After securing some reform of insurance contract law in the Consumer Insurance (Disclosure and Representations) Act 2012 and the Insurance Act 2015 (which comes into force on 12 August 2016), the Law Commission has turned its attention to the doctrine of insurable interest, with the publication of a draft Insurable Interest Bill.
The Courts have historically always required an insurable interest as a necessary component of a contract of insurance. Historically, quite prescriptive rules were established to reflect social concerns surrounding life policies in particular, but also to deter gambling.
The Law Commissions proposals (reflecting the consensus from previous consultation) include some broadening of the categories of persons who may have an interest in a Life policy and modification of the rules for non-life policies (but not marine). The Law Commission is also consulting on the question of insurable interest in ILW or parametric contracts.
Whilst the life reforms may serve a useful social purpose in encouraging the growth of life-related products designed to protect modern families, the purpose of the non-life proposals appears more esoteric.
Status of Proposals
In March 2015, the Law Commission published an Issues Paper on insurable interest. It sought views on updated proposals, having consulted on this twice before: in an Issues Paper in 2008, and as part of a 2011 Consultation Paper.
The Commission reported that it had been told that the current law, which was said to be unclear in some respects, and antiquated and restrictive in others, had the effect of inhibiting the insurance market’s ability to write particular types of product for which there was demand.
The Commission’s updated and simplified proposals are intended to be relatively permissive to ensure that, broadly speaking, insurance products which insurers want to sell, and policyholders want to buy, can be made available without technical concerns about insurable interest.
The Commission hopes that the resulting draft Bill will be suitable for the special parliamentary procedure for uncontroversial Law Commission bills. Comments on this draft Bill are sought by Friday 20 May 2016. It hopes to publish a final draft Bill and report in autumn 2016.
The draft Bill introduces the concept of “life-related” insurance. A contract of life-related insurance includes any contract of insurance under which the insured event is the “death, injury, ill-health or incapacity of an individual”.
The term is intended to cover traditional life insurance contracts which pay out on the death of the life insured (or in some cases the earlier surrender or expiry of the policy). It is also intended to capture insurances which otherwise depend on human life or health such as personal accident, critical illness and disability insurances. This category would also cover insurance-linked investment products which have a life insurance element, including annuities.
The key change insofar as life-related policies are concerned is that clause 2(2) sets out a non-exhaustive “definition” of insurable interests in a life-related context, which is broader than the current legislation.
The list encompasses three broad categories of interest. The first is based on specific relationships: if the relationship exists, there is no need for the insured to demonstrate financial dependency or expectation of financial loss. Insurable interest is taken on the basis of the nature of the relationship. For the first time, this list is expanded to include a cohabitant, reflecting a huge shift in social attitudes since the 19th century. It also includes children and grandchildren (where the policy is taken out by parents or grandparents), and the trustees of pension and other group schemes.
The second category is based on the prospect of economic loss: a policyholder may insure the life of another person on the grounds that they would suffer a financial loss on the other’s death (or the occurrence of another insured event such as injury or incapacity). This category already includes debtors, and employers taking out “key person” policies on employees. Previously, it has not included extended family, but is now extended to cover the interest of children and grandchildren in parents and grandparents. Somewhat controversially, these interests have not been included in the first category where there is an interest as of right. An economic loss is required. This seems to be the result of a residual concern that children or grandchildren may “knock off” elderly relatives – the concern is expressed in terms of moral hazard – although it is difficult to see why a child or grandchild with an economic interest should be any less of a moral hazard than one without.
The third category relates to investment linked insurance products, which should prevent technical insurable interest objections stifling the development of that market.
With regard to non-life policies, the purpose of the new Bill is far from clear. The Bill re-writes the law, but whether it amounts to any material change of the law in practice is uncertain. Despite some hearsay evidence suggesting that insurable interest questions arise fairly regularly (which conflicts with our experience), we question whether the Courts in the modern era will allow technical and unmeritorious insurable interest defences to succeed in any event.
Clause 3(3) of the Bill sets out a non-exhaustive “definition” of insurable interest in a non-life context. It provides that an insured has an insurable interest if the insured:
- has a right in the subject matter of the insurance;
- has a right arising out of a contract in respect of the subject matter;
- has possession or custody of the subject matter; or
- will suffer an economic loss if the insured event relating to the subject matter occurs.
With respect to the Commissioners, this seems to us to be a somewhat circular definition.
The Commission describes the final limb as potentially very wide, but we suspect it is no wider than the current state of the law (as would be applied in 2016). The key point is to preserve a line between insurance (where an interest is required) and gambling.
With regard to marine policies, the Law Commission has accepted the consensus view that sections 4 to 15 of the Marine Insurance Act 1906 should remain in place. We are sceptical that re-writing the law for non-marine contracts is any more necessary.
Finally, the Law Commission has published a consultation paper on what it calls parametric contracts, including Industry Loss Warranty (ILW) products. These products provide for a fixed sum to be paid on the occurrence of the event without the policyholder having to demonstrate the extent of its own loss. Under these contracts, the fact that the event insured against has occurred may be sufficient to trigger a payout (although the policyholder may be required to demonstrate at least a nominal loss). Such products can be structured either as insurance or as derivative contracts.
In our view, the existing law is sufficiently clear to differentiate an insurance (or reinsurance product) from a non-insurance derivative. Insurance (or reinsurance) has always required an insurable interest. This differentiates ILW products from “tonners”, where the so-called insured or reinsured was effectively betting on the tonnage of ships sinking or aircraft crashing. But as confirmed in Feasey v Sun Life Assurance Co of Canada  EWCA 885, it has never been the case that the amount of loss was a component of the insurable interest requirement. We are therefore dubious that any new legislation is required to regulate the development of this area.
The Insurable Interest Bill may therefore serve an extremely useful social purpose insofar as it relates to Life-related policies, but otherwise may run the risk of amounting to a solution in search of a problem.