First published in The International Comparative Legal Guide to Insurance & Reinsurance 2015, by Global Legal Group
Since 2006, the Law Commissions of England & Wales and Scotland have been working on reforms to insurance contract law in the UK. As a result, the Consumer Insurance (Disclosure and Representations) Act 2012 was passed (and came into force on 6 April 2013). It brought into effect various reforms relating to a consumer’s duty to make disclosure to insurers. “Consumers” in this context refers to insureds who are individuals who purchase insurance which is unrelated to their trade, business or profession. We covered the changes which were introduced by the 2012 Act in our chapter in the 2013 edition of this publication. The Law Commissions continued their work on further reforms and in July 2014 presented an Insurance Bill to the UK Parliament. It is intended that this Bill will follow the special, streamlined Parliamentary procedure for uncontroversial Law Commission bills, in order to reach the statute books before the next General Election in May 2015. We set out below the changes to date and the changes which are intended to be enacted during 2015.
Changes in the Insurance Bill and Possible Future Changes
The proposed Insurance Act will apply to all insurance contracts (including consumer insurance) apart from the section relating to Misrepresentation/Non-Disclosure, which will apply only to business insurance policies (reform of consumer insurance already having been enacted, as described above). The overall principle is that the Act should be a mandatory regime for consumers but a default regime for business insurers.
In the current Bill, it is stated that the Act will come into force at the end of the period of 18 months beginning with the day on which it is passed. Assuming that the Bill will be enacted before the General Election in May 2015, this means it would take effect in late 2016 and apply to insurance contracts written subject to UK law thereafter. The current position under English law, as well as the proposed changes, are set out below.
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As the law currently stands, it takes only the slightest breach of warranty to discharge the contract, even though that breach may be quite immaterial to either the risk or the loss.
It was stated by Lord Goff in Bank of Nova Scotia v. Hellenic Mutual War Risks Association (Bermuda) Ltd(“The Good Luck”)  1 AC 233 case that:
“A warranty… is a condition which must be exactly complied with, whether it be material to the risk or not. If it be not so complied with, then, subject to any express provision in the policy, the insurer is discharged from liability as from the date of the breach of warranty.”
If a breach of warranty occurs at the time the contract is concluded, it can be said that the contract ends as soon as it begins, and may not have come in to existence at all. Where a breach occurs during the insurance period, duties which had fallen due before the breach remain due (i.e. payment of premium) and the procedural conditions for the settlement of underlying claims must still be adhered to.
The basic rule is that, with some exceptions, a warranty is independent of all questions of materiality. So:
- the fact warranted may be of no relevance to the risk (see Yorkshire Insurance v. Campbell AC 218); and
- a loss need not be occasioned by the breach of warranty in order that the breach may protect the insurer (see Glen v. Lewis (1853) 8 Ex 607).
Basis of the Contract clauses will be prohibited (as is already the case now for consumer contracts) and it will not be possible for business insurers to contract out of this particular change.
All warranties will become “suspensive conditions”. This means that an insurer will still be liable for losses under the policy prior to the breach of a warranty but also after the breach has been remedied, if the breach is capable of remedy.
Thus, for example, if an insured breaches a warranty that an alarm system will be inspected every six months, that breach will be “remedied” if the system is inspected after seven months, and so coverage will be suspended for only one month in such circumstances.
It had also been proposed that, where a term in the policy (not just a warranty) is 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, a breach would entitle the insurer to refuse claims only for losses falling within that category of risk. However, this provision was removed from the Bill originally presented to Parliament.
As at the date of going to press, the government is still attempting to achieve sufficient support across government and from stakeholders for an amended version of this provision to be re-included and for the Bill to then continue along the uncontroversial bill procedure route.
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Under the Marine Insurance Act 1906 (“MIA”) the following information must be disclosed:
- S.18 MIA: “…the assured must disclose to the insurer, before the contract is concluded, every material circumstance which is known to the assured” (protecting the insurer against material non-disclosure); and
- S.20 MIA: “Every material representation…before the contract is concluded, must be true”(protecting the insurer against misrepresentation).
The following does not need to be disclosed:
- anything that the insurer knows or is presumed to know, i.e. because it is obvious. There is, however, a fine line between what the insurer ought to know and that which he could not discover without detailed enquiry;
- anything which the insurer has waived knowledge of. For example, the insurer’s request for disclosure of accidents in the last five years may mean that he is taken to have waived the right to argue that earlier accidents are material;
- anything that is superfluous; or
- anything that diminishes the risk.
S.18(2) of the Marine Insurance Act provides an objective statutory test to determine the “materiality” of the undisclosed information and its effect on the “prudent” underwriter: “Every circumstance is material which would influence the judgment of a prudent insurer… in fixing the premium or determining whether he will take the risk”.
The House of Lords, in Pan Atlantic v. Pinetop  1 AC 501, advanced this test further by adding a subjective limb. Therefore, to determine the materiality of undisclosed information, the court will:
- apply the objective test of materiality; and
- apply a subjective test of reliance, i.e. that the non-disclosure was a factor inducing the particular underwriter in question to enter the contract.
The HL in Pinetop held that where the first limb is satisfied, the court has the right to presume that the insurer was induced into entering the contract (satisfying the second limb). In Marc Rich & Co AG v. Portman  1 Lloyd’s Rep. 430, Longmore J. held that this presumption should be available to the insurer only where “the underwriter cannot (for good reason) be called to give evidence and there is no reason to suppose that the actual underwriter acted other than prudently in writing the risk”. If the underwriter is called to give evidence and if the court cannot make up its mind whether the insurer was induced, then the insurer should fail in its defence of the claim. The presumption is not a presumption of law, merely an inference which might arise on the facts. If an undisclosed fact would have had a significant impact on all reasonable underwriters, then the inducement will be likely to be proved, subject to contrary evidence adduced by the assured.
These proposed changes will apply only to business insurance (consumer insurance having already been dealt with in the 2012 Act).
It is proposed that the duty to volunteer information will be retained (unlike the current position for consumer policies). An insured will have to make a fair presentation, which will include putting a prudent insurer “on notice”.
The Law Commissions criticised the practice of convoluted presentations and “data dumping”: “a lack of structuring, indexing and signposting may mean that a presentation is not fair”. Hence, the proposed clause requires disclosure “in a manner which would be reasonably clear and accessible to a prudent underwriter”.
When deciding what an insured knows, it is the knowledge of senior management (which will include the board of directors but also those managing the whole or a substantial part of its activities) or those responsible for arranging the insurance which matters (and blindeye knowledge is included). An insured must carry out a reasonable search for information, and what is reasonable will depend on the size, nature and complexity of the business.
The Bill creates a positive duty of inquiry for the insurer, also. An insurer “ought reasonably to know”something if it is known to an employee/agent who ought reasonably to have passed it on, or relevant information which is readily available. An insurer will also be presumed to know things which are common knowledge, or which an insurer offering insurance of the class in question to insureds in the field of activity in question would be expected to know in the ordinary course of business.
So, for example, where an insured says he makes valves and then lists his three principal clients (all in the petrochemical industry), this might be sufficient to inform the insurer of the possible increased risks should the valves fail because they are being used in a combustible setting.
It might prove difficult to establish what an insurer ought reasonably to know on the basis of information which is “readily available”. How far should an underwriter be looking at information on the internet? In the recent case of Sea Glory Maritime v. Al Sagr  EWHC 2116 (Comm), the insured argued that, even though certain information was not disclosed, it was available online and it was market practice for insurers to check that information. It is an established principle that there is no presumption of knowledge of the facts concerning particular ships merely on the ground that they have been published in Lloyd’s List. Blair J. said that electronic databases should not be treated as equivalent to information in hard copy such as newspapers: “an underwriter does not have to carry the information in an electronic database in his head. On-line information is available to be called up when required”.
However, the judge agreed that the fact that information is available to an underwriter online does not necessarily give rise to a presumption of knowledge. Each case will turn on its particular facts.
Another issue is how much an insured would need to disclose before the onus switches to the insurer to ask further questions. This is not
discussed in the Bill.
An insured’s knowledge does not include confidential information which is acquired by the broker (or other agent) through a business relationship with a third party.
Remedies for Misrepresentation/Non-Disclosure
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Under the current law for non-consumer insurance, the sole remedy for material misrepresentation or non-disclosure (be it fraudulent, negligent or innocent) is avoidance of the contract (see sections 17, 18 and 20 of MIA). This essentially means that the contract is rescinded and the parties are put back in the positions they were in before the contract came into being. Unless the insured acted fraudulently, the insurer must repay any premiums received from the insured (subject to the terms of the policy). Further, the insured must repay all previously paid claims. There is no right to damages.
Under the proposals:
- It will be possible to avoid a policy (and keep the premium) only where the misrepresentation or non-disclosure was deliberate or reckless (recklessness is not defined in the Bill but in R. v. Page Crim. LR 821 the Court of Appeal approved a direction to a jury that a statement was reckless if it was a “rash statement ... with no real basis of fact to support it and not caring whether it was true or false”).
In all other cases (even where the insured is innocent), a scheme of proportionate remedies will apply, as follows:
- where the insurer would have declined the risk altogether, the policy can be avoided, with a return of premium;
- where the insurer would have accepted the risk but included a contractual term, the contract should be treated as if it included that term (irrespective of whether the insured would have accepted that term); and
- where the insurer would have charged a greater premium, the claim should be reduced proportionately (for example, if the insurer would have charged double the premium, it need only pay half the claim). This contrasts with some other jurisdictions, where only the additional amount of premium is payable to the insurer. The Law Commissions have explained that this is because it was felt the insured should have something to lose (i.e. more than just paying the amount of premium they should have paid in the first place), leaving the insurer to face a higher risk.
It is also worth noting that the test of what the insurer would have done had it known the true facts is entirely subjective. In practice, it will be hard for insureds to disprove that a particular insurer would have viewed a certain breach as so serious that he/she would not have written the risk at all. The issue will become one of credibility.
The proportionate remedies give insurers a chance to obtain a remedy beyond the “nuclear option” of avoidance. However, it will still have to be shown that there has been a material misrepresentation/non-disclosure. Although the threshold will remain the same, it may be that the courts will be more willing to find a material misrepresentation/non-disclosure where the remedy is not as drastic as a complete loss of cover for the insured.
3. Damages for Late Payment
English law does not allow an action by an insured against an insurer to recover damages for consequential loss caused by the insurer’s unjustified refusal to pay a valid claim. This is based on a combination of two separate rules. First, the cause of action for payment of an indemnity is analysed as one for payment of unliquidated damages. The insurer is said to be in breach of a promise to hold the insured harmless against loss caused by an insured peril from the time of its occurrence (regardless of when a claim is made or rejected). The second rule derives from the law of damages, namely that there can be no cause of action for damages for late payment of damages. The assured’s sole remedy is an award of interest.
This rule therefore bars a claim for financial loss consequent upon insurers’ refusal to accept liability or to pay a valid claim in a timely fashion. The leading English case on this point is Sprung v. Royal Insurance (UK) Ltd  Lloyd’s Rep. IR 111.
Changes to this area were suggested by the Law Commissions but were not included in the final version of the Bill, as presented to Parliament. Although a provision on late payment damages was debated at the committee stage of the Bill’s progress through Parliament, it has not so far been re-introduced into the Bill.
The proposal was that it would be an implied term of an insurance contract that insurers would pay sums due within a reasonable time. Insurers would be allowed a reasonable time for investigating the claim and reasonableness would depend on, amongst other things, the type of insurance, the size and complexity of the claim and factors outside the insurer’s control.
Where an insurer can show reasonable grounds for disputing a claim (whether as to the amount of any sum payable or as to whether anything at all is payable), failure to pay the claim while the dispute continues would not be a breach of the implied term. However, the conduct of the insurer in handling the claim may be a relevant factor in deciding whether there has been a breach and, if so, when.
If adopted, this proposal is likely to introduce a fair amount of uncertainty for insurers when deciding whether they can validly delay payment because of concerns regarding a claim. The Law Commissions indicated that they intended to target only poor claims handling but it is not clear how the courts would interpret the new provisions.
It remains to be seen it this proposal resurfaces in the Bill before Parliament. Even if it does not, the Law Commissions have said that they intend to introduce similar provisions at the next legislative opportunity.
4. Good Faith
In addition to the specific duty of good faith in relation to nondisclosure and misrepresentation, there is an overarching principle of good faith which applies to both the insured and the insurer.
Where an insurer breaches this duty, the remedy of avoidance is unsatisfactory because the insured generally wants its claim paid.
It is proposed that the remedy of avoidance for a breach of the duty of utmost good faith will be abolished (although, as mentioned above, the ability to avoid will be retained in some cases where the insured breaches the duty in relation to disclosure/misrepresentation). The Law Commissions did not suggest a remedy of damages instead (despite contemplating introducing that remedy at one point). Rather, they suggested that the courts will allow good faith to be used as “a shield rather than a sword”, i.e. insurers may be prevented from exercising an apparent right if they have not exercised it in good faith. It is perhaps unclear, however, how a legitimate right can be exercised in a manner which amounts to bad faith (and the Law Commissions acknowledged that there is conflicting case law on how far the courts will recognise this concept).
5. Fraudulent Claims
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An insurer is not liable to pay a fraudulent claim and can recover any sums already paid in respect of it. It is not clear, however, whether an insurer is able to avoid the contract as a whole.
It is proposed that the insurer will also have the option of terminating the contract from the date of the fraudulent act (not the discovery of it), without any return of premium. The Law Commissions believed that insurers would want this option, rather than an automatic remedy, because it allows them more commercial flexibility. The insurer can then refuse to pay any claims from that point onwards (but will remain liable for legitimate losses before the fraud).
The Bill does not seek to define what a fraudulent claim is, so there is no distinction between someone who presents a completely fraudulent claim (i.e. claims for something that never happened) and someone who has genuinely suffered a loss but has used a fraudulent device to increase his chance of being paid. An example of this is the case of Sharon’s Bakery v. Axa  Lloyd’s Rep. IR 164, where a genuine fire destroyed equipment which was owned by the insured and worth the amount claimed by the insured. Following the fire, the insured submitted a false invoice (purporting to relate to its purchase of the equipment) in support of its claim and this amounted to “fraudulent means or devices” in aid of its claim. The whole claim was therefore forfeited.
There is also nothing in the Bill about whether the fraud must be substantive. In Aviva Insurance v. Brown  EWHC 362 (QB), the judge rejected the argument by the insured that an insurance claim will fail only if there is fraud to a “substantial extent”.
Further provisions have also been included regarding group insurance claims, with the effect that, where a group member acts fraudulently, only that member would forfeit the entire benefit of the claim (and, at the insurer’s option, any subsequent benefit) but the other group members would be entirely unaffected.
Contracting out of the Changes
The proposals in the Bill are intended only to be a “default regime” for non-consumer insurance. However, the Law Commissions have indicated that they wish to discourage boiler-plate clauses which optout of the default regime as a matter of routine, particularly in the context of mainstream business insurance: “In sophisticated markets including the marine insurance market we expect contracting out will be more widespread.”
In other words, business insurers cannot expect it to be “business as normal” by simply inserting a clause into a policy to the effect that the changes in the new Act (when it is passed) do not apply. It is also worth bearing in mind that there will be no “default position” if an insurer does contract out. So an insurer will need to specify what remedy/position will apply instead, otherwise there will be a void (and the courts may imply back in the position set out in the Bill).
Thus, insurers will need to identify each and every change which they do not intend to apply and cater for an opt-out for that change separately in the policy. It will probably be best if insurers focus on what is truly important to them, and set out the consequences of breach of any policy terms. Accordingly, very careful consideration will have to be given to the drafting of business insurance policies in the future.
Where insurers do intend to opt out (and hence include a “disadvantageous term”), they must take sufficient steps to draw that 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 Bill also provides that “...the characteristics of insured persons of the kind in question, and the circumstances of the transaction, are to be taken into account”. Guidance from the Law Commissions explained that additional steps by the insurer would be needed where a small business purchases insurance online but, conversely, more leniency will be allowed where a sophisticated insurance buyer purchases cover at Lloyd’s (“[t]his is a fast-paced market, and we would not want to interfere unnecessarily with its operation”).
The contracting-out provisions will not apply to settlement agreements (and hence an insured will still be able to enter into a settlement on less favourable terms than the default rules).
Finally, as mentioned above, it will not be possible for business insurers to contract out of the prohibition for Basis of the Contract clauses (although they can, of course, still specifically agree a warranty in respect of any particular matter).
Together with the consumer insurance reforms that came into effect in 2013, the proposed Bill represents the greatest legislative change to insurance contract law in the UK in over 100 years. Some of the more robust defences currently available to insurers are likely to be watered down, although insurers may be able to contract out of most of the changes for policies bought by companies and businesses.
The Law Commissions have indicated that they intend to keep working on the reform of UK insurance contract law in 2015. They have stated that they intend to publish a third and final report addressing insurable interest, and policies and premiums in marine insurance, and that this will be preceded by an issues paper on insurable interest which they hope to publish in the first half of 2015.
Insurable interest: it is a long-standing principle under English law that an insurance policy will be invalid if the insured does not have an “insurable interest”. Briefly, that requires the person taking out the insurance to stand to gain a benefit from the preservation of the subject matter of the insurance (or to suffer a disadvantage if it is lost). However, the precise application of that principle has become confused, with a mix of common law and statute.
The Law Commissions propose that the requirement of insurable interest should be imposed by statute alone. They suggest a statutory restatement confirming that the requirement of an insurable interest applies to all forms of insurance (and, in the absence of which, the policy will be void – with the insured entitled to a refund of his premium payments). It is proposed that the law is changed so as to widen the category of those able to insure the life of another on the basis of financial loss (there was widespread support for widening the test to one based on a reasonable expectation of economic loss).
The Law Commissions have also looked at two provisions of the MIA which were said to appear to be outdated and problematic. There is a proposed abolition of the need for a formal marine policy (section 22 of the MIA). Reform of section 53(1) of the MIA (which makes a broker liable to pay premiums to the insurer and applies only to marine insurance policies) is also proposed. As currently drafted, section 53(1) overrides the normal rule of agency law that an agent is not personally liable on a contract effected for his principal.
It is suggested that the policyholder will be liable to pay premium to the insurer and the broker will act as the policyholder’s agent. The issue of whether the broker is liable to pay the premium to the insurer should be a matter of agreement between the broker and the insurer. However, there is some debate about whether marine brokers should continue to be jointly and severally liable for paying premiums, unless they contract out.
It has also been proposed that section 53(2) of the MIA should be amended (in relation to both marine and non-marine insurance) to give the broker a general lien over all property of the insured that has lawfully come into the broker’s possession in its capacity as broker (and should give brokers the right to retain any funds held on behalf of the insured to settle the insured’s outstanding debts in respect of premiums or charges).