The Law Commission and Scottish Law Commission have published their provisional proposals for the reform of insurance contract law. The first consultation paper is seeking feedback on their proposals to change the law on misrepresentation, non-disclosure and warranties. Laura Hodgson examines the proposed changes.

Problems with the current law

The law of non-disclosure and misrepresentation

As the law now stands, the duty of utmost good faith imposes a heavy burden of responsibility for full disclosure of information by the prospective policyholder to the insurer. Information must be given to the insurer about anything that would influence a prudent underwriter’s assessment of the risk. If a policyholder fails to give any information, regardless of whether this failure was deliberate or not, an insurer can avoid the policy if they can prove that they would not have agreed to the risk on the same terms if they had known the information. Furthermore, an insurer can avoid the policy where the policyholder makes an incorrect statement of fact that is material.

The law of warranties

Warranties in an insurance contract must be strictly complied with. When an insurer finds that a warranty has not been complied with (the requirement for compliance is exact) it is not required to pay any claims that arise after the date of the breach. This applies even where the breach of warranty bears no relation to the loss concerned or whether the breach is later remedied.

The Commissions argue that the law as it now stands is not in line with the reasonable expectations of policyholders nor with a modern insurance market.

The Commissions argue that although the Financial Services Authority and the Financial Ombudsman Service (FOS) provide greater consumer protection than the law, these are not adequate substitutes for law reform.

The proposals

The Commissions are proposing a mandatory regime for consumer law which is based upon the guidelines currently applied by the FOS. For business insurance, a “default” regime is suggested.

Pre-contract information: consumers

The Commissions are proposing that insurers should be obliged to ask for replies to the questions that they want answered rather than expect a consumer to know what a prudent underwriter would want to know.

An insurer would have a remedy where it can show that:

  • the consumer made a misrepresentation;
  • which induced the insurer to enter the contract; and
  • a reasonable person in the circumstances would not have made the misrepresentation.

The insurer’s remedy would depend on the consumer’s degree of fault. Where the consumer had made a “deliberate or reckless” misrepresentation, the insurer would be entitled to avoid the policy. If the consumer has behaved negligently, the remedy would aim to put the insurer into the position it would have been in had it known the true facts.

The Commissions also propose abolishing “basis of the contract clauses”. This phrase is intended to transform statements into warranties. Where a consumer makes a statement of past or current fact before entering an insurance contract, it should be treated as a representation rather than a warranty. The consequences of the change will mean that where a policyholder has included an incorrect statement on a proposal form, insurers would not have an automatic right to avoid the entire contract.

Pre-contract information: business

For businesses, the Commissions are proposing a “default” regime. The proposal is that the duty of disclosure should remain. However, the Commissions suggest that the current scope of the duty is too wide. At present, the insured is required to provide information on anything that would influence the judgement of the prudent insurer in fixing the premium or determining whether they will accept the risk. It is not always evident to businesses, especially smaller firms, what would influence a prudent insurer.

The Commissions are proposing that where an insurer wishes to avoid a claim for misrepresentation it must show either:

  • that a reasonable insured in the circumstances would have appreciated that the fact in question was one that the insurer would want to know about; or
  • that the proposer actually knew the fact was one that the insurer would want to know.

Where an insured acts reasonably and honestly they should not lose cover according to the Commissions’ new proposals. Where a test of reasonableness is applied, what is reasonable will depend upon the type of insurance market, whether the business concerned received professional advice and what questions were asked of the insured.

Under the proposals parties would be free to contract out of the default regime. The easiest and clearest way of agreeing different rules would be through a specific fact warranty. The Commissions propose that a warranty of this type would maintain “strict liability”.

Warranties as to the future

The Commissions’ propose to reform the current law which allows an insurer to avoid claims for warranty breaches which bear no relation to the loss in question. The proposal would bring the law into line with current accepted good industry practice. The Commissions’ suggestions are that, for consumers:

  • A warranty should be set out in writing.
  • An insurer may only refuse a claim for a breach of warranty if it had taken sufficient steps to bring the requirement to the consumer’s attention.
  • The consumer should be entitled to be paid a claim if they can prove, on the balance of probabilities, that the event or circumstances constituting the breach did not contribute to the loss.

In relation to business insurance the Commissions’ proposal is that:

  • A warranty should be set out in writing.
  • A business should be entitled to be paid a claim if it can prove, on the balance of probabilities, that the event or circumstances constituting the breach did not contribute to the loss. However, unlike consumer insurance, this would be a default rule, which the parties could choose to contract out of. The parties could agree other terms should they wish.
  • A breach of warranty would not automatically discharge the insurer from liability, but would instead give the insurer the right to terminate cover for the future.

The Commissions also propose to deal with standard term business contracts that defeat the reasonable expectations of insureds. In some instances, insurers will seek to rely on an exclusion where there is no connection to the loss concerned. The proposal is that where parties contract on standard terms insurers cannot rely on a warranty, exception or definition of the risk if it would render the cover substantially different from the expectations of the policyholder.

Pre-contract information and intermediaries

The Commissions are proposing that an intermediary should be treated as the insurer’s agent if the policyholder would reasonably regard them as such, or if the insurer is in a better position to monitor and control the actions of the intermediary. The test to determine whether an intermediary is independent, and not the insurer’s agent, would be to determine whether it conducted “a fair analysis” of the market. This test is defined in the Insurance Mediation Directive.

The Commissions intend to publish a separate consultation paper in 2008 to cover remaining topics that are to be considered. These will include post-contractual good faith, insurable interest and damages for late payment of claims.

The Commissions seek responses to their proposals by 16 November