The Duty to Explain: a Gamble in Insurance Litigation

The Korean Insurance Law Association (KINSLAW) is the only academic institute in Korea that is specialised in insurance law. At a seminar hosted by KINSLAW in October 2023, the most debated topic was the “Duty to Explain” prescribed in the Standardised Contracts Regulation Act of Korea (to be explained hereunder). The controversy of the Duty to Explain and its impact on the insurance industry and law are further supported by the sharp increase in the number of Supreme Court cases that have overturned the appellate decisions on the issue of Duty to Explain.

Consider the following scenario. There is a casualty insurance policy in which a special exclusion clause provides that the policy does not provide coverage for casualties arising from dangerous recreational activities such as professional climbing, maneuvering a glider, scuba diving, skydiving, hang gliding, etc (the “Exclusion Clause”). Before the policyholder signed the policy, the insurer did not explain to the policyholder the Exclusion Clause in detail and instead provided a policy guideline booklet which simply stated that, “[t]his policy does not provide coverage for casualties arising from dangerous recreational activities including professional climbing, hang gliding, etc”. In short, the guideline booklet did not explicitly state that casualties arising from scuba diving are not covered. Subsequently, the policyholder drowns while scuba diving and the bereaved family lodges an insurance claim against the insurer under the policy.

An ordinary insurance practitioner would conclude from this situation that the insurer would naturally be exempt from the policy because the policyholder agreed to the policy that contained an exclusion clause on scuba diving casualties, which was the cause of death. However, the Korean Supreme Court determined in such case that the insurer is liable to cover the death of the policyholder under the casualty policy on the basis that the insurer failed to specifically provide a detailed explanation of the Exclusion Clause to the policyholder at the time of policy execution (Case No 98Da43342). The Court reasoned that the express wording of the Exclusion Clause in the policy and the policyholder’s agreement thereto are by themselves insufficient for the insurer to satisfy its duty of explanation owed to the policyholder. Instead, the insurer should have specified in the policy guideline booklet the exclusion of scuba diving casualties from coverage or, alternatively, explained in detail the Exclusion Clause to the policyholder prior to the policy execution.

The Standardised Contracts Regulation Act of Korea (SCRA)

Needless to say, it would be unfortunate if a policyholder unexpectedly suffers a loss due to their unawareness of a material provision in the insurance policy. As a preventive measure, legislations have been enacted around the world to ensure that the policyholder would be given a sufficient opportunity, such as receiving precise directions on where to find the contract provisions online for printing in cases of online contracts, to be advised of material policy provisions before signing the contract. “Material policy provisions” are terms and conditions that are likely to affect the policyholder’s decision to agree to the insurance policy or to the terms themselves. Examples include the insurance premium rates, subjects of duty to notify, bases for policy rescission and the insurer’s exemption clauses.

However, as shown in the example provided above, the problem in Korea is that it is insufficient for the policyholder to have been given ample opportunity to become aware of the policy conditions before their signing thereof. The SCRA provides that, despite the ample opportunity for the policyholder to become aware of the terms of the policy prior to the signing, material provisions (such as exemption clauses) would be carved out from the policy if they were not specifically explained in detail to the policyholder and instead only the remaining terms would become effective. To make it worse, the insurer also bears the burden of proof in showing that it has, in fact, satisfied its “Duty to Explain” owed to the policyholder.

While, on the one hand, the SCRA specifically stipulated the Duty to Explain since its enactment in 1986, in traditional industry practice, however, the insurer’s Duty to Explain was deemed to have been satisfied once the policyholder had written by hand “I have read and understood the terms and conditions of the policy” prior to execution of the policy. It is understandable for this kind of practice to typically take place as it would be unrealistic to individually explain in detail the terms of the insurance policy, especially in light of the policy terms being highly technical and complicated. Following its legislative reform in 1986, the SCRA conflicted with industry practice, which led to a flood of insurance claim disputes over the true and proper interpretation of the Duty to Explain, thereby affirming the need for a realistic solution that would alleviate the legal ambiguity and prevent unnecessary legal disputes. In such disputes, the Korean courts have shown a tendency to consistently interpret the SCRA in favour of the insureds.

Criticism from legal scholars

There has been strong criticism from legal scholars in insurance law towards the extended application of the Duty to Explain under the SCRA to insurance policies. The main reasons for such criticism are outlined below.

Incoherent application of Duty to Explain and material provisions

Whether the insurer fulfilled the Duty to Explain is a question to be determined on a case-by-case basis. However, to generally rely upon the failure of the insurer to fulfil this Duty as the basis for nullifying certain terms of the insurance contract would lead to an incoherent result of irregularly applying the “material provisions” for some policyholders while others are freed therefrom. In other words, while policyholders should be subject to the same risks as a class, such as insurer’s liability exemption clauses based on the fundamental principle of an insurance contract, a breach of the Duty to Explain unjustifiably frees only some policyholders from the exclusion clauses. This kind of unequal treatment among policyholders would hamper concluding insurance policies on the basis of large-scale and standardised contracts. Therefore, the provisions of the SCRA should not be blindly applied to insurance policies.

Fairness and approval of policy terms

If an unfair term that is to the disadvantage of the policyholder exists in a policy, then it would sufficiently protect the interests of policyholders for such term to be nullified and removed from standard insurance contracts. By extension, if a term is deemed to be fair and was approved by the supervisory agency, then subjecting the policyholder to the term cannot be deemed to be unfairly unfavourable to the policyholder solely because the insurer failed to individually explain it.

Uniqueness of Korean approach to Duty to Explain

Korea is the only country that has imposed on the insurer a legal duty to explain in detail terms and conditions of a contract. When the SCRA was reformed in 1986, the corresponding German law on standardised contracts regulation (Gesetz zur Regelung des Rechts der Allgemeinen Geschäftsbedingungen) was an influential reference. However, under the German law, there was no “Duty to Explain”; instead, it would suffice to rely on a method through which the contracting party would be expected to become sufficiently aware of the terms and conditions (Verschaffung der Möglichkeiten zumutbarer Kenntnisnahme). Even the Civil Act of Japan, which has a legislation system similar to Korea, did not impose in its 2019 reform such “Duty to Explain” as a condition for allowing contractual terms and conditions to validly come into the contract.

Practical challenges in indefinite application of Duty to Explain

Even for long-term insurance contracts, it is unreasonable to indefinitely allow the policyholder to exclude certain terms from the policy on the basis of the insurer’s breach of Duty to Explain. This is especially true in light of the burden of proof imposed on the insurer to demonstrate that it has fulfilled the Duty to Explain. Imagine a dispute arising from a ten-year insurance contract. In such case, the insurer would be excessively burdened with the task of proving that, at the time of contract execution ten years ago, it explained in detail the material provisions to the policyholder and, therefore, satisfied the Duty to Explain.

An attempt was made by legal scholars to reform the Commercial Code of Korea (KCC) that would restrict the application of the SCRA’s Duty to Explain to insurance contracts. Five years following the reform of the SCRA, in 1991 a new provision was added to the KCC that, in the event the insurer breaches the Duty to Explain, the policyholder may rescind the insurance contract within three months from the date of policy execution (Article 638-3). The underlying aim of this Article was to prevent the policyholder from asserting a nullity or rescission defence on the basis of the insurer’s breach of Duty to Explain if the policyholder fails to rescind the insurance contract within the three-month period. By inserting Article 638-3 into the insurance law chapter of the KCC, the expectation among legal scholars was that this Article would take precedence over the SCRA because the insurance law chapter of the KCC is a special law to the SCRA.

Compromise by the Korean Supreme Court – exceptions to Duty to Explain

To the disappointment of legal scholars, the Korean Supreme Court determined that, even if an insurance policy is not rescinded during the three-month period as stipulated in Article 638-3 of the KCC, a policyholder may nonetheless rely on the insurer’s breach of Duty to Explain under the SCRA to nullify the insurance policy (Case No 98Da32564). The Court reasoned that Article 638-3 of the KCC does not run against Article 3 of the SCRA (which stipulates the Duty to Explain) and hence they may be simultaneously effective. From the perspective of an insurance practitioner, it may be difficult to agree with the Court’s reasoning, but this ruling has not been overturned despite the strong opposition from legal scholars.

As a gesture of compromise, however, the Supreme Court partially responded to the criticism by providing the following types of circumstances under which the insurer would be exempt from the Duty to Explain:

• terms and conditions that the policyholder is sufficiently aware of;
• terms and conditions commonly provided in insurance contracts that are easily anticipated by the policyholder without a separate explanation; and
• terms and conditions that repeat or elaborate on provisions of law.

Unpredictability in judicial interpretations

There is a case law database named “Law Village” that was established by the Korean Supreme Court to facilitate legal research of essential decisions. In the database, 82 decisions on Duty to Explain are recorded that were rendered from 1986 (ie, when the SCRA was reformed) to March 2023, and 38% of these decisions represent instances where the Supreme Court reversed the appellate court’s decision. Narrowing down to decisions rendered from 2010 to 2023, the rate of disagreement rises to 42%, an increase which suggests the Korean courts’ unpredictable and varying appetites in interpreting Duty to Explain.

The lack of uniformity across the Korean courts in their interpretation of Duty to Explain is further demonstrated by the finding that, of the total number of lawsuits filed in court from 2020 to 2022, only 3-5% of these consist of instances in which the Supreme Court reversed the lower court’s decision. Although it may not be entirely appropriate to compare these two statistics, the vast difference between the percentages (ie, 38-42% versus 3-5%) at least suggests that even the highly professional and experienced judges sitting at the appellate courts and Supreme Court hold varying understandings of Duty to Explain. Over time, the difference in interpretation appears to have grown deeper and more frequent, thus signifying the unpredictable nature of legal disputes over Duty to Explain in the high-level courts.

To better illustrate the above, several instances of reversed decisions are examined below.

Terms and conditions that the policyholder is sufficiently aware of

In the case of a marine cargo policy governed by English law, where the subject vessel was unspecified at the time of policy execution, it was agreed that, if the subject vessel failed to satisfy the specifications under the Institute Classification Clause, the insured would promptly notify the insurer of the situation and the parties would mutually agree on the insurance premium. The policy also provided that the requirement of the vessel to satisfy the Institute Classification Clause constituted a warranty, a breach of which would serve as a cause of exemption for the insurer under the English Marine Insurance Act. In this instance, the marine cargo policy for an undesignated vessel had been annually renewed with the same insurer on the same terms and conditions over several years. The dispute arose when the subject vessel sustained wet cargo damage, and it turned out that the now-designated vessel did not satisfy the specifications under the Institute Classification Clause. The insurer alleged exemption from liability based on the insured’s breach of warranty.

The Korean Supreme Court determined that the warranty clause under English law is an unfamiliar clause to the Korean insured that requires a specific and detailed explanation, but the insurer failed to explain the warranty to the insured, thereby breaching the Duty to Explain. The Court further reasoned that the annual renewals of the insurance policy on the same terms and conditions cannot be relied upon to find that the insured had sufficiently understood the warranty clause. Hence, the Court reversed the appellate court’s decision and rejected the insurer’s breach of warranty defence based on its breach of Duty to Explain (Case No 99Da55533).

Terms and conditions commonly provided in insurance contracts that are easily anticipated by the policyholder without a separate explanation

In the case of a casualty insurance policy, one exclusion clause denied coverage for any complications arising from medical treatment. Such exclusion clause is typically included in not only the standard policy approved by the Financial Supervisory Service (FSS), but also insurance policies (which are based on the FSS-approved standard policy) adopted by local insurers that are widely and commonly used in practice. The appellate court dismissed the insurance claim on the basis that the exclusion clause is a commonly used clause in casualty insurance, and that the insured should reasonably expect its inclusion in the policy without a separate explanation. However, the Supreme Court reversed the lower court’s decision because the insurer cannot be viewed to have fulfilled the Duty to Explain solely because the exclusion clause was approved by the FSS and widely used in the industry (Case No 2020Da256675 and No 2020Da256682).

Terms and conditions that repeat or elaborate on provisions of law

Article 652 of the KCC obligates the policyholder to notify the insurer if, during the insured period, the policyholder becomes aware of a change or increase in the potential occurrence of an insured peril. In a case where five casualty insurance policies were executed between the parties, the first casualty policy provided special coverage for motorcycle casualties while the remaining four policies did not provide the same. Instead, the remaining four policies provided the insured’s duty to promptly notify the insurer if the insured regularly rides motorcycles and, in the event of a breach of such duty to notify, the insurer was entitled to rescind the contract. Following the execution of the policies, the insured began riding motorcycles for food delivery but failed to promptly notify the insurer of this fact. When the insurer learned that the insured suffered spinal injuries while regularly riding motorcycles, the insurer rescinded the contract on the basis of the insured’s breach of duty to notify.

The appellate court found that the insurer was entitled to rescind the policy because the insured breached his duty to notify the insurer of his motorcycle use and the policy provision on the notice duty was not within the scope of Duty to Explain. The Supreme Court disagreed and determined that the notice provision was subject to Duty to Explain. While the Court recognised the inherent danger of riding a motorcycle, it explained that the insured could not have expected the policy to include a provision imposing a duty to notify the insurer in the event the insured regularly rode motorcycles. Further, the Court found that the insured’s duty to notify under the policy was not a duplicate or elaboration of Article 652 of the KCC, and thus the insurer was obligated under the SCRA to explain the notice provision to the insured (Case No 2020da291449).

A gamble in insurance litigation

As seen from the statistical finding based on “Law Village”, the Korean Supreme Court and the appellate courts disagree on their respective interpretations of Duty to Explain in more than 40% of cases, a result which is significant as it underscores the uncertainty surrounding lawsuit outcomes until a final and conclusive judgment is rendered. This unpredictability in litigation appears to be exacerbated by the three categories of exception to Duty to Explain given that the presiding judge’s subjective interpretation of the exceptions leads to varying results as suggested from the case law previously discussed. Given that the Duty to Explain is almost always a vigorously disputed issue in high-profile insurance claims, it is essential for insurers to take extra care in ensuring that there would be no viable uncertainties over its fulfilment of Duty to Explain prior to execution of insurance contracts. Otherwise, an insurer subjects itself to an agonising process of trying but ultimately failing to predict the outcome of an insurance lawsuit.