Insurance policies are contracts that are subject to the same rules of construction that apply to any other commercial contract, but there are additional established principles that have been developed through common law, and which were recently confirmed once more by the Supreme Court.
This article explores the evolution of the approach to the construction of insurance policies. It could be said that there has been an evolution from the original, rather rigid ‘objective and natural meaning/objective commercial intention’ to the current ‘what would/might a reasonable policyholder understand’. It is interesting to speculate as to whether this is leading us towards some eventual, future construction that takes into account ‘the policyholder’s reasonable expectation of cover’.
There are suggestions that any perceived evolution in approach has not actually superseded the earlier approaches adopted but rather has provided clarification about the approach to include a test of ‘what a reasonable person might understand’. However, there are fears that accommodating the understanding of the reasonable person risks, in practical application, diluting the rigour of the established principles based on the objective and natural meaning of the words used in an insurance policy.
MacGillivray on Insurance, when discussing the modern approach, states:
“This reformulation has not superseded the earlier canons of construction which continue to be cited by the courts as aids to the construction of insurance documents[1]… there is perhaps a risk that the new approach gives too little weight to the words used by the parties and provides a temptation to cast doubt on wordings which are clearly expressed and make sense in their contractual context. The need for certainty in insurance transactions requires that primacy of the words used should be respected”.[2]
Construction All Risks Insurance notes that at the beginning of the 20th century, the court applied various rules and principles of construction (or ‘canons’ of constructions) within a particularly rigid framework.[3] The early approach to interpreting an insurance contract was to “start from the literal meaning of the words and only to displace that meaning where there is a clear reason to do so”.[4]
In 1924, Lord Atkinson expressed his views regarding the judicial approach to interpretation, being that the words in a policy should be given their objective and natural meaning, stating:
“What is this kind of diluted sense in which this word is to be read if not the ordinary sense? We have not been shown from either the nature of the document or the context in which the word is used, or from any other reason or source, why it is to receive any but the ordinary meaning. I think it must receive the ordinary meaning”.[5]
Despite this benchmark, the courts have subsequently felt that there was progressively no option but to move away from this rigid approach to view insurance policies in a wider context – given the constant development of new risk markets, global developments, and taking into account commercial and technical considerations – all within an ever-evolving regulatory framework. While Lord Atkinson’s views demonstrate that at that time words were to be given their ordinary sense, there is evidence that other factors such as the nature, context or other reasons/sources might have allowed a departure from the strictest objective application of ordinary and natural meanings.
Construction All Risks Insurance notes that the modern approach is to “shift away from the literal methods of interpretation and to view contracts with a more commercial or technically sensitive eye”.[6] It goes on to state that: “The court has become much more flexible in its approach to construction and acknowledges that the various rules should be applied holistically and should not be allowed to compartmentalise the process of interpretation”.[7]
This flexibility of the canons of construction emerged around 1940 when the understanding of the parties to the contract of insurance became a relevant consideration. When faced with ambiguous words, the Court of Appeal determined that such words “ought to be construed in that sense in which a prudent and reasonable man on the other side” – that is, the side to whom the policy is proffered – “would understand them.”[8]
In the late 1990s Lord Hoffman set out the classic framework of contractual interpretation in five principles to be observed[9] – paraphrased below – which provide a pretty definitive summary of the approach at the time:
Colinvaux’s Law of Insurance notes that the most recent restatement of the principle in respect of the modern approach to construction in the context of insurance policies is the Supreme Court decision in the FCA v Arch Insurance (UK) Ltd [2021], which states that an insurance policy:
“must be interpreted objectively by asking what a reasonable person, with all the background knowledge which would reasonably have been available to the parties when they entered into the contract, would have understood the language of the contract to mean… In the case of an insurance policy…the person to whom the document should be taken to be addressed… is an ordinary policyholder who, on entering into the contract, is taken to have read through the policy conscientiously in order to understand what cover they were getting”.
The difference is subtle, but the FCA case could well be said to represent a move from the ordinary meaning in the considered determination of a senior judge to the best estimation of a senior judge to what the ordinary policyholder would have understood. The dial does move here in practical application and in the rigour of approach.
This shift and arguable lessening of rigour are highlighted in MacGillivray on Insurance, citing the words of Lord Hoffmann in Investors Compensation Scheme v West Bromwich Building Society [1998][10] in which he re-stated the principles of interpretation, reflecting an increasing emphasis on the background circumstances of a contract under scrutiny. MacGillivray states:
“The rule that words are to be given their natural or ordinary meaning reflects the proposition that it is not easily accepted that contracting parties have made linguistic mistakes, especially in formal documents. However, evidence of background circumstances not only enables a court to choose between possible meanings in a case of ambiguity but to conclude in an appropriate case that the parties have mistakenly used the wrong words or syntax to express their intentions”.[11]
This ability to choose between possible meanings to allow for what the reasonable person understands, with a trajectory towards further emphasis on the parties’ subjective views and expectations in the future, possibly signposts some further, eventual dilution of the objective rigour in examining certain contractual relationships. It certainly may serve to embolden policyholders when claiming under a policy, and prompt complaints where they are not satisfied with an outcome. The insurance industry is very properly evolving and moving with the trend to become more consumer-focused in its approach to policy wordings, in the explanations of cover provided to policyholders at inception, and in the approach towards claims handling with a focus on outcomes. All of that is no doubt to the good.
It is interesting to speculate whether we will one day see this process of evolution catch up with other forms of contract where implied terms have long been the norm, based upon expectation. It may be far off, but the day may be on the distant horizon where disputed policy wording will be subject to a test of a meaning in favour of the reasonable expectation of the policyholder. We shall see.
[1] John Birds, Ben Lynch and Simon Paul, MacGillivray on Insurance Law, (15th Edition, 2024) at paragraph 11-040.
[2] ibid. with reference to Charter Reinsurance Co v Fagan [1997].
[3] Paul Reed, Construction All Risks Insurance, (3rd Edition, 2021) at paragraph 13-048.
[4] ibid. (paragraph 13-027).
[5] Lord Atkinson in London and Lancashire Fire Insurance Company v Bolands [1924] at 846.
[6] n.4.
[7] n.3 (at paragraph 13-049).
[8] Slesser LJ in English v Western [1940] relying upon a passage from MacGillivray on Insurance Law, 2nd Edition.
[9] Lord Hoffman in Investors Compensation Scheme Ltd v West Bromwich Building Society; Same v Hopkin & Sons (a firm) (1998) 1 W.L.R. 896.
[10] n.9 (at paragraphs 912 to 913)
[11] n.1 (at paragraph 11-039)
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