It is common knowledge that before buying an insurance policy, you are required to provide certain information in order to receive your quote. While this is a relatively straight-forward exercise when insuring your car, when you apply the same principle to insuring a business it becomes far more complicated. A failure to get this initial step right can have devastating consequences. Yet surprisingly, it is a step businesses often get wrong.
A recent study (Mactavish Corporate Risk & Insurance, The Case for Reform, 2011) of 600 business policy holders and 100 senior insurance executives found that 87% of participants were unaware of just how onerous the duty of disclosure is. This is a common problem addressed by the Law Commission in their consultation paper on the "Business Insured's Duty of Disclosure and the Law of Warranties", published at the end of June 2012 (the Consultation Paper).
The 'duty of disclosure' is found at s18 of the Marine Insurance Act 1906, which provides that a business must disclose "every material circumstance" which it knows, or ought to know, "in the ordinary course of business". A material circumstance is "every circumstance which would influence the judgement of a prudent insurer in fixing the premium, or determining whether he will take the risk".
Failure to comply with this duty allows the insurer to 'avoid' the contract - to treat the policy as if it never existed and leave the business to bear the loss itself.
The duty of disclosure: common problems
The problems with the law as it stands are numerous. Some of the key issues that businesses should be aware of are:
- Insurers are not required to ask you questions in order to guide you on what you ought to disclose. As such, many businesses have no idea what is relevant disclosure, or even how to go about collating all disclosable information. There are two competing interests here - collating vast amounts of information is expensive, and failure to disclose a material fact or circumstance may invalidate the policy.
- A lack of clarity in the law has allowed the development of a 'soft market'. There is a danger that businesses are being lulled into a false sense of security. This is as a result of insurers allowing sub standard presentations and disclosures, and paying out on claims as a gesture of good will in circumstances where the duty of disclosure has not been met.
- The remedy is too harsh. In the case of non-disclosure (even a minor incidence), the policy could be treated as if it never existed. This is a draconian measure.
- Uncertainty leads to litigation. A recent survey (Airmic, 2010. The survey was taken of Airmic insurance buyers and risk managers for around 75% of FTSE 100 companies.) estimated that some 4,000 disputes had arisen in the last ten years as a result of non-disclosure issues and that on average each dispute cost £157,200.
Proposed changes to the Law
The Consultation Paper recognised the problems highlighted above. In an attempt to address the issues businesses are facing, it makes the following key proposals:
- The law which imposes disclosure obligations must be clarified. Case law will be codified into statute so businesses will have a clearer idea of what their obligations are. Importantly, insurers will be obliged to ask businesses to make further disclosures in potential problem areas. If insurers fail to make additional enquiries which would have led to proper disclosure, the insured will no longer be fully liable for the failure to disclose.
- A fuller definition of knowledge is required. In the case of a corporate entity, it is proposed that knowledge should include information known to both the "directing mind and will of the organisation" and the persons arranging the insurance. Furthermore, the information that persons 'ought to know' should be assessed with reference to the size, nature and complexity of the business in question.
A new system of remedies for non-disclosure is needed. In the new system, the blanket application of 'avoidance' as a remedy would apply only to cases of dishonesty. In other cases, the principle of putting the insurer into the position it would have been in, had it received full and accurate disclosure, will prevail. For example:
- where the non-disclosure would have meant the insurer would have avoided the policy altogether, the claim may be refused and the premium returned;
- where the insurer would have accepted the risk, but included another term in the insurance contract, the contract should be treated as having included that term; and
- where the insurer would have charged a greater premium, the claim should be reduced proportionately
Practical benefits that would arise from a change in the law
- With greater clarity in the law, and a fairer system of remedies, it is likely that there will be fewer disputes on the issue of non disclosure, and reduced legal costs as a consequence.
- With greater insurer input into directing what information needs to be disclosed, businesses will spend less time and money in preparing presentations and collating information.
- The new proportionate remedy system will mean businesses will be better protected in the event they are found to have made a material non disclosure.