While insurance legislation has been greatly reformed in the last few years, the impact of those reforms has yet to be fully felt, especially where consumer insurance contracts are concerned. This newsletter considers some of these recent reforms and the issues that insurers and intermediaries will need to consider for consumer insurance contracts.

The Consumer Insurance (Disclosure and Representations) Act 2012 (CIDRA) came into force in April 2013 and the Insurance Act 2015 (the Insurance Act) was passed on 12 February 2014 and enters into force on 12 August 2016. The Consumer Rights Act 2015 (the CRA) comes into force on 1 October 2015 and also applies to consumer insurance contracts. Given the nature of, and sales practices relating to, consumer insurance policies (particularly in the general insurance sector) insurance mis-selling is likely to become apparent through complaints about claims handling. The Financial Conduct Authority (FCA) and the Financial Ombudsman Service (FOS) are therefore playing an increasingly important role in this area.

The insurance policy

The insurance policy is the document that contains the contractual terms between the insurer and the insured. However, it is not the only document that is relevant to the enforceability of an insurance contract. Other documents such as policy summaries, sales scripts and even training materials are becoming increasingly important for the FOS and the FCA in considering whether policies can be enforced in accordance with their written terms. Insurers and intermediaries need to carefully consider the wording of these documents and their related systems and processes, not only to properly frame the scope of the insurance they are writing, but also to help manage their regulatory exposures.

CIDRA

CIDRA applies to all “consumer insurance contracts” entered into on or after 6 April 2013 and it affects all insurers or brokers dealing with consumer insurance. In respect of policies caught (including any variations to them), CIDRA changed the rules relating to pre-contract non-disclosure and misrepresentation set out in the Marine Insurance Act 1906 (the 1906 Act).

This represents an important shift away from the policyholder’s historic duty of disclosure. Applicants for consumer insurance contracts are now no longer under a broad obligation to pro-actively volunteer information. Instead, the focus is on answering questions put forward by the insurer and on taking “reasonable care not to make a misrepresentation”. CIDRA then creates new remedies for insurers in circumstances where the consumer does not take such care.

Because the practical effect of CIDRA is that insurers must now ensure that all material information required is obtained through the questions they ask potential consumers during the sales process, they must carefully assess the adequacy of these questions, as well as the other procedures and processes they put in place when underwriting consumer insurance contracts. If not, they may not have an adequate remedy where there has been a misrepresentation or a failure to disclose important information. 

In the event that there has been a misrepresentation, the first step will be to assess whether the policyholder has breached its duty to take reasonable care not to make a misrepresentation to the insurer. CIDRA prescribes that whether or not a policyholder has taken reasonable care not to make a misrepresentation is to be determined in light of all of the relevant circumstances and the legislation gives examples of things which may need to be taken into account. These include:

  • the type of consumer insurance contract in question and its target market;
  • any relevant explanatory material or publicity produced or authorised by the insurer;
  • how clear and how specific, the insurer’s questions were; 
  • in the case of a failure to respond to the insurer’s questions in connection with the renewal or variation of a consumer insurance contract, how clearly the insurer communicated the importance of answering those questions (or the possible consequences of failing to do so); and
  • whether or not an agent was acting for the consumer. 

This list is not intended to be exhaustive. It should be noted that the standard of care required is that of a “reasonable consumer” unless the insurer was, or ought to have been, aware of any particular characteristics or circumstances of the consumer. In practice, the burden of proof is likely to be placed on the insurer to ask clear and unambiguous questions. Insurers will need to make sure that the questions asked are explicit, that scripts at the point of sale and throughout the duration of the policy are appropriate and that all records of questions asked are maintained. 

Insurers must also pay careful consideration to any proposal forms to ensure that they do not include “basis of contract” clauses which are ineffective following CIDRA. Basis of contract clauses have the effect of converting representations made in the proposal form into a warranty which would give the insurer the right to avoid the policy if the facts given are incorrect.

The Insurance Act

The Insurance Act seeks to extend the reforms made to consumer contracts of insurance (as well as making wide-ranging reforms to the law relating to non-consumer insurance contracts).

The Insurance Act introduces a new range of remedies, 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 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 Insurance Act also includes provisions relating to 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. 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.

Accordingly, insurers must pay careful attention to policy wordings relating to the circumstances in which the insurer can exclude, limit or discharge its liability to ensure that consumer insurance contracts are drafted in line with the new legislation. This is particularly important as it is not possible to contract out of any of the provisions in the Insurance Act in respect of consumer insurance contracts, where such action would put the consumer in a worse position than that provided in the Insurance Act. 

The provisions in consumer insurance contracts relating to fraudulent claims may also need to be amended to reflect the position under the new legislation. 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 Insurance 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).

If an insured makes a fraudulent claim under a policy, the terms of the policy should reflect that the insurer may not be liable to pay the claim and that it may recover from the insured any amounts already paid in relation to that claim.

The Consumer Rights Act 2015

Although the CRA largely reflects current best practice and the FCA principles, the new legislation introduces rules relating to digital content, consumer cancellation rights and it clarifies existing consumer legislation on unfair contract terms. The CRA replaces the Unfair Contract Terms Act 1977, and incorporates the provisions of the Unfair Terms in Consumer Contracts Regulations and the ‘grey list’ of terms that may be regarded as unfair. For more information on the CRA and a consideration of some of the key issues likely to affect financial institutions dealing with individuals, please see here

From an insurance policy perspective, when considering policy wordings, the CRA introduces a new prominence requirement. Insurers must ensure that terms which go to the core of the bargain in the policy are “transparent” and “prominent”. Such terms must be in plain and intelligible language and brought to the consumer’s attention in a way that a “consumer who is reasonably well-informed, observant and circumspect” would be aware of the term. This largely reflects the approach the FOS and FCA have previously taken to the regulatory requirement to communicate with customers in a way that is clear, fair and not misleading.

FCA and FOS approach

In the current regulatory environment, the FOS and FCA’s approach to policy terms can be difficult to predict. Although there are detailed rules which will apply to the sale of consumer insurance policies, including the Insurance Conduct of Business Sourcebook (ICOBS), the FOS does not always need to decide cases based on the law and the FCA also regulates the sale of insurance using less formal guidance and rules including its high level Principles for Business (the Principles). As these Principles are high-level, they are necessarily broad.
  
Although each of the Principles is equally important, when considering the sale of consumer insurance contracts, the following two principles are particularly relevant:

  • Principle 6 which requires firms to pay due regard to the interests of its customers and to treat them fairly (the TCF Principle); and
  • Principle 7 which requires a firm to pay due regard to the information needs of its clients and to communicate information to them in way which is clear, fair and not misleading. 

The TCF Principle is central to the FCA’s approach to the retail market and the requirement for the fair treatment of retail customers. This principle is expected to be embedded into a firm’s culture, practices and policies and should be carefully considered throughout the entire product lifecycle from conception to sale to post-sale. Products and services must be designed with the intended market in mind and they must be targeted appropriately to minimise the risks that they are not purchased by consumers for whom they are unsuitable. 

It is crucial for firms to ensure that communications with policyholders (and potential policyholders) are clear, fair and not misleading. This includes communications before and at the point of sale. Post-sale disclosure also plays an important role in helping to ensure that policyholders are aware of not only the performance of the product, where relevant, but also their opportunities to act at certain points in the product life cycle and changes in the terms and conditions of the policy.

There have been several examples of FOS decisions leading to large redress exercises supervised by the FCA including in particular the recent PPI scandal. The FCA and FOS’s approaches can interlink and the FOS may adopt the FCA’s approach when determining complaints. Equally, the FCA may adopt the FOS’s approach when supervising firms and considering whether to take enforcement action.

The future for insurers and intermediaries

The FCA has undertaken significant recent work in insurance-related areas, including thematic reviews and market studies which have considered the use of price comparison websites, premium financing, general insurance add-ons and conflicts of interest. Although this work may provide an indication of the FCA’s approach in the future, it may also increase the risk that it will identify new issues as it considers products and sales practices in more detail than it has done to date.

Both the FCA and FOS can change their approach over time, so that what they do in the future may be different from what they do today. Insurers can, to some degree, protect against potential future enforcement action by ensuring that the FCA Principles are considered throughout the entire product life-cycle from conception of the policy, ensuring that policies and other sales documents are drafted clearly, through to sales and claims where processes must be robust. The entire document-set around a product must also be clear, coherent and transparent. This can all help an insurer with an appropriate defence in the event that, in the future, the FCA decides that there is an issue with policies or sales processes in place.