The Act inserts provisions into the Insurance Act 2015 which will apply to contracts entered into on or after 4th May 2017.

The new section 13A of the Insurance Act will add an implied term to every insurance contract requiring a (re)insurer to pay any sums due in respect of a claim made by the (re)insured "within a reasonable time" (which will include a "reasonable time" to investigate and assess the claim).

There will be a remedy for breach of the implied term where late payment of a valid claim has resulted in the (re)insured suffering consequential loss. The remedies available are said to include damages (in addition to having the claim paid and interest). Such damages are not punitive in nature, in contrast with US "bad faith" damages. Instead they are assessed by reference to the amount of loss the insurer could reasonably have foreseen (at the time the policy was bound) that the insured would incur if a claim was paid unreasonably late.

What is a "reasonable time" will depend on all the relevant circumstances, including the size and complexity of the claim, the type of insurance and factors outside the (re)insurer's control. Where a (re)insurer can show that there were reasonable grounds for disputing the claim (either in full or as to quantum), the (re)insurer will not breach the new implied term "merely by failing to pay the claim…while the dispute is continuing, but … the conduct of the (re)insurer in handling the claim may be a relevant factor in deciding whether that term was breached and, if so, when". Thus, even if a (re)insurer initially had reasonable grounds for contesting a claim (which is subsequently proved to be valid) it might in principle breach the implied term. This could happen where, for example, the (re)insurer has conducted the investigation unreasonably slowly, or has been slow to change its position when new facts come to light.

(Re)insurers will be allowed to contract out of these changes, save in respect of consumer insurance or where the (re)insurer's breach is deliberate or reckless. "Recklessness" in this context means where the (re)insurer did not care whether or not it was in breach. The general contracting out rules set out in the Insurance Act will apply and accordingly the (re)insurer must take sufficient steps to draw the "disadvantageous term" to the insured's attention before the contract is entered into and the disadvantageous term must be "clear and unambiguous as to its effect". The characteristics of the insured and the circumstances of the transaction are also to be taken into account.

Reason for the Change

The change being introduced by the Enterprise Act 2016 responds to arguments that the current rule under English law, as represented by the case of Sprung v Royal Insurance (UK) Ltd [1999] 1 Lloyd's Rep IR 111, is an anomaly which places England and Wales out of step with many other jurisdictions (including Scotland).

This rule is based on a legal fiction that a (re)insurer's primary obligation under an indemnity insurance contract is to "hold the indemnified person harmless against a specified loss or expense" (see Lord Goff's speech in The Fanti [1991] 2 AC 1, at para 35) – in other words, to prevent the event insured against from happening. Accordingly, under English law, insurance payments are not debts due under a contract but are instead damages for breach of contract, and English law does not recognise a claim for damages for the late payment of damages.

(Re)insurers' Concerns

The rule in Sprung had been widely criticised. However, (re)insurers have expressed concern that the availability of damages for late payment will introduce considerable uncertainty for their working practices and might require additional expenditure, such as the recruitment of additional staff to handle claims. There is also a perceived risk that, when proceeding against (re)insurers, policyholders might include a claim for damages for late payment in order to pressurise (re)insurers into dropping defences.

The ability to recover a late damages payment from (re)insurers will also present challenges, in particular where reinsurers have liaised closely with, and perhaps even directed, the reinsured in handling a claim. The duties owed by a Lead Underwriter to the following market when handling claims (which are currently uncertain under English law) may also become the renewed focus of attention. (Re)insurers with only a small line on a risk may also seek to argue that their failure to pay did not cause the loss sustained by the insured.

The effect on setting reasonable reserves when dealing with a claim, to reflect the new risk of a potential damages claim, also remains to be seen. Whether (re)insurers will want to disclose privileged documents received from their lawyers to defend a claim for damages is also uncertain.

Exactly how much time will be reasonable for investigation and payment will become fully clear only with further future case law on the point. Two recent cases have given some indication of the courts' likely approach (albeit neither was concerned with late payment of damages). In Gentry v Miller& Anor [2016] EWCA Civ 141, the Court of Appeal held that a period of two months (which included the Christmas period) to investigate a (at the time) low value road traffic accident claim may be reasonable, By contrast, in Brit UW Ltd v F&B Trenchless Solutions [2015] EWHC 2237 (Comm), the judge cited a period of 4-5 months as being a reasonable timeframe to allow investigation of a complex claim under a contractors' combined liability policy, the taking of legal advice and deciding whether to avoid.

It might be worth noting that the Financial Ombudsman Service already applies a remedy of damages for late payment, with broad acceptance from the industry. Consumers and micro-businesses are, in any event, far more likely to sustain losses as a result of late or non-payment of a claim than larger businesses, which in general will have better cash flows to cope with delayed insurance claims (in the absence of a catastrophic loss event). 

(Re)insurers' ability (largely) to contract out of the change when covering business risks might go some way to alleviate concerns. It will also be possible, when paying a claim, for the parties to specifically include any potential late payment claim in the receipt or settlement agreement. Also, as a result of a late amendment to the Enterprise Bill, a claim for late payment damages must be brought within one year of the payment of all sums that are due under the policy, thus providing some comfort to insurers that potential damages claims will not hang over them for some years.