The Changing Manifestation of Risk: Comments on Innovation, Unconscionability and the Duty of Utmost Good Faith

Geoff Masel Lecture

It is a great pleasure, and indeed a great honour to be asked to deliver the Geoff Masel Lecture for 2020. The lecture honours one of the people who founded the Association and who placed experience, learning and professional education at the foundation of a healthy insurance industry. 

I delivered a version of this lecture in opening the AILA Conference in Hobart last year.  I was asked to deliver it again for this year’s Geoff Masel Lecture.  I have made some excisions and additions, but have broadly kept faithful to the request and directed my remarks to risk, innovation, unconscionability and the utmost good faith.

The context of the speech when originally given was a discussion at the conference thematically of new and rapidly changing areas of risk: such as class actions, cyber security, and the influence of climate change.

But risk is timeless; and both ever-changing and ever-constant.  Human engagements and relationships have a constancy and a fluid movement which are one, yet different.  Just as a river may appear stable in its banks, yet, it is different from one instant to another as its fluid state moves water from the hills to the sea, so risk has a structural form but precise and changing features.

Risk, the underpinning and informing feature of insurance, has been dealt with in legal structured form recognisable by the modern practitioner since ancient times. Take the uniquely maritime concept of general average, for example. General average has origins in the laws of the maritime city of Rhodes.^[1]  General average was the “system of maritime law by which sacrifices of property made, and loss and expenditure incurred, as a direct result of actions taken for the purpose of preserving a common maritime adventure from peril are rateably shared between all those whose property is at risk in the adventure.”^[2] The substance of the rules of general average today remain consistent with the original Rhodian origins. It was really an early form of marine insurance, charting new ground, which has persisted to today.^[3]

Risk is not new. Nor is the quantification and monetisation of risk. The fluid change in the manifestation of risk derives from changes in human existence and organisation: whether due to technological advances, structural market change, politics, transformation of mediums of communication, or government and legislative intervention. It is clear to anyone practising in insurance that new technologies, and the so-called phenomenon of “innovation leading and regulation following”, caused by rapid technological advances and intra-industry structural changes, are driving new areas in insurance.^[4] Autonomous vehicles, or driverless cars, are a good example of how challenging it can be to create a regulatory framework to manage the risks of innovative new products. Should autonomous cars be allowed on the road without a person inside it capable of taking control of the car? What happens if a car malfunctions and causes a collision? From both a criminal and civil perspective, and in turn an insurance perspective, who is liable: the car manufacturer, the passenger, both?

What I wish to discuss this evening, however, is the changing manifestation of risk in terms of the expressions by law of human values.

Values are hardly new to the law: equity is built on conscience, the protection of the vulnerable, and of trust given and relied on; the common law has values at its heart – reasonableness, and fairness.

Commercial law is riddled with values in its principles and rules. Without values commercial law would not be certain; rather it would be the arbitrariness and tyranny of the written word, but the written word not as the vehicle for expressing human relationships, but for the expression of power. Certainty is not gained by the written word alone. It is derived and felt from an understanding of a stable and known position, often a space. That comes as much from a known demand for, and expectation of, a requisite degree of trust, honesty and lack of sharp practice, as from any clarity of expression.

But it is fair to say that Parliament in recent times has expressed values in statutes more frequently than in years gone by. Importantly, good faith and unconscionability (decoupled from, but still closely related to, their common law and equitable anchors) have been introduced into Commonwealth statutes governing business behaviour.

The task of the profession, and of the courts, is to conceptualise and interpret Parliament’s will faithfully in a way which vindicates both the command of Parliament and the techniques and values of the common law and equity.

These matters will affect insurance in the contemporary manifestation of risk in the subject matter of indemnity cover, but it will also affect insurers in the expectations as to their behaviour, in particular by reference to the duty of the utmost good faith.

Let me say something about unconscionability and unfairness. Statutes such as the Australian Consumer Law and the Australian Securities and Investments Commission Act 2001 (Cth) prohibit conduct that is unconscionable in commerce. The statutes are both general in their expression and highly particular in their identification of relevant functions.

The general norms were discussed by the Full Federal Court in cases such as Paciocco^[5] and Kojic,^[6] where it was said:

… The evaluation [of unconscionability] includes a recognition of the deep and abiding requirement of honesty in behaviour; a rejection of trickery or sharp practice; fairness when dealing with consumers; the central importance of the faithful performance of bargains and promises freely made; the protection of those whose vulnerability as to the protection of their own interests places them in a position that calls for a just legal system to respond for their protection, especially from those who would victimise, predate or take advantage; a recognition that inequality of bargaining power can (but not always) be used in a way that is contrary to fair dealing or conscience; the importance of a reasonable degree of certainty in commercial transactions; the reversibility of enrichments unjustly received; the importance of behaviour in a business and consumer context that exhibits good faith and fair dealing; and the conduct of an equitable and certain judicial system that is not a harbour for idiosyncratic or personal moral judgment and exercise of power and discretion based thereon.

The statutes also descend to specificity, looking at factors such as strength of bargaining position, pressure, unreasonable non-disclosure and the intelligibility of documents. From these one does not pick and choose. All the circumstances must be examined and evaluated. These factors are not a closed, nor an exclusive, universe.  But notice that they all deal in some way with the exercise of economic and private power.

As you will know, relatively recently in 2016, the unfair contracts regime in the Australian Consumer Law was extended from only applying to standard form contracts with consumers to contracts with small businesses. That is, contracts for the supply of goods or services, or a sale or grant of an interest in land, where one of the parties is a business employing fewer than 20 persons and the upfront price payable is within a set limit. So, what is an unfair consumer or small business contract? Section 24 of the Australian Consumer Law requires that a number of factors be considered and satisfied: a significant imbalance in the parties’ rights and obligations arising under the contract; the contract not being reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; the cause of detriment (financial or otherwise) to a party; the extent to which the allegedly unfair term is transparent; and the contract as a whole. The meaning of “transparent” is defined and rather self-explanatory:^[7] it asks whether the term is legible, is expressed clearly and in reasonably plain language, and is readily available to any party that is affected by the term.^[8]

One can see the relation between these factors in the unfair contracts regime, and those factors set out in statutory unconscionability provisions. Both stem, fundamentally, from the upholding of good commercial conscience. Now, those participating in commercial life and in the insurance industry have always appreciated that trust and honesty are at the heart of business goodwill, the institution of insurance and reduction of risk. This should be reflected in commercial law and commercial behaviour. The statutory imposition of normative standards in commercial dealings, with value-based content derived from equity and common law, but especially the former, brings with it the need to consider in more substance and depth the need to act, as a business, in good conscience. Put another way, it generates an additional operational risk. What do the broad concepts of such “unconscionability” and “unfairness” mean? What is unconscionability? This question was the subject of some divergence in the High Court in the recent case of Kobelt.^[9] I will not dwell on this case today, other than to make some comments about unconscionability as a concept.

Unconscionability is less precise or has less shape than “misleading or deceptive”. But it is more precise or has more shape than conduct that is merely unfair. Decoupled from a doctrine to set aside a transaction where it was a basis for relief, it has, in statute, become a basis for a civil penalty as a description of conduct directed to a norm of right behaviour.^[10] It is not to be defined because it is indefinable. Vital to the evaluation of whether conduct in business is unconscionable, and to understanding unconscionability itself, is the proper approach to the task. You should approach the task as clients or practitioners by looking at all the facts, as a whole. Do not isolate constituent parts. The conclusion is an overall evaluation.

A majority of the High Court in Kobelt may be seen to require in the statutory standard some special disadvantage in those the subject of the conduct.^[11] The validity of this will be worked through over time. For the purposes of insurance, consideration should be given to the position of insureds in consumer and retail insurance in particular.

An appreciation of the technique to approach the evaluation helps one understand the nature and character of the norm being investigated and assessed.  It is essential not to deconstruct or abstract the judgment or assessment, nor to seek to reduce it to a false certainty by seeking out some defining element. It is human behaviour that is to be evaluated and characterised. To behave unconscionably should be seen, as part of its essential conception, as serious, often involving dishonesty, predation, sharp practice, unfairness of a significant order, a lack of good faith, or the exercise of economic power in a way worthy of criticism. None of these phrases is definitional. They are all the kinds of behaviour that, viewed in all the circumstances, may lead to an articulated evaluation of unconscionability. They are standards at the heart of commercial decent behaviour.

This brings me to non-financial risk; specifically that connected to reputational damage and loss of trust. The management of non-financial risk in the post-Royal Commission world is an important point of discussion. Will the Royal Commission generate a sustained impetus for businesses to address non-financial risk in human terms before it can manifest in financial loss?

I say “in human terms” because I do not think it will be of assistance to view non-financial risk as an abstracted risk, separate from the human relationships with which it is concerned. When I speak of non-financial risk, much of what I refer to is trust; and a lack thereof. The financial services sector is one of the least trusted sectors globally.^[12] As such, speaking of non-financial risk purely in terms of risk and potential financial loss is not helpful. It narrows the focus, and can lead one into error by suggesting that such problems can be dealt with in the same way as other operational risks: through security systems, checks and balances along the way. But that is not so. To address issues of trust and public confidence in institutions, whether private or public, those institutions need holistically to reconceptualise their approach to appropriate and conscionable commercial dealings. One can easily (as some statutes do) fall into the trap of over-articulating and over-abstracting rules in an attempt to bring about good behaviour by companies and their employees. I venture to suggest that many of the commercial problems of corporate and financial regulation exposed in the recent Royal Commission^[13] would be made more ruthlessly manageable by a full understanding and a daily application of the fiduciary principle, rather than by ever more detailed regulation by rules and exceptions which has as its (false) working assumption the ability exhaustively to define good faith, fiduciary responsibility, and behaviour in good commercial conscience.

After all, good faith is not a new concept. In the insurance context, it was over 250 years ago that Lord Mansfield in Carter v Boehm cemented the principle that parties to an insurance contract owe each other duties of utmost good faith.^[14] You may or may not be aware of the facts of this case. Self-appointed Governor of Fort Marlborough in Sunatra Mr Carter (who was not in fact a Governor, but an employee of the British East India Company) took out an insurance policy against Fort Marlborough being taken by a foreign enemy. The evidence showed he was aware that the French were likely to attack and that the fort, while built to withstand attacks from the local Sumatrans, was not built to resist the resources of European enemies. Mr Carter did not disclose this information to the insurer. This was during the Seven Years’ War, 1756–1763, a war involving all of the great European powers at the time and spanning five continents. Historically interesting coalitions were formed by England and France, on separate sides of this conflict. The outcome of the war destroyed France’s supremacy in Europe, its nascent interests in India and its Treasury (with dire consequences a generation later). The war also wrecked the Treasury of Great Britain, and substantially altered the balance of power in Europe. It resulted in the new taxation by Britain in the American colonies; which in turn contributed in causing the American Revolution.

I will return to the duty of utmost good faith in a moment. Before doing so, let me say something about the techniques involved in understanding the kind of statutory provisions of which I have been speaking.

The form and nature of the Parliamentary will or command are various. A statute may fulfil many functions. The function may be apt for strict rules admitting of great precision, or not, as the case may be. As I have said, a feature of modern statutes has been the creation of norms of conduct expressed generally as commands for an expected standard of behaviour in relation to social, often commercial activity: s 52 of the Trade Practices Act 1974 (Cth) (now s 18 of the Australian Consumer Law), and other provisions in trade or commerce that deal with unconscionable conduct and unfairness.^[15] Some of these norms have an obvious relationship with equity, borrowing directly from it or using it terminologically and substantively as the statute’s source of norms and values.

These statutes are examples of legislative policy, expressed in the required norm of conduct, becoming a source of law – as Cardozo J said in 1937: “a new generative impulse transmitted to the legal system.” ^[16] Also, these statutes are more like vehicles for the development of a field of substantive judge-made law, the task of the courts being not so much to construe the language and ascribe meaning, but to develop the norm or doctrine chosen as the criterion for the operation of the statute; that is, to fill out the content of the norm. In these kinds of provisions the Parliament plainly intends the courts to give shape to the broad mandate of the statute by the values and norms that the statute has expressly or implicitly chosen.^[17] Further, these statutes can be seen to be what Justice Gummow referred to as “a socially directed rule, expressed as an abstraction, to the infinite variety of human conduct revealed by the evidence in one case after another”.^[18] Such a rule (usually generally expressed in its abstraction) calls forth the need for the process of characterisation of the facts by reference to the content of the statutory norm aided, but not exhausted, by the construction and interpretation of the provision. This distinction, but relationship, between construction and interpretation, on the one hand, and characterisation, on the other, is important.

Such a rule also calls forth the need for caution in the process of construction and interpretation, in the ascription of meaning. The reach of operation or engagement of the provision will be drawn from its application over time to that infinite variety of conduct. That means great caution needs to be shown in not attempting to fix for all time a rigid content of meaning to the words by over-definition at the outset. The temptation on judges (to which they often succumb) is to take the generality of the words chosen, rearticulate them in terms of attempted exhaustive meaning, often narrowing the generality in search of certainty, and then apply the rearticulated meaning to the facts before them. This risks freezing, by the rules of precedent, the meaning of the general words to one particular application of them by attempted rearticulated exhaustive definition. What is thereby created is a more particular and more precisely worded substitute or default or re-presentation of the general word. It is, of course, necessary for the judge to articulate in the context of the human conduct before him or her, why the general words apply or not, as the case may be. That articulation should explain what are the human elements that, in all these circumstances, lead to the conclusion (by way of characterisation) that the general words apply, or not. By this process, construction of meaning of the words is interwoven with application to factual context and with explaining or articulating the relationship between the two.

The above involves a recognition that words can only do so much. There is a limit to text. Text is the vehicle for meaning, but meaning must apply to a whole human context. If a person is required by a statute to act fairly, or efficiently, honestly and fairly, or in good faith, or not unconscionably or not in bad faith, the task of the court is to ascribe a generality of meaning to such words that conform to the generality of the expression, and develop through articulated application of them over time, case by case, the human reality of that meaning through examination of experience and concrete factual situations. This is not to be achieved through exhaustive particularised definitional reduction of the general into defined particular expression supposedly capable of fitting over the infinite variety of facts. It will be achieved by interpreting the words of generality by reference to the values that the statute requires and articulating, on a case by case basis, why the general words are engaged, or not. This recognises the reality that some concepts can only be expressed at an appropriate level of generality if they are to maintain their whole intended meaning.

Statutes that deal with moral values are expressed in language that evokes a moral sense and a requirement for a conscious awareness of self and empathy. Questions such as “Is that fair?” or “Is this unconscionable conduct?” evoke a relational human value and emotion. To answer such a question one does not go to a particularised definition or a checklist, but to a source of rightness of human engagement. It is as much empathetic emotion or sentiment, as rule.

Moral values are not worked out rationally; they are not defined. Moral values can be seen as a form of experience that is irreducible, like colour or smell.^[19] So, expressing rules for them is difficult, and expressing definitions of them is impossible.

To explore the best way to think about and decide such questions it will help to ask: How does equity do it? Equity’s technique will help because of its familiarity with the application of such values. Equity recognises moral values in their relational context at the requisite level of generality: loyalty, honesty, trust, confidence and conscionability born of the context and the particular relationship. The extent of such concepts and what is required depends always on the circumstances and context of the case. Expressions such as “relation of confidence”, “relation of influence”, and “fiduciary relation” do not describe fixed categories possessing fixed and uniform legal content or characteristics. Their content and the obligations of conscience flowing from them depend upon the particular circumstances.^[20] There are also rules, sometimes very strictly applied, such as the conflict rule governing fiduciaries. Such rules are directed proscriptively to context; not prescriptively requiring the doing of certain things at certain times. This reflects the inability to express a moral value other than at the requisite level of generality.

Statutes that deal with morality or rightness of behaviour need to be expressed at a requisite level of generality. They must, however, also provide the values and considerations that will attend the judgment that must be made of the generally expressed norm. But the expression of those statutory considerations should not be definitional. To the extent that the statute over-particularises a human, relational, moral value by abstractly expressed prescriptions, it risks draining the human reality from it, by transforming something able to be recognised as a whole (loyalty, trust, acting in another’s interests) into a deconstructed checklist, unrecognisable as a whole, only seen to be satisfied by detailed consideration of abstracted parts.

Decisions about questions as such unconscionable, unfair, good faith and similar expressions are not reached by applying definitions but by understanding and applying the principle with its attendant value to the facts and circumstances and drawing a conclusion by the process of characterisation,^[21] which involves the making of a value-based judgment by reference to ascribed meaning (construction), found facts (of all relevant circumstances) and expressed principle or rule (containing relevant public or private values).

Let me return to, and finish on, the utmost good faith.

The duty, since Carter v Boehm, until the reforms in the Insurance Contracts Act 1984 (Cth) (Insurance Contracts Act), manifested itself in remedies for the benefit of the insurer in the area of non-disclosure. Under the common law the remedy for breach by an insurer was rescission:^[22] hardly useful in most cases to an insured. This was so until s 13 of the Insurance Contracts Act implied the duty into all contracts of insurance. I do not propose to examine the many cases that have now dealt with the question.^[23]

I think it very valuable that the duty of utmost good faith has not been over-articulated. A number of judgments, largely dealing with TPD claims, have established that when determining a claim for TPD benefits, the insurer must, broadly: act reasonably, apply the policy wording correctly; consider all relevant material; and give the relevant individual an opportunity to respond to adverse information. This process also requires more than mere honesty by the insurer. As the High Court in 2007 in CGU v AMP^[24] unanimously confirmed, an absence of good faith is not limited to dishonesty. Rather, “utmost good faith may require an insurer to act with due regard to the legitimate interests of an insured, as well as to its own interests…consistently with commercial standards of decency and fairness.”^[25]

These broad conceptions “commercial standards of decency and fairness” require examination and consideration using the techniques of characterisation to which I have referred. Minds might differ about any particular conclusion, and the standards are broad, but anchored in fair behaviour.

The special position of insurance to people of all degrees of sophistication is obvious. There is a community and individual reliance on the decency and fairness of behaviour by insurer and insured.

That rules and definitions do not help should not be feared. Commercial decency and fairness are surely not too much for which to ask.

In CGU v AMP, the High Court then made the comment that the Insurance Contracts Act did not empower a court to make a finding of liability against an insurer as a punitive sanction for not acting in good faith.^[26] A punitive element has however since been incorporated.

The Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019 (Cth) amended the Insurance Contracts Act to – among other things – permit ASIC to take steps where an insurer fails to comply with the duty of the utmost good faith.^[27] This new provision permits the court to impose a civil penalty for such conduct of the greater of 5000 penalty units^[28] ($1,050,000 at present), or alternatively, under the new Part IXA, “Enforcement”, impose a pecuniary penalty. Under s 75D, a pecuniary penalty may be applicable to the contravention of a civil penalty provision (such as s 13(2A)). Only ASIC has the power to apply for pecuniary penalty orders, not an insured party.^[29]

For bodies corporate (covering most insurers), this pecuniary penalty is the greatest of three options:

1. The penalty specified for the civil penalty provision, multiplied by 10.
2. If the court can determine the benefit derived and detriment avoided because of the contravention – that amount multiplied by 3.
3. Either:
   1. 10% of the annual turnover of the body corporate for the 12‑month period ending at the end of the month in which the body corporate contravened, or began to contravene, the civil penalty provision; or
   2. if the amount worked out under subparagraph (i) is greater than an amount equal to 2.5 million penalty units – 2.5 million penalty units.

The penalty for the civil penalty provision multiplied by ten comes to $10,050,000. The penalty generated by 2.5 million penalty units, ostensibly the maximum penalty which can be imposed under this provision, comes to over half a billion dollars.

This introduction of civil and pecuniary penalties to the Insurance Contracts Act was a direct result of the Royal Commission. The Treasurer stated in the opening of the Minister’s second reading speech:^[30]

It is clear, through the work of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, that some financial institutions have engaged in conduct that falls well short of community expectations. This is not acceptable. This bill delivers a clear message to those financial institutions and individuals that complying with the law is not negotiable. If the law is breached, the courts will have a broader range of penalties to impose, which will act as a significant deterrent.

The amending Act received Royal Assent on 12 March 2019. ASIC has commenced a proceeding against an insurer seeking pecuniary penalties under the Insurance Contracts Act in the Federal Court. I will not comment on that case other than to say that the introduction of these provisions create very real financial consequences for conduct which falls short of standards of commercial decency and fairness.  The statute turns the non-financial risk of misbehaviour (whether intentionally or not) into quite a tangible financial risk.

It is beyond doubt that, along with other members of the commercial community, insurers will have to face questions of values in how they behave, as well as in how their insureds behave. This is hardly new; nor is it to be feared – as long as the business of insurance is approached by insurers, brokers, and insurance practitioners as one that is relational, human and built on decency, fairness and honourable conduct. The relationships between brokers, underwriters and underwriting agents, advised by knowledgeable practitioners, form the architecture for the carriage of those values. This has always been the case. The new amendments to the Insurance Contracts Act make it more important than ever to ensure that the commercial approach of all insurers should be based on commercial decency and fairness.