurance, both of these studies shows that individuals who are at high risk (those not wearing a helmet and those who drove without seatbelts) purchased less insurance.

There are many different factors that affect UK insurance claims. As people in the UK get older they are more likely to suffer from health complications. Consequently they are furthermore likely to claim health insurance, in order to get lower policy often people do not adhere to ‘utmost good’. They will not divulge all the information to the insurance company; this means that the insurance quote that is given is quite often low. As each insurance company competes with one another for the lowest prices, the whole of the UK insurance industry lowers its prices. Also adverse selection often means that people who are at a greater risk to claim for insurance tend to choose companies which offer them lower premiums, and these companies then lower their prices so they can keep attract more customers and keep up with the increasing UK insurance market.

Now more common in the UK is other factors which not only affect individuals but the wider community. There is a large increase in factors other then health and other more common things. This includes terrorism and climate change. Uberrimae fidei cannot play a part in this because individuals are unable to conceal other factors such as this as it is widely known within insurance businesses. Consequently as well as this and competition with other insurance companies insurance companies have to change their premiums and other benefits. Adverse selection plays an important part in this as it means that whole groups of people will be changing to a greater risk groups and are more likely to claim.

Other factors also play an important part, this includes the background of the individual, if the person has a previous history of car insurance claims or house insurance claims then they are likely to have a non exisistent no claims history, therefore they are more likely to claim under their new insurance, also if the individual has claimed in the past the insurance company is likely to lose money in pay outs, however if the individual does not tell the ‘upmost truth’ then they are deceiving the insurance company, on the other hand if the insurance company does not fully disclose to the individual then they are not also telling the upmost truth. Additionally this adversely selected group of people are also likely to change the face of UK insurance as they claim more often than others and this then leads insurance companies to lower their premiums, and in competition with one another all insurance companies are likely to change their insurance premiums.

Uberrimae fidei and adverse selection plays a key role in the interaction of UK insurance. Different types of insurance companies affect people in different ways. To begin with, car insurance is a great factor on an individual’s gender, health and any previous car convictions. Norwich union offers a lot for all groups, there are a lot of additional cover options such as breakdown cover, courtesy car, travel abroad etc. However diamond and “Sheila’s wheels” will only offer car insurance to women. They are the main targeted audience. There are a lot of insurance companies targeted at older people.

“RIASsurance” is specified for older people as they are more pronged to risk. They specify in car insurance, home insurance and travel insurance for old people. The insurance company targets individuals over the age of 50. They also give offers some of which are protecting no claims discounts, fast repair service, extra personal accident cover for the car insurance. For home insurance, they offer contents cover up to £50000. Identity theft assistance service, this is a support service for victims of crime, Building cover up to £1 million. Etc.

“Yell.com” is another home insurance company that issues coverage against the actual building and the contents in it. The company will give quotes against additional household properties e.g. garage, greenhouses etc. Uberrimae fidei and adverse selection is part of this insurance as the party involved cannot lie about the policy being agreed with. Also the risk involved is important to allow the company to know how much the insurance will cost.

Car insurance for young individuals is a lot higher; they are also a high category for risk, likewise the much older generation. “Insure your motor.com” has made schemes to help young drivers to insure their cars safely. Cheaper car insurance is provided for the drivers aged 17-30. The scheme gives coverage against the codes DR, IN, AC, BA, UT, LC, and TT. Some drivers name themselves on their parents’ second policy; however this could be seen as a non-disclosure if the young driver is the main driver. Both individuals will have to be honest otherwise the policy is breached. Therefore uberrimae fidei comes into insurance, however with “Insure your motor.com” the young individuals’ rate is a lot cheaper compared to other car insurance companies.

Health insurance is another important part for individuals, Tesco and other companies help in health insurance.

The reason for Tesco health insurance is that they provide quality cover for the individual and the family, Tesco provides insurance for everyone. A person can choose from 250 private hospitals, this avoids the NHS waiting list. There is also no medical history required up to 75 years. The Tesco health insurance covers surgical procedures; there is also extensive cover for patients in hospital and patients having a one day treatment.

The premium year covers £1000's per year for patients in and out of hospital. It goes towards consultations and diagnostic tests. There are charges and fees for accommodation, tests and dressing. The fees includes for anaesthetists and surgeons when in hospital. The price of the insurance depends on adverse selection therefore the insurer has to take into consideration the risk assessment. The older the person, the more he/she will pay for the insurance.

In conclusion both Uberrimae fidei and adverse selection is important in UK insurance and is also a key part of it evolving. Furthermore from in the past there were not as many reasons as to why individuals must claim insurance, and there are more risks than before.