Development of Latvian Insurance Contract Law Under the Influence of European Union Law

European Union law universally defines an insurance contract as a civil law transaction characterised by the insurer's obligation to provide the insured person, in the event of the occurrence of an insured event, with the services agreed in the contract, by collecting a premium in advance (CJEU, 2015).

As regards the insurance regulatory framework in general, it should be noted that the provision of insurance services in the EU is unified by the Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking up and pursuit of the business of Insurance and Reinsurance (Solvency II) and related legislation.

It follows from the European Union's unified framework for the provision of insurance services that an insurance contract is a commercial transaction because the insurer is a merchant. This is also prescribed in Latvian law (Section 1(1) of the Commercial Law). An insurer is a merchant who performs commercial activities directly related to insurance (Section 10(1)3 of the Insurance and Reinsurance Law). Such findings are available in the legal literature (see, e.g. (Rone, 2019)). However, the author has repeatedly observed that this understanding of the status of the insurer is not always respected in legal practice. This is due to the specifics of the insurance contract and the historical development of insurance, that is the weak development of insurance institutions during the period when Latvia was part of the Soviet Union.

Under the Treaty on the Functioning of the European Union, the freedom of establishment and the freedom to provide services do not apply to activities related to the exercise of official authority (Article 51), so insurance contract law – similar to most civil law – is not subject to any unification. The legal relations between the parties to an insurance contract must be governed by the national civil law framework of each country.

Latvian legislation provides for a definition of an insurance contract that is consistent with the generalisation provided for in European Union law.

Latvian case law contains a number of opinions on what constitutes an insurance contract, stating that an insurance contract as a legal transaction is an act of will of legal subjects, which creates legal consequences and is binding for both parties (Supreme Court, 2016).

However, Latvian case law also contains opinions that although the law does not prevent the parties from freely agreeing on the terms of the insurance contract, they cannot contradict the provisions of the law describing the nature of an insurance contract, which generally regulate the rights and obligations of the insured person, the policy holder and the insurer, as well as the consequences of non-fulfilment thereof, and the insurer may refuse to pay insurance benefit only on grounds specifically provided for in the law (Supreme Court, 2014).

The case law also specifies the following: ‘The obligations of the parties under the terms of an insurance contract cannot be interpreted in isolation from the provisions of the law and, in that context, no additional restrictions may be imposed on the insured person to the detriment of their position. Namely, the insurer must base its refusal on the existence of circumstances pointing to a specific activity or inactivity (gross negligence) of the insured person as the cause of the insured risk. In any case, the insurer's reference to breach of contract must not be formal, that is unrelated to the occurrence of the insured risk’ (Supreme Court, 2022).

Although these conclusions have been drawn on the basis of the provisions of the expired Insurance Contract Law, the legal framework has not undergone any significant changes in this respect with the entry into force of the Insurance Contract Law, except for a clear formulation of the subject matter of insurance contract.

The author considers that in case of adjudication of a dispute in court, it is important to initially ascertain which obligations of the parties are to be determined by free agreement in the insurance contract, and which obligation the legislator has regarded as its exclusive competence by creating mandatory legal provisions on them.

In this respect, only a judicial analysis of the content of the provisions of insurance contract law will be relevant. The legislator can help by further clarifying the subject matter of the insurance contract and possible agreements under that contract.

Currently, Section 8(6) of the Insurance Contract Law provides that the insurance object, the aggregate of insurance risks and exemptions laid down, sum insured and liability limit laid down in the insurance contract shall be regarded to be the subject matter of the insurance contract.

No restrictions for various exceptions in the insurance contract have been provided either previously or currently in the Insurance Contract Law.

Section 18 of the reviewed law, which essentially reproduces Section 12 of the previous law, prescribes that the parties may provide other exceptional cases in the insurance contract when the insurer does not reimburse losses. There is no provision on the part of the legislator in relation to the breach of obligations of the policy holder or the insured person or any specific breach of contract or law. There would be no reason to try to modify the content of the insurance contract by extending the customer's eligibility for insurance benefit since firstly, the insurer has set the insurance premium – the price of the insurance service according to the contractually granted eligibility for insurance benefit, and, secondly, paying insurance benefit unreasonably makes future insurance services more expensive since the insurance premiums collected by the insurer from its customers – policy holders – are the main source of funds for paying insurance benefits.

In order to be able to say that an insurance contract must not contain exclusions which are not related to the unjustifiable behaviour of the policy holder or the insured person, it must be expressly provided for by law. This will only require additional effort from insurers to formulate the descriptions of the risks to be insured in such a way as to exclude the occurrence of risks that the insurer does not undertake to insure. Therefore, such a path to clarifications in the law would not be justified.

However, it seems that clarifications on the essence of insurance contract can be called topical.

The issue of the essence of insurance contract, analysing the essential and natural components of insurance contracts, has been discussed in the Latvian legal literature (Alfejeva, 2017, Mantrovs, 2018, Torgāns, 2018). There is also an opinion that the essential elements of an insurance contract are not deducible from the Insurance Contract Law (Rone, 2019).

Thus, an opinion has already been expressed that the content of Section 8 of the Insurance Contract Law is not sufficient to identify the subject matter of insurance contracts and, consequently, essential elements thereof.

Dealing with the ambiguity of the content of insurance contract, which is often encountered in legal practice, and respecting the fact that the insurer is a professional and is the one who draws up the terms of insurance contract, Section 8(1) of the Insurance Contract Law may be clarified by prescribing that the interpretation of the terms of the insurance contract which binds the insurer the most shall take precedence over other interpretations. As follows from the author's legal practice experience and reviewed references, such a provision can be found in the legal framework of several European countries and has so far been applied in Latvia through the so-called contra proferentem principle. In this way, the legal protection of the beneficiaries of insurance benefits would be strengthened by a legal provision.

As regards the subject matter of insurance contracts, in the author's opinion, the only thing that should be added to it is the deductible since at present, the law generally lacks a widely applicable definition of the deductible and its relation to the subject matter of the insurance contract.

Deductible is defined in insurance contracts as the part of the losses (in percentage or monetary terms) resulting from an insured event that the insurer does not indemnify. This definition should be included in Section 1(1) of the Insurance Contract Law.

Section 8(6) of the Insurance Contract Law may include a more precise definition of the insurance subject, also integrating the deductible.

Section 1(1)18 of the Insurance Contract Law prescribes that a compensation principle is an insurance principle based on which the insurance benefit is calculated by taking into account the amount of losses incurred in an insurance event. Section 42 of this law is based on the previously existing Insurance Contract Law and Section 42(1) prescribes that the insurance benefit disbursed in accordance with the compensation principle may not exceed the losses caused in the insurance event, while Section 42(2) prescribes that parties may agree on the method for the assessment of losses and also the value of specially irreplaceable object in the insurance contract.

By its very nature, the compensation principle is an internationally recognised and indisputable principle of insurance, which can only be disapplied in personal insurance. This principle prescribes that the insurance benefit is intended solely to cover the insured person's losses, thus preventing the insured person from enriching themselves by making a profit at the expense of the insurance benefit. In other words, if the insurance benefit is determined according to the compensation principle, the insured person can only claim an amount equal to their actual losses, taking into account the types of indemnifiable losses covered by the insurance contract and deducting from this amount the deductibles provided for in the insurance contract (Blend, 1995, 8–394).

This principle also applies to situations where the insured person has more than one insurance contract for the same risk. For example, if a vehicle insured under two insurance contracts is damaged in a road accident that both contracts identify as an insured event, the owner of the vehicle can only claim the total amount of the insurance benefits from both insurance contracts, that is the losses related to the damage to the vehicle.

The compensation principle plays an important role in ensuring the availability of insurance services by allowing insurers to set the premium – the price of a given insurance service – only to compensate for losses, without redistributing customer funds in an unlimited way, as in the case of a lottery, for example.

However, it shall be acknowledged that the definition and regulation of the compensation principle in the Insurance Contract Law are often misunderstood, seeking to justify the payment of an insurance benefit in the amount of the sum insured, rather than according to the assessment of the losses suffered, thus departing from the basic idea of the compensation principle. For it is possible, for example, that by deducting the amount of the deductible from the sum insured, the insurance benefit would be equivalent to the amount of the losses, thus formally satisfying the requirement of Section 42(1) of the law. However, this clearly contradicts the nature of the compensation principle and the determination of the deductible.

The main basic task of determining the deductible is to reduce the customer's moral hazard in insurance. Moral hazard theory (Barker, 1996; Cummins & Tennyson, 1996; Dembe & Boden, 2000; Hoyt et al., 2006, Bourgeon & Picard, 2020) distinguishes cases where the insured person contributes to the occurrence of the insured risk, including, for example, by being more reckless with safety requirements after signing the insurance contract because the losses will not be borne by the insured person but by the insurer under the insurance contract.

This moral hazard can be reduced by introducing the insured person's co-payment – deductible. Accordingly, the insurance benefit cannot be equivalent to the amount of the losses in case the insurance contract provides for a deductible – it must, in the absence of other restrictions, be less than the losses for the value of the deductible.

Thus, Section 42 of the Insurance Contract Law can be clarified as follows:

‘(1) According to the compensation principle, the insurance benefit shall be calculated on the basis of the amount of the losses arising from the occurrence of the insured risks, less the deductible, if any, provided for in the insurance contract, and other deductions provided for in the insurance contract. The insurance benefit payable shall in no event exceed the losses which the insured person has suffered as a result of the insured event.

(2) Parties may agree on the method for the assessment of losses, which may not conflict with the principles of assessment of losses in civil law, and also the value of specially irreplaceable object in the insurance contract.

(3) The insurer and the insured person have the right, by mutual agreement, to reduce the initial value of the insurance object if a specially irreplaceable object considerably loses its initial value. If such agreement cannot be reached, any of the parties has the right to unilaterally terminate the insurance contract.’

In addition to the aforesaid, there is considerable ambiguity regarding the so-called extended notification period in civil liability insurance contracts.

Section 49 of the Insurance Contract Law prescribes that a civil liability insurance contract can provide that an insurer shall compensate the losses which are causally linked to the event in a retroactive period or insurance period, if a third party has submitted a claim against the insured person for the compensation of losses within the time period specified in the insurance contract after the end of the insurance period.

However, despite the express possibility of the legislator to allow the parties to an insurance contract to freely agree upon the insurance cover only for third party claims submitted within the time limit specified in the insurance contract after the end of the insurance period – within the so-called extended notification period, the question of the application of this period may be subject to the assessment of unfair terms in consumer contracts (Section 6 of the Latvian Consumer Rights Protection Law, which is based on Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts).

In this respect, it is interesting to turn to an analysis of international experience. At the beginning of this century, when the unification of civil law became topical, a European Commission Expert Group was set up, which in 2014 came up with its conclusions on the impossibility of unification in the coming years (Final Report of the Commission Expert Group on European Insurance Contract Law, 2014).

In its report, the expert group drew a number of topical conclusions on important aspects of insurance contract law in the national legal frameworks of the European Union.

In Section 4, after discussing two possible but different principles of cover in civil liability insurance contracts – occurrence-based and claims-made, the Expert Group concludes that a key issue in civil liability insurance is the determination of the duration of such cover in claims-made insurance contracts.

The claims-made principle provides that the insurer will only pay insurance benefit for those cases of civil liability of the insured person, for which the victim (third party) has made a claim during the insurance period or the extended notification period.

When looking at the differences and shortcomings in the legal framework in this context, the experts point out that there are limitations to the determination of the extended notification period in a number of countries. There are also countries, such as Italy and Germany, where the extended period determination clause is valid without limitation but subject to judicial review in relation to consumers on the basis of unfair contract terms. For example, in Germany, a court ruled on this issue that contractual terms limiting the insurer's period of liability are valid, provided that other elements of the contract compensate for the limitation. Such other elements may include retrospective cover that under the contract, the insured person's option to give notice before the end of the period specified in the insurance contract of events may give rise to claims against the insured person.

It seems that the Senate of the Republic of Latvia had a similar idea when it ruled that the assessment of the unfairness of a term of an insurance contract must be made by determining whether the insured person can actually fulfil it (SC, 2023). Only the finding in the same Senate judgement that the terms of an insurance contract cannot be contrary to the purpose and meaning of the insurance contract requires further development in the context of mandatory legal provisions or provisions on misleading the consumer at the time of conclusion of the contract. The solution to this case would be that the insured person should be given the opportunity to give notice during the extended notification period of events which may give rise to claims against the insured person, which would compensate for the failure to bring a third-party claim during this period and would be similar to the German case law referred to above and studies by the European Commission Expert Group.

It should be noted that the European Commission Expert Group also concludes that the unfairness of contractual terms may be interpreted differently in the Member States, despite the fact that it is based on the relevant directive (Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts), which is also a matter for the future search for a unified interpretation, which may be helped by preliminary rulings of the Court of Justice of the European Union.

Accordingly, in order to dispel possible ambiguities and to provide protection not only to consumers but also to other parties to the contract, Section 49 of the Insurance Contract Law can be clarified as follows:

‘A civil liability insurance contract can provide that an insurer shall compensate the losses which are causally linked to the event in a retroactive period or insurance period, if the insurer has received notification of an event that may result in claims against the insured person for the compensation of losses within the time period specified in the insurance contract after the end of the insurance period (in the extended notification period).’

From the very beginning, Latvian insurance law incorporated the obligation of the recipient of insurance services to provide truthful information about the claimed insurance event. This obligation, both when concluding an insurance contract and when filing an insurance claim, is based on European practice (Li et al., 2016).

Currently, this obligation and the consequences of nonfulfilment thereof are provided for under Sections 27, 29 of the Insurance Contract Law (formerly Sections 21, 22 of the Insurance Contract Law).

The case law on the application of Sections 21, 22 of the Insurance Contract Law and Sections 27, 29 of the Insurance Contract Law is diverse, often linking the assessment of the insurer's right to refuse to pay insurance benefits to the materiality of the information withheld.

There is also no information in legal practice on the application of Section 22(2) of the Insurance Contract Law, which has essentially the same content as Section 29(2) of the Insurance Contract Law.

It is also not clear from the content of Section 27 of the Insurance Contract Law that the recipient of insurance services is obliged to provide the insurer with all relevant information on the occurrence of the insured risk in order to enable the insurer to determine exactly what risk has occurred and what causally related losses have been suffered by the insurer. The obligation to provide information should also be extended to the rightful user of the insured object – the tangible thing, because although it already follows from the provisions of the Insurance Contract Law in their context, it is not always clearly understood by the insurer's customers.

However, it is important for customers to be aware of the importance of this obligation as it prevents unjustified payment of insurance benefits and thus prevents the price of insurance services from being driven by fraudulent claims. There have been opinions in the legal literature on the possibilities of combating fraud through the modernisation of insurance contract law (Rawlings, Lowry, 2017).

Thus, Section 27 of the Insurance Contract Law should be clarified as follows:

‘Section 27. Obligations of a Policy Holder, Insured Person and Beneficiary after Occurrence of Insurance Risk

(1) An insured person claiming an insurance benefit shall be obliged to, without delay at the earliest opportunity, notify the insurer of the occurrence of an insurance risk, provide the insurer with all information in their possession concerning the circumstances of the occurrence of the insured risk and take all possible reasonable measures in order to reduce the losses, complying with the instructions of the insurer, if any have been given. The same obligation shall apply to the person who is the rightful user of the insured object – the tangible thing.

(2) The policy holder, insured person and beneficiary shall provide the insurer with all information in their possession concerning the circumstances of the occurrence of the insured risk and the amount of the losses suffered, as well as other information at their disposal relating to the occurrence of the insured risk and requested by the insurer, and shall fulfil other obligations provided for in the insurance contract. The policy holder, insured person and beneficiary may not object to the activities of the insurer with the aim to establish and assess the amount of losses, circumstances of their emergence, and also to the request of the insurer to submit to the insurer all the documents and information at their disposal which characterise the occurrence of the insurance risk and losses caused thereby, including documents containing health data of persons and a commercial secret.

(21) The policy holder, insured person and beneficiary shall be responsible for the veracity of the information provided by each of them to the insurer according to this Section, and also none of them may gain an advantage due to the fact that others have provided incomplete, false or misleading information. The insured person shall be liable for incomplete or false information provided to the insurer by the rightful user of the insured object – the tangible thing.

(3) The provision of the information laid down in this Section shall not be considered to be a violation of the Law and other laws and regulations, as well as a violation of the provisions of the contract, and it shall not give rise to civil, administrative or criminal liability of the policy holder, insured person and beneficiary.’

Section 29(2) of the Insurance Contract Law should be clarified as follows:

‘(2) If the policy holder, insured person or beneficiary has not fulfilled any of the obligations laid down in Section 27 of this Law due to ordinary negligence, the insurer shall be entitled to refuse to pay the insurance benefit only if the failure to fulfil such obligation has made it impossible to establish with certainty whether or not the event claimed is to be regarded as an insured event.’

The Insurance Contract Law has introduced a new legal institute in Latvian contract law – the insurer's subrogation right. Previously, this right was combined with the concept of recourse.

According to Section 1(1)23 of the Insurance Contract Law, subrogation right is the right of the insurer who has disbursed the insurance benefit to take over the right to claim of the insured person against the person responsible for losses in the amount of the disbursed sum.

However, in correctly defining the new legal institute and determining the legal aspects related to it, the legislator has clearly mistakenly – inconsistent with the principles of indemnification of losses under Latvian civil law – provided that the subrogation right does not exist in cases of personal insurance. This would only be correct if, in the case of personal insurance, insurance benefits were always determined by the amounts provided for in the contract and not by the amount of the losses, taking into account the principle of compensation. However, in practice – and this is not prohibited by law – in personal insurance, the amount of insurance benefit is partially determined by the amount of losses, for example, compensating for medical treatment in connection with an accident – in this case, there is no legal justification for relieving the person who caused the losses and is not a party to the insurance contract from the civil law obligation to indemnify.

Thus, Section 45(1) of the Insurance Contract Law should be clarified as follows:

‘(1) An insurer who has disbursed insurance benefit has the subrogation right, except in the cases of personal insurance where the compensation principle does not apply.’