Our previous article on the Insurance Act 2015 highlighted the potential practical difficulties and compliance issues for insurers in seeking to apply statutory remedies in the event that an insured has breached the duty of fair presentation.
This next article highlights the difficulties that could arise in the event that an insured has breached a term of the insurance contract. In particular, we consider how coverage arguments overpolicy breaches could raise questions as to insurers’ and intermediaries’ governance, risk management and compliance systems and controls – especially as to product targeting, design, marketing, sales and advice.
Insurance statute and case law reveals that insurance policies may contain a variety of terms that can operate to prevent insureds from benefiting underapolicy, including terms that can be classed or labelled as ‘exclusions’, ‘conditions precedent (to liability)’, and ‘warranties’.
The Insurance Act seeks to improve the position for insureds in two ways. First, the Act changes the longstanding law on warranties. Warranties typically refer to information or circumstances that the insured promises will or will not arise ( e.g. that an office will have a burglar alarm).
Before the Act comes into force, the breach or inaccuracy of a warranty will “automatically” discharge the insurer from liability under the policy from the moment of breach, regardless of whetherthe breach has caused or increased the occurrence, value orrisk of loss (see ‘ The Good Luck’  1 AC 233).
However, section 9 of the Act prevents information represented or provided on a pre - contractual basis, such as in an application form, from taking effect as a warranty. At s10, the Act changes (in short) the consequence of breach of warranty from automatic discharge to a suspension of the insurer’s liability unless and until the breach is remedied.
Secondly, and probably more problematicformanaging compliance risk, s11 of the Act seeks to restrict insurers’ ability to rely on insureds’ breaches of contract to prevent the payment of claims.
S11(2) and (3) provides that: “If a loss occurs, and [a] term has not been complied with, the insurer may not rely on the non-compliance to exclude, limit or discharge its liability under the contract for the loss if the insured … shows that the non-compliance with the term could not have increased the risk of the loss which actually occurred in the circumstances in which it occurred.”
S11 states that it: “applies to a term … other than [one] defining the risk as a whole, if compliance with it would tend to reduce the risk of … loss of a particular kind … at a particular location, [and/or] at a particular time.” [Emphasis added]
The practical meaning and effects of s11, and the approach of the Law Commission to its drafting, have been questioned by commentators (see e.g. MacGillivray on Insurance Law, 13th Ed, 10-131). What constitutes a “term defining the risk as a whole” is certainly arguable. The Law Commission and other commentators have sought to explain this phrase by reference to policy terms that mandate or forbid a particular use or categorisation of property. However,
this approach does not fully shed light on the meaning of s11. For this article, we have identified three decisions that directly use most, or the substance, of the phrase.
In Harding Maughan Hambly v Compagnie Europeenne de Courtage D'Assurances et de Reassurances  CLC 524, Rix J, in construing the terms of draft and final documentation for a ‘political risk’ policy, noted that changes in identifying co-insureds “emphasise[d] the difficulty of regarding the risk as a whole as based on the expropriation of [certain] assets” [emphasis added].
Identifying the “risk as a whole” was important in Harding because the issue was whether a broker had been the effective cause of the placement of a policy. In that sense, “ risk as a whole” means the essence or substance of a risk.
In Brit UW Limited v F & B Trenchless Solutions  EWHC 2237 (Comm) a coverage dispute arose on a policy covering employers', public and product liability for a tunnelling contractor, and the purpose of the following pre-contractual representation:
“Rail works – av 4 times per year max – no lines active, controlled by Network Rail, working on rail for drainage and cables, no installation of train lines …”
In evidence, the underwriter summarised the representation, which summary the Court accepted, as follows:
“It is just a risk as a whole … there is inherent risk with tunnelling. That is increased when a train is active on the railway line above it.” [Emphasis added]
In mentioning “a risk asa whole”, the underwriterappears to be referring to a type of tunnelling risk. This highlights aparticularproblem with s11: it does not appear to take account of policies that contain extensive or complex formulations of cover, such as multiple lines or cover extensions or ‘write-backs’.
A further important consideration as to what may “define the risk as a whole” is in Handelsbanken v Dandridge,  EWCA Civ 577: “in defining the insured risks under the … policy it is necessary to have regard both to the perils insured and the exclusions, since together they delimit the risk” [emphasis added].
At face value, these dicta could be taken to confirm that any and all exclusions are inherent in “defin[ing] the risk as a whole”. If so, this would mean that insurers would be able to use exclusions to house the substance of warranties, conditions and other terms that could otherwise be qualified by s11. However, the dicta relate to case law on a specific and well - developed type of insurance cover: “Institute War Clauses” – the decision in Handelsbanken does not expressly seek to have a wider application.
It should not be assumed that an exclusion necessarily defines, or does not define, a risk as a whole. Whetherthis is the case will be aconstruction point, notwithstanding the observation in the 2015 IUA/LMA Guidance on the Act that “it is difficult to conceiveof an exclusion clause with which the insured does or does not comply.”
The Act gives rise to significant legal risk (“the possibility that lawsuits, adverse judgementsfromcourts, orcontracts thatturn outto be unenforceable, disruptor
adversely affect the operations or condition of an insurer”: CEA 'Solvency II Glossary', March 2007). Failure to manage this risk could materially increase the severity and frequency of coverage disputes and other manifestations of underwriting risk (“the risk of loss or of adverse change in the value of insurance liabilities, due to inadequate pricing and provisioning assumptions”: ‘Solvency II’ Directive, Art 13(30)). Such outcomes would raise questions as to the effectiveness of product governance systems and controls, such as stress tests.
Further, it is possible to conceiveof intermediaries facing heightened compliance risk as a result of the Act. If the implications of the Act are not fully addressed, with appropriate changes to wordings, both new and existing products could have unexpected outcomes for insureds, thus giving rise to coverage disputes which in turn crystallise insureds’ legal risk. This is not just a problem for intermediaries involved in product ‘manufacture’ or ‘provision’, but also those involved in ‘distribution’ in the form of advising insureds on policy-buying.
This article was first published on the Thomson Reuters Accelus (’Complinet’) website