Timing and background
The Insurance Act 2015 (the Act) will come into force on 12 August 2016. The Act aims to provide a more up to date framework for commercial insurance in England and Wales. This newsletter considers the key legal issues in the Act which focuses on four main areas of reform:
- the duty of disclosure in non-consumer insurance contracts;
- the law of insurance warranties;
- damages for late payment of insurance claims; and
- insurers’ remedies for fraudulent claims.
The Act received Royal Assent on 12 February 2015 and the majority of its provisions are due to come into force on 12 August 2016.
The exceptions are the provisions which relate to the amendment of the Third Parties (Rights against Insurers) Act 2010 (the 2010 Act) and the provisions relating to late payment of insurance claims. These provisions were not originally included in the Act but have since been inserted by Part 5 of the Enterprise Act 2016. The 2010 Act is due to come into force on 1 August 2016 and the provisions relating to late payment will come into force on 4 May 2017. The 18 month delay between royal assent and commencement is designed to provide all stakeholders with the opportunity to prepare for the changes to the law and to amend their current practice as necessary.
Following consultation, the Law Commission decided not to include provisions in relation to ‘insurable interest’ and policies and premiums in marine insurance. The Law Commission carried out a separate, additional consultation with a draft bill on reforms relating to insurable interest in contingency and indemnity insurance. The Law Commission hopes to publish a final draft bill and report on these matters in autumn this year.
Areas covered by the Act
Pre-contractual duty of disclosure in non-consumer contracts
Many of the provisions in respect of disclosure which are set out in the Act do not represent ‘new’ law but, instead, seek to clarify the law of disclosure as it applies in a non-consumer context. Under the Marine Insurance Act 1906 (the 1906 Act), duties to disclose information and not to misrepresent material facts to insurers are duties placed on the insured and his agent with no corresponding duty on the insurer to ask questions about the risk. The common law evolution of these duties regularly caused an imbalance in the rights between insurer and insured.
Section 3 of the Act defines a new statutory duty of disclosure in relation to non consumer insurance, which reflects the existing duty in section 18(1) of the 1906 Act, but makes some important changes. Under the Act, an insured will have to make a fair presentation of the risk to the insurer before the contract is entered into. Section 3(2) of the Act calls this the ‘duty of fair presentation’. This duty of fair presentation replaces the existing duties of disclosure and representation in sections 18 to 20 of the 1906 Act.
The duty is on the insured to:
- make disclosure of every ‘material circumstance’ which the insured knows or ought to know (s3(4)(a)); or
- give the insurer sufficient information ‘to put a prudent insurer on notice that it needs to make further inquiries’ for the purpose of revealing those material circumstances (s3(4)(b)); and
- make that disclosure in a format that is reasonably clear and accessible to a prudent insurer (s3(3)(b)); and
- ensure material representations on matters the insured knows (or ought to know) to be substantially correct or on other matters (eg expectation or belief) to be made in good faith (s3(3)(c)).
Section 7(4) of the Act lists the following (non-exhaustive) things which may be ‘material circumstances’ in this context:
- special or unusual facts relating to the risk (s7(4)(a));
- any particular concerns which led the insured to seek insurance cover for the risk (s7(4)(b)); and
- anything which those concerned with the class of insurance and field of activity in question would generally understand as being something that should be dealt with in a fair presentation of risks of the type in question (s7(4)(c)).
Of these three categories, the final one would seem to cause the greatest concern. The Law Commission hopes that it will encourage insurers and insureds to work together to develop guidance and protocols over what a fair presentation of the risk should include in certain circumstances. Where an insurer could show that it had not been told information which the guidance specifically stated should be included, the insurer might find it easier to demonstrate that the risk had not been fairly presented. The provisions, however, could potentially limit the power of insurers to avoid non-consumer policies on discovery of information that had not previously been disclosed.
Further, the standard of disclosure that has been set for the insured is arguably higher under the Act, in particular the use of a standard of the ‘prudent insurer’ (being an objective standard, understood to mean an ideal insurer with consistent and high standards).
A ‘fair presentation’ does not have to be made in a single document or by oral presentation and the Act recognises that information obtained by the insurer may be gathered over a period of time. Therefore, all information provided at the time the contract is entered into forms part of the ’fair presentation’, which only ’crystallises’ once the contract is entered into. This will likely put a greater emphasis on accurate record and document keeping by insurers for evidential purposes.
Section 4 of the Act defines what is meant by the ‘knowledge of the insured’ (in relation to non-consumer insureds). This is a simple question in the consumer realm but far more complicated where large commercial organisations are buying insurance. It is proposed that where an insured is a corporate entity, ‘knowledge’ should include information known to those individuals who are part of the senior management of the organisation or to those persons responsible for the insured’s insurance (usually the risk manager). The original draft bill and explanatory notes narrowed the meaning of ‘senior management’ to those of the board of the insured entity but excluding, for instance, managers of particular branches of a corporate entity. However, the wording of the Act is broader and includes information known by individuals who play ‘significant roles’ in managing or organising the insured entity. This could potentially extend to managers of particular branches. The legislation will apply flexibly depending on the nature of the policy.
A further potential area of concern is section 4(4) of the Act. This clause creates an exception regarding the knowledge of individuals who are responsible for arranging insurance. The effect is that where the individual has acquired confidential information through a business relationship that is unconnected with the contract of insurance it need not disclose such information during a fair presentation of risk. This clause will be particularly relevant where insurance cover is arranged by brokers who act for several participants in the market. In certain contexts, confidential information disclosed to a broker for the purpose of arranging one policy may be relevant to the risk covered when a broker arranges an entirely unconnected policy for a different insured. Clause 4(4) will allow brokers to withhold that information in their presentation of the risk. A difficulty which arises is that a corporate entity that is commercially connected to another can also provide information to a broker, even though it is unconnected to the contract of insurance. Clause 4(4) will allow brokers to withhold information in that context.
In the Act, knowledge will include both actual knowledge, constructive knowledge and ‘blind-eye’ knowledge. Section 4(6) of the Act defines what an insured ‘ought to know’ (constructive knowledge) by reference to the information which would be revealed by a ‘reasonable search of information available to the insured’. This definition creates an active, rather than passive, concept of knowledge where an insured must take steps to find out information. Where policies cover multiple entities it will often be necessary for the insured to make enquiries of each entity covered. For example, in the construction context, lead contractors may have to make enquiries of sub-contractors working at a particular site; for multi-group policies a holding company may have to make enquiries of its subsidiaries. The reasonable search concept is flexible and is likely to be defined in subsequent case law.
The Act creates some uncertainty as to the scope of the insured’s knowledge for the purposes of making a fair presentation. The definition of knowledge is flexible, leaving it open for the insured to argue that information was not included in the presentation of risk simply because it falls outside of the newly defined tests. To avoid disputes in this area, it is in the interest of both parties to define the scope of the insured’s knowledge at the underwriting stage. One area where clarity may be necessary is in defining the scope of the reasonable search of information and clarifying the types of persons whose knowledge will be imputed directly to the insured.
Section 3(5) of the Act does not require the insured to disclose a circumstance in certain situations including where the insurer ‘knows it’, ‘ought to know it’ or is ‘presumed to know it’. Section 5 outlines what these exceptions mean and is based on the exceptions set out in section 18(3) of the 1906 Act:
- the knowledge of the insurer includes the individuals whose knowledge will be directly attributed to the insurer (eg underwriters, certain employees who are involved in making underwriting decisions);
- the insurer ought to know something if an employee or agent of the insurer knows information and ought reasonably to have passed this information onto the underwriters or the information is held by the insurer and is readily available to the underwriter; and
- the insurer is presumed to know something if it is common knowledge (which replicates the language of the 1906 Act but without retaining the reference to ‘common notoriety’) and the insurer would reasonably be expected to know about it in the ordinary course of business. This section also explicitly references difference classes of insurance and different fields of activity, as the underwriter is only expected to have knowledge and insight relevant to the type of insurance provided.
A new system of proportionate remedies for breach
The Act introduces a new range of remedies, set out in Schedule 1, which are intended to be commensurate to the seriousness of the breach. The new remedies replace the current single remedy of avoidance under the 1906 Act. This is also in line with the provisions of the Consumer Insurance (Disclosure and Representations) Act 2012 (CIDRA). Where the insured has acted dishonestly, the insurer will still be able to avoid the policy (and retain the premium).
In respect of negligent conduct:
- where the insurer would have declined the risk altogether, the policy can still be avoided with a return of premium (although, where a policyholder has acted deliberately or recklessly, the insurer need not return the premium);
- where the insurer would have accepted the risk but would have included a certain contractual term, the contract should be treated as if it included that term; and
- where the insurer would have charged a greater premium, the claim should be reduced proportionately. This contrasts with some other jurisdictions where only the additional amount of premium is payable to the insurer.
The difficulty created by the system of proportionate remedies is that an insurer must be able to show how it would have responded if information which was not disclosed had been revealed during the fair presentation of risk. This creates evidential difficulties. If an insurer wishes to prove that it would have charged a higher premium it may have to rely on internal underwriting policies or comparable policies written on that basis. The disclosure of such information may not be possible in many circumstances or may involve revealing highly commercially sensitive pricing information.
Crucially, however, insurers will be able to contract out of these remedies in the context of non-consumer insurance – provided that this is done through the use of clear and unambiguous language which is expressly brought to the attention of the policyholder before the contract is concluded (see ‘The contracting out argument’ below).
The Act introduces three changes into the current law relating remedies for breach of warranty in an insurance contract:
- Section 9 abolishes ‘basis of the contract’ clauses in non-consumer contracts (much as they are already prohibited under the CIDRA). Under the current law, an insurer may add a provision to a proposal or policy stating that the insured warrants the accuracy of all answers given which effectively converts such statements to warranties. Section 9(2) of the Act prevents any term in the policy or proposal from doing this in non consumer contracts. However, it should be noted that the scope of this section is limited as it is still possible for insurers to include specific warranties in the policy itself.
- All warranties will become ‘suspensive conditions’, with the effect that breach of a warranty will no longer discharge insurers’ liability. Rather, a breach of warranty suspends the insurer’s liability under the contract from the time of the breach until such time the breach is remedied. An insurer will not be liable for any loss which occurs during the suspension of liability. When the breach of warranty is remedied the insurer’s liability will be restored.
- Section 11 of the Act concerns warranties and other terms which are designed to reduce the risk of a particular type of loss, or the risk of loss at a particular time or in a particular place (Particular Warranties). Section 11 does not apply to terms which define ‘the risk as a whole’. In most circumstances it will be clear when section 11 is to apply. However, the line between Particular Warranties and terms which define the risk as a whole can be unclear. For instance, a warranty which states that all employees have undergone an enhanced background check may be construed either as a Particular Warranty or a term which defines the risk as a whole.
The effect of section 11 is that if a loss occurs, and the term has not been complied with, the insurer may not rely on the non-compliance to exclude, limit or discharge its liability under the contract for the loss if the insured shows that the non-compliance with the term could not have increased the risk of the loss which actually occurred in the circumstances in which it occurred. The causal nature of the test means that it is fact specific and could be the subject of disputes in the future. A solution would be to move from mechanical drafting of warranties to a more considered approach where both the insured and insurer are clear what types of risk (particular or general) are caught by each clause.
The Law Commission has also clarified that sections 10 and 11 of the Act may apply together where the relevant term which has been breached is a warranty. Breach of a warranty would suspend the insurer’s liability under the whole contract (section 10(2)) unless the warranty is caught by section 11(1). In this scenario, the insurer’s liability would only be suspended for losses of the relevant type, relevant location or at the time. If the breach is remedied, the insurer’s liability will be restored.
Under the current law, the extent of the remedies available to an insurer in respect of fraudulent claims is unclear and, in the Law Commission’s view, requires clarification. At present, insurers faced with a fraudulent claim can claw back any payments made under the policy, including those in respect of entirely legitimate claims made prior to any fraud taking place. The proposals in the Act give the insurer the option to terminate the insurance contract from the point the fraudulent act occurred so that losses suffered after the fraudulent act need not be paid but legitimate losses before the fraudulent act will be.
If the insurer does terminate the contract, it may refuse all liability to the insured under the contract in respect of a relevant event (ie the occurrence of loss or damage which is insured under the contract or where the policy is a ‘claims made’ policy, the notification of a claim even where no loss has occurred).
Section 13 of the Act sets out remedies for fraudulent claims in relation to group insurance and provides that where a fraudulent act is committed by one or more group members, the group member(s) concerned should be treated as if they are a party to the contract and, as a result, the insurer’s rights are exercisable only in relation to the cover provided for the fraudulent insured(s) and the exercise of the insurer’s rights does not affect the cover provided under the contract for anyone else. The Act does not define ‘fraud’, ‘fraudulent claim’ or ‘fraudulent device’ and what constitutes a fraud is still to be determined in accordance with common law principles. Recent case law has considered whether forfeiture is an appropriate remedy for every instance of fraud. The Law Commission stated that case law should develop a more sophisticated and precise definition of fraud but the remedy of forfeiture should remain the same.
The provisions relating to damages for late payment were not originally included in the Act as they were considered to be too controversial for the Special Public Bills Committee procedure which was used to pass the Act quickly. They have since been added to the Act through Part 5 of the Enterprise Act 2016 and will come into force on 4 May 2017.
The normal rule of contract law is that if one party breaches a contract it would be entitled to damages and any foreseeable loss that occurs. This position does not apply to insurance contracts. An insurer’s liability under an insurance contract governed by English law is not treated as a debt but rather as damages which arise for a breach of contract to avoid the loss from occurring in the first place. Therefore, in accordance with English common law principles, an insured is not able to claim additional damages where a claim is not paid in a reasonable time.
This position is unusual and is not the case in Scottish law or in many other jurisdictions around the world. As a result, insureds who have to make a claim are not entitled to damages for non-payment or an unreasonable delay in payment by an insurer (although the insured will be entitled to simple interest and costs if it commences proceedings).
From May 2017, late payment will attract damages from the insurer. Insurers will be allowed a ‘reasonable time’ for investigating and assessing the claim. Reasonableness will depend on, amongst other things, the type of insurance, the size and complexity of the claim, compliance with any statutory or regulatory rules or guidance and factors outside the insurer’s control. It may be difficult to state with any certainty what is a ‘reasonable’ amount of time for an investigation and this change could lead to an increase in claims handling costs, which in turn could impact premium rates.
Any new legal rule usually has a period to ‘bed-in’ and it is expected that the creation of this new cause of action will cause an initial spike in claims. Furthermore, it is possible that a claim for an ‘unreasonable delay’ will simply be tacked onto claims as a matter of course. Insurers must be prepared for the change and take a robust line against unmeritorious claims which seek to force a rushed and ill-considered payment. In most cases an insured will face a high burden as all of the usual caveats apply to a successful breach of contract claim. To succeed, an insured must prove that there has been a breach (an unreasonable delay in paying a claim) which caused loss that was foreseeable at the time of entering into the insurance contract. The insured must also take steps to mitigate its loss.
Importantly, an insurer has a defence where there are reasonable grounds for disputing the claim. In most circumstances, the insurer will not be liable where the failure to pay the claim occurs whilst the dispute is continuing. The conduct of the insurer in handling the claim will be considered when deciding whether a term is breached.
An insured will also still be entitled to recover interest pursuant to the contract and/or statute. Contracting out of the implied term on late payment is proposed to be permitted where the late payment was not deliberate or reckless.
The Law Commission noted that where an insurer breaches its duty of utmost good faith, the remedy of avoidance is unsatisfactory because the insured generally wants its claim to be paid. Accordingly, the Act abolishes the remedy of avoidance for a breach of the duty of good faith (see section 14(1) of the Act).
One answer to the criticisms raised to the various changes introduced by the Act is for the parties to a non-consumer contract to ‘contract out’ under section 16 of the Act.
This raises concerns about an act where much of the market could contract out of the majority of the provisions. It is argued that this in itself could lead to uncertainty, increased costs and decreased market efficiency. However, in reality, wholesale contracting-out by insurers seems unlikely to occur as:
- market competition should (and is expected to) promote the use of the new contract terms proposed in the Act;
- contracting out may not be simple, its effect could be uncertain and it may be costly; and
- contracting out may decrease market efficiency eg in the area of warranties and conditions precedent.
The Law Commission has stated that it does not want ‘opting-out’ to be the default regime as a matter of routine (eg through the use of boilerplate opt-out clauses) particularly in the context of mainstream business insurance. The parties to an insurance contract should consider whether contracting out of any or all of the default provisions are appropriate in their particular circumstances. In sophisticated markets, including the marine insurance market, it is expected that contracting out will be more widespread.
The requirements proposed by the Law Commission in section 17 of the Act (the ‘transparency requirements’) are intended to balance those interests to the extent the parties have agreed terms which are less favourable to the insured than provisions in the Act. Such terms will only be valid if the insurer complies with the ‘transparency requirements’ in section 17, which requires insurers to take sufficient steps to bring the ‘disadvantageous term’ to the attention of the insured (or his agent) before the contract is entered into. These transparency requirements seek to:
- encourage insurers to consider whether opting out of the default regime is necessary or appropriate in the circumstances;
- enable policyholders to make an informed decision (with or without the aid of a broker) about whether to agree the alternative position, to negotiate for the default position or to seek an alternative insurance provider;
- ensure that the contracting out provisions are not so onerous as to interfere with the smooth running of the insurance market, particularly at the more bespoke and sophisticated end of the market; and
- give the courts room to differentiate between different scenarios, from well advised, commercially aware insurance buyers to small businesses buying their insurance protection ‘off the shelf’ and, increasingly, online.
There is an argument that a good degree of certainty in English insurance law has been built up by the market over many years and that the courts have, to date, managed to strike a balance between commercial insureds and insurers. It may not always be the right one but market participants generally understand where the balance lies and can make decisions accordingly.
Key concerns remain in relation to the practicalities of the new right for damages for late payment of claims and also the concept of identifying ‘knowledge’ for business insureds. For corporations, the proposals mean that their management will need to pay closer attention to the quality of information given to their insurers in order to be certain that a fair presentation has been made. The board of an insured will need to make certain that there are systems in place to ensure that the correct information is given to insurers at the time the policies are written or renewed.
Whilst it is generally acknowledged that there is a need to reform the law of warranties in insurance contracts (and changes such as the prohibition on basis of contract clauses have been welcomed by the industry itself), the Act has not gone so far as codifying what a warranty is, which would ultimately have helped to establish which terms carry the remedies for breach explained elsewhere in the Act. In addition, the Act does not expressly define ‘insurance’ and accordingly the common law definition of insurance continues to apply.
Whilst many of the changes to insurance contract law are welcome, there are concerns that the new provisions may lead to uncertainty, increased litigation and increased costs for both insurer and insured and may ultimately impact the competitiveness of the London market. It also remains to be seen whether this could be exacerbated or superseded by any further changes that may result from the European Commission’s work in this area or by the consequences of Brexit.