Optimal Rules of Negligent Misrepresentation in Insurance Law

Abstract

This article analyzes rules for negligent misrepresentation in insurance contract law. Before contract signature, the applicant can be asked by the insurer to fill in a questionnaire concerning the risk, and may then omit or make untrue statements about facts. Such misrepresentation is considered negligent by the court when it is unclear the misrepresentation was due to a mistake or intentional.Rules of negligent misrepresentation differ significantly across jurisdictions. For example, the rule of common law allows the insurer to rescind the contract, whereas the German rule does not allow the insurer to reduce cover at all. Other rules, that differ in the strictness of the consequences for the insured, apply in other European countries, and yet others have been proposed in current attempts to harmonise both American and European insurance contract law. This article allows for an evaluation of these rules through an analysis of the degree to which the insured should be allowed to lower coverage in case of negligent misrepresentation.On the one hand, a strict rule renders it easier for an insurer to separate different types of risk without having to use other costly means of separation such as a deductible. On the other hand, a strict rule exposes the insured, who may have committed a mistake, to risk. In this trade-off, the optimal rule depends, among other factors, on the cost for the insurer of auditing types when claims are presented, on whether the insurer can commit to an auditing strategy, on the risk aversion of the insured, and on the likelihood for the insured of making a mistake.