The Insurance Bill received Royal Assent on 12 February 2015, and became an Act of Parliament. The amendments under the Act have been the subject of much commentary. However, little has been said about how these changes might impact on the risks faced by insurance brokers, particularly when a significant number of claims against brokers arise when an insured client’s cover is declined by an insurer.
It is tempting to think that any potential curtailment of an insurer’s ability to avoid a policy might reduce the risk to brokers but does this stand up to scrutiny? It is appropriate to test this by examining three of the main areas of the changes: (1) presentation of risk; (2) warranties; and (3) remedies for insurers.
Presentation of risk
The Act introduces the concept of a "fair presentation" of the risk in place of the insured’s current duty of disclosure. A fair presentation has to satisfy two separate tests: (1) substance; and (2) form.
The substance test represents a watered-down version of the current obligation on the insured to disclose all material circumstances which are known, or ought to be known, by it.
However, the second element, form, is new. The disclosure of material circumstances by the insured will have to be made “in a manner which would be reasonably clear and accessible to a prudent insurer”. This is a new layer of advice that will need to be given by brokers to their clients (no such duty expressly exists at present). In most cases that should be straightforward, but not always. Consider what should happen, for instance, if an insured provides a lot of irrelevant information to a broker which might obscure something material, and which the client "hasn’t got the time" (or inclination) to sift through it.
Performing the sift of the documents has obvious risks for the broker, but assuming the broker does not refuse to act, the presentation will have to be submitted in the knowledge there is a risk of it falling foul of the form test. Warnings will have to be given to the client in such circumstances and the onus passed back to the client to provide the brokers with the information needed – which may cause some tension in the commercial relationship. Consideration will also have to be given to the contents of any such a warning - we know from cases such as Jones v Environcom that caution has to be exercised in adopting standard phraseology, so extra care may be needed.
The current position is fairly draconian (if you are an insured): if a warranty is breached it discharges an insurer from all liability from the date of that breach. The Act introduces a more flexible approach so that a breach of a warranty will not automatically discharge the insurer from liability. Instead liability will be suspended for the duration of the breach. This allows for the possibility of an insured remedying the breach, and cover continuing following that remedy. This is good news for insureds.
Ironically, this benefit to insureds might place a broker in a worse position in the event that a claim is declined for breach of warranty. Consider the positon where a broker discovers mid-term that a warranty is being breached but does not advise the insured to remedy the breach. The insurer rejects a subsequent claim under the policy due to the breach, and the insured then considers the advice it received from its broker. Under the existing law, provided the broker can establish that he gave appropriate advice at policy inception he will be able to argue that the failure to advise later is irrelevant, as the breach of warranty is fatal to cover as soon as it occurs. However, under the amendments, this argument would not be available as the breach could have been remedied, and the broker would find himself facing a valid claim. The changes in the law arguably introduce a further duty to “warn” on the shoulders of the broker.
The application of proportionate remedies by insurers is perhaps the biggest area of potential concern for brokers. It is likely that there will be fewer instances of policies being avoided, firstly because the threshold to establish the right to avoid will be higher, and secondly insurers will have alternative options: the proportionate remedies.
Proportionate remedies will arise where there has been a breach in the duty to provide a fair presentation of the risk which is “neither deliberate nor reckless”. The remedy available to insurers will depend on what the insurers can establish they would have done had they received a fair presentation. The possible options are that the insurers would:
- not have entered into the contract at all – in which case the policy is treated as though it never existed;
- have entered into the contact on different terms – in which case those terms are applied retrospectively; or
- have charged a different premium – in which case the remedy is to reduce proportionately the liability of the insurer.
While the first remedy is likely to be the worst for the insured, absent any other issues regarding the advice given by the broker, it should not present any difficulties for brokers in terms of E & O risk.
The other two remedies are likely to be better for an insured, although the potential result of each will vary, which could be significant. Therefore, an insured is likely to have a vested interest in which remedy is applied and should engage with an insurer during the decision process. Brokers will often be asked to play a part in this process, and there are dangers which might arise.
Looking at an example illustrates the problem. There has been a breach by the insured as a result of its failure to include details of its acquisition of a new business in the presentation of the risk. A claim arises out of the operation of the new business. Insurers consider that, had a fair presentation been made, they would have either written the policy on different terms excluding any claims against the new business, or they would have charged twice the premium. The latter option is immediately more attractive as, while it would result in halving the level of any claim payment from insurers, at least part of the claim will be covered (unlike the first option).
Later in the policy year the insured receives a number of claims against the “old” part of the business. The result of previously excluding any claims against the new business would not impact on these claims and they would be covered in full. However, conversely, if a higher premium would have been charged (to reflect the new acquisition), this would impact on these claims also – reducing any claim payment from insurers by half. Therefore, what might initially seem to be the more attractive option could, ultimately place the insured in a worse position.
This example is, of course, convenient and real life is rarely as straightforward. However, it does highlight the risks for brokers. It is entirely possible that well-meaning advice on how to approach one particular claim might adversely affect the insured later. Therefore, where brokers are involved in this process, it will be necessary to carefully weigh-up the options, and provide advice on the pros and cons for each.
The task for brokers will not stop at the time any remedy is applied. Advice will need to be given as to how the application of a remedy will impact on policy coverage going forward, and whether it still meets the client’s needs.
So, where are we?
Overall the changes are good news for insureds, and those that advise them. However, as can be seen there are areas where risks for brokers might increase – certainly there will be additional points to consider when advising clients. As with all changes in the law, it is important to be ready for those changes and being alert to potential risks and traps will limit a broker’s exposure.
The amendments under the Act will apply to contracts entered into from August 2016. Therefore, there is time to prepare for these amendments, but as we know time has a tendency to creep up on us all…