Like most sections of the Insurance Contracts Act 1984 [Cth Act 80 of 1984] it is designed to protect the Insured.
The main point is that an insurer is not able to deny liability for a defect, unless the defect is known to the Insured or ought to reasonably be known to them. The Section, however, does not protect all Insureds. The attached paper by South Australian lawyer, Michael Fotheringham, a Partner with Winter Hilditch & Fotheringham, addresses the subject in excellent detail.
With Michael’s kind permission, I attach a copy of his paper. http://www.policycomparison.com/pci/ui/s46%20Insurance%20Contracts%20Act.pdf
It is important to understand this particularly, as many of the home and contents in the Australian market do not have a write back provision for resultant damage arising from a defect. This is particularly the case for while the article was correct at the time, the position appears to have changed with the 2010 case of Greg Nelson v The Hollard Insurance Company Pty Ltd  NSWSC 199.
This case considered whether section 46(2) of the Insurance Contracts Act 1984 (Cth) applied to a clause excluding liability for ‘inherent defects, structural faults, faulty workmanship or faulty design’ where the clause was not expressed to operate by reference to a condition existing before entry into the insurance contract.
Greg Nelson purchased insurance for a newly acquired yacht. Before completing his insurance, the Insured inspected the yacht for defects and also employed a qualified marine surveyor to survey the vessel. No defects were found in the yacht and the condition was shared with the insurer before finalisation of the insurance contract.
The insurance cover obtained by Mr Nelson covered the vessel for loss or damage arising out of ‘occasional slipping, cradling and launching for the purpose of maintenance and repair’; but excluded liability, as I explained earlier, for any loss or damage caused by or resulting from ‘inherent defects, structural faults, faulty workmanship or faulty design’.
Subsequently, while the yacht was being slipped and cradled for routine maintenance, it suffered a structural failure and sustained damage. The parties agreed that the damage to the yacht was caused by either an inherent defect, structural fault, faulty workmanship or faulty design, or a combination of these factors, not discovered by the inspection of the yacht conducted before entry into the insurance policy.
The insurer denied liability for the damage, on the basis that such liability was expressly excluded by the insurance policy. Mr Nelson argued that the exclusion of liability was rendered inoperative by s46(2) of the Insurance Contracts Act 1984, which as Michael points out in his article states:
…Where, at the time when the contract was entered into, the insured was not aware of, and a reasonable person in the circumstances could not be expected to have been aware of, the defect or imperfection, the insurer may not rely on a provision included in the contract that has the effect of limiting or excluding the insurer’s liability under the contract by reference to the condition, at a time before the contract was entered into, of the thing.
The court surprisingly to me agreed with the insurer. As there were no reported cases on s46 of the Insurance Contract Act, the court applied Asteron Life Limited v Zeiderman  NSWCA 47, the current authority on s47 of the Insurance Contract Act, a substantially similar provision. In Asteron, it was held that a life insurer could expressly exclude specific events such as the development of cancers, but not pre-existing conditions under s47 of the Insurance Contract Act. In particular, it was held that:
An insurer is entitled to exclude cover for particular events, irrespective of when they occur, and an exclusionary provision of that character does not fall within the statutory preclusion in either s46 or s47 of the Act because it could not be said that a limitation or exclusion was made ‘by reference to’ a condition of a thing or a sickness or disability at the time the contract was entered into. When the time of entry into the contract is irrelevant to the exclusion, the sections do not apply.
In Mr Nelson’s case, Justice Einstein considered Asteron to have made it clear that in determining whether s46 (or s47) of the Insurance Contracts Act 1984 applies to render an exclusion clause inoperative, it is necessary to consider the terms of the policy, not the particular facts of the case. He also considered himself bound to follow Asteron despite the requirement to construe s46 remedially.
In applying Asteron in the Nelson case, Justice Einstein found that the insurer was able to rely upon the exclusion of liability in the policy because the exclusion did not operate by reference to a condition existing before entry into the insurance contract. Rather, the exclusion operated by reference to subsequent events of loss or damage caused by the inherent defect, structural fault or faulty design, events that his Honour considered could occur at any time.
This suggests that an exclusion clauses that are not expressed to be operative by reference to the existence of a condition before entry into the contract of insurance may survive the operation of s46 of the Insurance Contract Act.
I am certainly interested to see if other judges in different jurisdictions take the same technical approach, particularly with a claim involving home, contents or private motor, particularly where resultant damage arises from a typically insured peril such as fire, which has been an insured peril for literally hundreds of years.
The importanceof understanding the full extent of all the policy exclusions cannot be over emphasised. Remember to use LMI PolicyComparison to keep on top of the changes that constantly occur in the wordings.