A single mother who owed her financier more than $40,000 on a written-off car has won a claim dispute and compensation after the ombudsman ruled her insurer gave poor and inadequate advice over the sum insured value at the inception of her policy.

The mother’s decision to select a sum insured that was only 56% of the $48,000 purchase price of the car was “patently unwise,” the Australian Financial Complaints Authority (AFCA) said. RAC should have pointed out the implication and significant risk of underinsuring a brand-new vehicle at less than the amount borrowed.

“It should be well known to an insurance representative that this would be a breach of most finance contracts. At the least the representative should have addressed the total loss terms of the policy and that the complainant may be left with a substantial liability and no vehicle,” the ruling said.

“The poor advice at inception of the policy undoubtedly contributed to the anxiety the complainant found herself in after the accident. That anxiety would have been aggravated when the insurer refused a new replacement vehicle.

“The complainant’s position was that she no longer had a car but still had a substantial debt to the financier.”

RAC’s decision to write her vehicle off after an accident in October and quickly remit $27,160 to her financier just a few weeks later – the agreed sum insured – left the insurer $30,000 better off than if it had provided a replacement new car as she requested and the policy promised. This was “difficult to ignore,” AFCA said.

RAC said it was unable to find the same vehicle in WA and so it had relied on a policy term stating “if the new replacement car is not available in WA we may pay the agreed value of your car”.

However, the mother produced two Contracts to Buy a Motor Vehicle – for $57,508 and $56,056 – and herself paid a dealership a $2000 deposit. RAC said that vehicle must have ceased to be available, and confirmed its original decision when she complained.

AFCA did not accept RAC’s argument that no car was available.

“A car may be available for purchase in WA without the car being in WA and available for immediate delivery,” it said. “I do not think the new replacement car benefit was intended to depend on which side of a state border a vehicle was located on any given date.”

One policy clause promised that "if we declare your car a total loss and less than two years have passed since it was first registered, and you are the first registered owner ... we will replace it with a new car … the same make and model as your car.” By proceeding instead with a cash settlement, disposing of the vehicle and retaining around $10,000 salvage, RAC’s net exposure was about $16,000.

“It is difficult to ignore that under that clause, the insurer’s net exposure was significantly more substantial, approximately $46,000,” the ombudsman said.

“I have reservations as to the appropriateness of the insurer proceeding with the writing off of the vehicle and selling the salvage. The vehicle was plainly a repairable write off. It was only a ‘total loss’ due to the substantial underinsurance.”

AFCA ruled RAC should either pay the balance of the cost of a new replacement vehicle, or provide a new replacement car and the driver return the $27,160 it had paid.

RAC had not proven that no replacement car was available, it said, with emails between RAC and a business that sources cars for sale from dealerships "confusing and unsatisfactory as evidence”.

AFCA said it was “somewhat inconsistent” that RAC argued on the one hand that a replacement car “must be available at the time the vehicle is determined to be a total loss,” but on the other hand also stated a replacement car “must be available for immediate purchase and delivery within WA at the time of enquiry”.

"I am unable to accept either of these interpretations. They are a gloss on the actual policy language,” the ombudsman said.

A recent determination on the same policy determined “available in WA” meant “the car can be ordered and supplied to a buyer in WA in the ordinary course of business even if there is wait between the order and the delivery”.

AFCA ruled RAC should provide a replacement vehicle consistent with the policy terms and also awarded $2000 compensation, saying the insurer proceeded to cash settle the financier before the mother had time to “fully ventilate” her complaint, and its refusal to provide a replacement car “precipitated an immediate crisis” for her as the balance due on the loan would have become payable.

See the full ruling here.