31 March 2021
When concluding an insurance contract, the insurance applicant has a duty of disclosure. The applicant is not obliged to disclose information unless the insurer enquires.
The insurer's remedy for breach of this duty varies. The insurer can either:
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Rescind the contract and keep the premium. The availability of this remedy depends on the degree of connection between the loss and the intention of the policyholder. If the policyholder deliberately breached this duty, then the insurer can avoid the policy, refuse all claims, and keep the premium.
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Rescind the contract but return the premium. If the policyholder was merely negligent in breaching the duty, the insurer can avoid the contract but must return the premium.
The insurer has no right to rescind the contract if it underwrote the contract fully aware that the applicant had not provided honest answers.
Also, the right of an insurer to rescind a contract is extinguished if it is not exercised within 30 days from the date the insurer discovers the non-disclosure. Moreover, there is a two-year limitation period from the conclusion of the contract. After this expires, the insurer cannot take any action to avoid the policy.
What is insurance non-disclosure under Chinese law?
To control for adverse risks, the insurance industry is strictly regulated. In turn, insurance policies allocate risk in society. However, the conclusion of an insurance policy involves its own risks; risk of non-disclosure by one of the parties being foremost among them.
In light of its tremendous growth, it is easy to forget that insurance remains comparatively new in China. The first law on insurance, the Insurance Act (1995, the "Insurance Act") was enacted in 1995 and then amended in 2002, 2009, and 2015.
Typically, non-disclosure arises out of the insured's failure to disclose material information to the insurer. This is the basis for the doctrine of utmost good faith in the duty to disclose.
The rules governing the insured's duty to disclose, misrepresentation, and remedies, are laid out in Article 16 of the Insurance Act.
The duty to disclose is found in paragraphs 16(1–2), together with the corresponding remedy of rescission for failing in this duty. Importantly, this duty only extends to non-disclosures or misrepresentations which go to the heart of the policy; in other words, which "affect the insurer's decision on whether to underwrite the insurance or raise the insurance premium":
Article 16
(1) Where the insurer makes any inquiry about the subject matter insured or about the insurant when entering into an insurance contract, the insurance applicant shall tell the truth.
(2) The insurance applicant fails to perform the obligation of telling the truth as prescribed in the preceding paragraph intentionally or for gross negligence, which is enough to affect the insurer's decision on whether to underwrite the insurance or raise the insurance premium, and thus the insurer shall have the right to rescind the contract.
Per paragraph 16(3), there are strict time limits on the insurer exercising a right of rescission. The insurer's right of rescission expires after 30 days of discovering the non-disclosure or misrepresentation. Moreover, there are no grounds for rescission two years after conclusion of the contract:
(3) The right to rescind as stated in the preceding paragraph shall be extinguished if not exercised within 30 days of the time the insurer knows of the cause for rescission. Once two years have elapsed after the contract is entered into, the contract may not be rescinded even if cause for rescission exists; where an insured incident occurs, the insurer shall be liable for paying indemnity or insurance benefit.
Paragraphs 16(4–5) describe intentional and grossly negligent misrepresentations in further detail, and treat the former more seriously than the latter. They both provide that the insurer shall not be liable for paying indemnity or insurance money for an insured incident that occurs before the contract is rescinded. The major difference is that whereas intentionally failing to tell the truth causes the insured to lose both benefits and premium, gross negligence will cause the insured to lose benefits but obtain a refund of the policy premium:
(4) Where the insurance applicant intentionally fails to perform the obligation of telling the truth, the insurer shall not be liable for paying indemnity or insurance money for an insured incident that occurs before the contract is rescinded, and shall not refund the insurance premium.
(5) Where an assured in gross negligence fails to make truthful disclosure so as to contribute materially to the occurrence of an insured event, the insurer shall not be liable for paying indemnity or insurance money for an insured incident which occurs before the contract is rescinded, but shall refund the insurance premium.
Under paragraph 16(6), the insurer has no right of rescission when it agrees to the policy despite knowing that the insured is not telling the truth:
(6) Where the insurer knowing the truth which the insurance applicant fails to tell enters into an insurance contract with the insurance applicant, the insurer, shall not rescind the contract and, if an insured incident occurs, shall be liable for paying indemnity or insurance money.
Finally, there is also a relevant portion of the Maritime Code of China, which addresses disclosure to a similar degree as the Insurance Act. Specifically, under Article 222,
[B]efore the contract is concluded, the insured shall disclose to the insurer material circumstances which the insured has knowledge of or ought to have knowledge of in his ordinary business practice and which would influence the insurer in deciding the premium or whether he agrees to insure or not.
Thus, while a Chinese insurer may rescind a policy for intentional or grossly negligent non-disclosure, it may not rescind for innocent or minor non-disclosures. While negligent non-disclosure (instead of grossly negligent or intentional non-disclosure) may entitle the insurer to other contractual remedies, this does not include rescission. That said, under Chinese law there are currently no legal definitions for the terms "intentional" or "gross negligence", leading to judicial uncertainty. Even though the policies might have the definitions for “intentional” or “gross negligence”, the difference between gross negligence and negligence is difficult to distinguish in many circumstances.
Note that not all non-disclosure by the insured will entitle the insurer to the right of rescission. non-disclosure which does not go to the heart of the agreement does not entitle a contractual party to rescission. According to some authors, there is a legal basis for this in the Interpretation of the Supreme People's Court on Several Issues pertaining to Application of the Insurance Law of the People's Republic of China (II), (the "SPC Interpretation II"). The SCP Interpretation II limits, under Article 6, the insured's duty to disclose to the insurer's scope of inquiry (投保人的告知义务限于保险人询问的范围和内容), and furthermore puts the burden of proof on the insurer when a dispute over the scope or content of the enquiry arises. Another author posits that "if the insurer is not asking about important facts, the insured does not breach the duty even by concealing or misrepresenting." For the latter opinion, there are disagreements in Chinese academia.
Thus while facts which involve assessing the underwritten risks are considered material, if the insurer asks about unimportant or irrelevant facts, the insured does not open the policy to rescission by concealing or misrepresenting such facts. Accordingly, the insurer's inquiry should be limited to material facts and the insurer should not expect a right of rescission after discovering misrepresentation or concealment of facts which had little or no bearing on the conclusion of the policy.
Nevertheless, to avoid rescission, certain facts must be proactively disclosed by the applicant even absent a question from the insurer. While the Insurance Act itself does not address this, interpretive guidance was made available in the 2006 Reply on Issues Related to Insurance Contract Disputes (the "Reply on Insurance Contract Disputes"). Originally, under the Reply on Insurance Contract Disputes, when the insured "knows or should know of certain material matters upon which insurability may turn, and said matters affect the insurer's decision on underwriting or pricing the premium, then even if the insurer has not made a clear inquiry, the insured must inform the insurer of said information." That said, this was limited to only information which the insured knows (rather than should know) in Article 5 of the SPC Interpretation II, which specifically classifies information that the policyholder knows of (投保人明知的与保险标的或者被保险人有关的情况) as facts to be declared under paragraph 16(1) of the Insurance Act. Since the duty to disclose said facts falls under Article 16, the insured's failure to disclose them will also entitle the insurer to the right of rescission.
The duty to proactively disclose facts therefore turns on two elements. First, the fact must be material. Second, the fact affects the insurer's decision on underwriting or pricing the policy's premium.
How then to decide which facts are material or immaterial? Somewhat confusingly, this appears to be a partially redundant enquiry between both the first and second elements. A material fact is one "[which] is enough to affect the insurer's decision on whether to underwrite the insurance or raise the insurance premium." Whether the standard used for "affect the insurer's decision" is a subjective or objective one remains an unsettled question under Chinese law. That said, judges from many courts have adopted the "objective standard" of the prudent insurer, rather than place themselves in the shoes of the insurance provider at issue.
Since the first element of the test, on materiality, requires answering the second element of the test, on "affect[ing] the insurer's decision", the second element in practice turns on causation. In other words, after establishing that a fact [1] was material (because it would have affected a prudent insurer's decision), the judge must then be satisfied that [2] the failure to disclose the fact did, in fact, affect the insurer's decision on underwriting or pricing the policy. If both first and second elements are satisfied, then the insured will be found to have failed in their duty to proactively disclose the fact at issue.
Note that since PRC law does not distinguish between sophisticated insurance applicants and individual insurance applicants, or "business insurance" and "consumer insurance" applicants. Accordingly, the above rules on misrepresentation apply both to natural persons and legal persons applying for insurance. Note however that other specific rules apply when an insurance brokerage is involved in the policy's negotiation.
What changes do the new Civil Code bring to insurance misrepresentation?
China's new Civil Code brings very few additions to China's insurance law regime. In fact, there are only a few articles related to insurance at all. These include, under the section on tort liabilities, a few clauses on compulsory automobile liability insurance (in connection with the Traffic Accident Social Assistance Fund). This is in order to ensure policies are in place to provide compensation to insureds and the third-party victims of traffic accidents. See Civil Code of the People's Republic of China, arts 1213, 1215–1216. There are also passing references to insurance in the book on real property rights, art 390, on security interests, and art 461, on rights to insurance indemnities when in possession of another's property, in addition to the book on contracts, which features art 909 on warehousing.
Nevertheless it is important to note that the Civil Code repealed the PRC Contract Law. As a result, Part III (Contracts) of the Civil Code is now the general law applicable to all contracts, including insurance agreements.
For further information, please contact:
Wan Jia, Partner, AnJie law firm
wanjia@anjielaw.com
