In Search of a Paradigm for Ethical Conduct in Insurance

Ethics, Morals, or Both?

"Ethics" and "morals" are often used interchangeably. In Aristotle's Nichomachean Ethics, written 2,500 years ago, the Greek word "ethos" means "character" in English and "ethikos," the adjective form of ethos, means "ethics" in our language. On the other hand, "morals" is derived from the Latin word "mos" meaning "custom" and reflects the customs of a particular group. This suggests that ethics and morals have different origins and developed in different contexts but, perhaps, in later treatments, overlapped.

The following distinctions are examples of how we might think of ethics versus morals: The source of ethics is external to the person, while the source of morals is more internal to the individual. We behave ethically because society or an instrument of society tells us how to act, whereas, one acts morally because he or she believes in something being right or wrong. Ethics is often framed within a particular context (e.g., occupation, profession, or company), while one's sense of morality applies across the board. Ethics, therefore, are specific to a time and place, but morality may transcend even cultural norms. ¹

It is common to speak of a code of ethics, but not a code of morality. From an enforcement perspective, ethical principles may also involve a method of punishment for ethical breaches, whereas moral failures may not. Additionally, it is not an ethical breach for a doctor to perform abortions, but it may conflict with a doctor's moral sensibilities. In the final analysis, both ethics and morals are about a person's attempt to "do the right thing," so even leading authorities conflate the two. ²

One caveat at this point. You may have heard it said that ethical questions arise only when you face a situation in which two or more ethical principles collide. I do not deny that such a situation presents a dilemma, but a conflict of ethical principles is not a necessary and sufficient condition for posing ethical questions. To the extent that a given action may involve two or more principles, the conflict may arise from a difference between one's moral sensibilities and an occupational ethical requirement. To some extent, this conflict is captured in the Isaac Asimov quote, "Never let your sense of morals get in the way of doing what's right."

Back to Basics: Foundations of Ethical Principles in Insurance

Approaches to the teaching of ethics take many directions. After sitting through several of the required courses over the years, reviewing a few company-sponsored ethics courses, and examining several insurance and noninsurance codes of ethics, I want to identify certain core values that form a pedestal on which a common core of instruction may rest in insurance. My purpose in this and future commentaries is to present my perspective on this challenge. As I will argue, the public policies undergirding insurance offer a beginning.      

Two events in the history of insurance are important in fashioning the industry's defining ethical values, values that set it apart from all other industries: Carter v. Boehm (1766) 3 Burr 1905, a British case from the days of mercantilism, and German Alliance Ins. Co. v. Lewis, 233 U.S. 389 (U.S. 1914), a US Supreme Court case of the early twentieth century.

Carter v. Boehm

This commentary addresses the significance of Carter v. Boehm and its progeny, while a second installment will describe German Alliance Ins. Co. v. Lewis. With that in mind, let us first look backward a few centuries to 1766 and the context of the British case of Carter v. Boehm, a decision often referenced in industry literature and forming one of the two pillars on which, I will argue, form the foundation for ethical principles in insurance.

Winston Churchill called it the First World War. On the continent of Europe, the conflict was called the Seven Years' War. In the American colonies, then and now, it goes by the name of the French and Indian War. In this war, England, her New World colony of America, and Frederick the Great of Prussia squared off against France, Austria, and Russia in several parts of the globe, involving what was then called the New World, Europe, India, the Caribbean, and elsewhere on the high seas and other places from 1756 to 1763.

The war formed the setting of James Fenimore Cooper's The Last of the Mohicans, provided a young George Washington with his first military experience on behalf of the crown, developed a sense of togetherness among the colonists that eventually led to the American Revolution, opened our borders to colonization beyond the Alleghenies by removing the French, and awarded Florida to the British colonies in the 1763 Treaty of Paris, ending the war. During the conflict, on the island of Sumatra, the East India Company, a British corporation engaged in development and care of newly colonized locations, built Fort Marlborough, a trading post.

Sumatra is located in the Indian Ocean and straddles the equator. To call the place a "fort" is somewhat misleading because the structure really was not much of a fort. It was strong enough to withstand attacks from the native population but not from armed forces of another nation, namely, France.

Recognizing the risk, Roger Carter, the governor in charge of Fort Marlborough, wrote his brother George in London on September 22, 1759, asking him to insure the post against hostile takeover. The amount of the property at risk was valued at over £20,000. Charles Boehm, a well-known London merchant, agreed to insure the fort for £10,000 for the period of October 16, 1759, to October 16, 1760, "for the benefit of Governor Carter, and to insure him against the taking of the fort by a foreign enemy." On March 31, 1760, the British abandoned the fort to the French.

Carter, having suffered a loss of £20,000, filed a claim with Boehm, who refused to pay on the basis of nondisclosure (i.e., "You (Carter) did not tell me the fort is in a war zone."). Specifically, Boehm contended that Carter knew that the French would attack but did not disclose that fact in applying for insurance. At initial trial, Carter won, but Boehm appealed. On appeal, Lord Mansfield, as judge, took the opportunity to establish a few important principles of insurance.

Carter v. Boehm generally held the following.

• The proposer (applicant for insurance) must disclose all material facts.
• Material facts are those that would influence an underwriter as to whether he or she should or should not accept the risk.
• The proposer (applicant) need not disclose what the underwriter ought to know (i.e., that which is common knowledge).
• The proposer (applicant) is not required to disclose things he or she could not know.

"Good faith forbids either party by concealing what he privately knows, to draw the other into a bargain, from his ignorance of that fact, and his believing the contrary," said Lord Mansfield. The duty to disclose material facts is a mutual duty imposed upon both insured and insurer.

Many references to the case fail to mention the outcome, so I will add that to the story. The court determined that Boehm was in a better position in London to know the state of affairs concerning the war and how it was going than Carter, who was lodged far away in the jungle 7,000 miles away. Consequently, the court ruled that since everyone knew that France and England were at war, this universal knowledge meant that Boehm had what we might call constructive knowledge of the risk (i.e., Carter's disclosure had been sufficient). To find in favor of Boehm would be tantamount to converting the insurance contract itself into a fraud, reasoned Lord Mansfield.

Utmost Good Faith

Based on this and subsequent decisions, writers about insurance have described insurance as a contract of utmost good faith, the principle that people generally agree Lord Mansfield was trying to establish. Here are some examples.

Karen Porter's text states it this way:

Because insurance involves a promise, it requires complete honesty and disclosure of all relevant facts from both parties. For this reason, insurance contracts are considered contracts of utmost good faith. Both parties to an insurance contract—the insurer and the insured—are expected to be ethical in their dealings with each other.

The insured has a right to rely on the insurer to fulfill its promises. Therefore, the insurer is expected to treat the insured with utmost good faith. An insurer that acts in bad faith, such as denying coverage for a claim that is clearly covered, could face serious penalties under the law.

The insurer also has a right to expect that the insured will act in good faith." ³

A Georgia agent licensing text for life and health insurance states, "The insurance contract has certain characteristics not found in the typical noninsurance contract: Utmost Good Faith. The insurance contract requires utmost good faith between the parties." ⁴

A leading text on life and health insurance goes further, stating, "First, the insurance contract is one of utmost good faith that is, each party is entitled to rely in good faith upon the representations of the other, and each is under an obligation not to attempt to deceive or withhold material information from the other. The rule of caveat emptor does not generally apply. The company must depend to a great extent on the statements of prospective owners/insureds in assessing their acceptability for insurance, and the buyer must rely upon the insurer's good faith because the insurance contract is intricate and highly technical." ⁵

As the concept has evolved, the duty of utmost good faith differs from ordinary good faith by requiring disclosure of all material information that one knows, whether or not asked, whereas good faith alone generally requires honesty in providing the information.

From a legal perspective, few states use the expression "utmost good faith" outside marine insurance transactions, New Jersey being one exception. In this commentary, my emphasis is not on the legal standards, rather, it is to emphasize the principle of utmost good faith as the industry standard, a standard that insurance is a business that must adhere to a different set of rules, a higher standard than found in ordinary business relations.

Further, all actions—whether in selling, servicing, underwriting, claims, or investment management—and aspects of the insurance enterprise should be judged on this standard: does my action comply with and advance my industry's standard of utmost good faith?

Utmost good faith as a standard opens the door to address topics like whether contracts of adhesion, the conditions sections of insurance contracts, the practice of including exclusions in definitions, subletting claims administration to noninsurance vendors and experts, the mixing of insurance and financial services, and the extensive use of "big data" in underwriting and claims comply with the principle.