The Law Commission and Scottish Law Commission (the Commissions) have published their provisional proposals for the reform of insurance contract law. The first consultation is seeking feedback on their proposals to change the law in relation to the following:
- Misrepresentation and non-disclosure by the insured before the contract is made.
- Warranties (and terms with similar effect).
- Situations where an intermediary was wholly or partly responsible for pre-contract misrepresentations or non-disclosures.
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 it would not have agreed to the risk on the same terms if it 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. A warranty can refer to a future, present or past situation. When an insurer finds that a warranty has not been complied with (the requirement for compliance is exact) they are 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 if 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 following problems have been identified with the law as it now stands:
- Policyholders are frequently unaware of their duty to disclose information which they have never been asked for but would “influence the judgement of a prudent underwriter”.
- Policyholders may be denied claims even when they have acted with integrity.
- The remedy for misrepresentation and non-disclosure is avoidance of the policy. This can be overly harsh on policyholders.
- Insurers have the added remedy of refusing claims where there is an incorrect warranty of past or present fact, regardless of whether the warranty is material to the claim.
- Policyholders are often not aware of the implications of “basis of the contract” clauses where their answers become warranties.
- Where a policyholder breaches a warranty as to a future action, an insurer is discharged from further liability, even where the breach has no relation to a claim.
- Policyholders are, in many circumstances, responsible for the mistakes made by intermediaries. It is often very hard to know whether an intermediary is acting for the insurer or the policyholder.
The law remains much as it was a hundred years ago and is in many ways out of step with the market. Consumer protection is given through other means such as standards of good practice, FSA conduct of business rules and the discretion of the Financial Ombudsman Service (the FOS). For example, the FSA Handbook states that an insurer must not refuse a claim on the grounds of misrepresentation unless it was fraudulent or negligent. The Law Commissions argue that although the FSA and the FOS provide greater consumer protection than the law, these are not adequate substitutes for law reform.
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 in consumer insurance
The Commissions are proposing that insurers should be obliged to ask for answers to the questions that they want to know rather than expect a consumer to know what a prudent underwriter would want to know. The FOS position is being suggested by the Commissions whereby insurers do not have a remedy unless a reasonable consumer would realise they should have given the information in response to the insurer’s question.
The consumer’s duty would be to act honestly, and to take all reasonable care to answer questions accurately and completely.
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 remedy the insurer receives 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.
Where a consumer was acting honestly but fails to reach the standard of the reasonable consumer the Commissions propose a series of compensatory measures for the insurer. The Commissions also propose whether there should be a discretion to prevent avoidance where an insurer would have declined a policy for a negligent misrepresentation but the policyholder’s fault is minor and the prejudice to the insurer could be adequately compensated by a reduction in the claim.
In relation to life insurance the Commissions are proposing a “cut-off” period for insurers’ defences to claims. The suggested period would be 5 years. Insurers could still avoid for deliberate or reckless mistakes but not for negligent mistakes.
The Commissions also propose abolishing “basis of the contract clauses”. 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.
Pre-contract information in business insurance
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 as the law currently stands. 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 the smaller firms, what would influence a prudent insurer.
The Commissions are proposing that where an insurer wishes to avoid a claim for misrepresentation they 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 on the insured.
The Commissions have asked for views on whether the remedy of avoidance should be reserved for dishonest conduct.
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”. An insurer could then refuse to pay a claim provided that the breach is material and had some connection to the loss.
The Commissions recognise that problems have arisen where less sophisticated businesses buy “off-the-shelf” insurance written on an insurer’s standard terms. The Commissions are proposing special controls to prevent insurers contracting out of the default regime in standard term contracts. A three limb test is proposed:
- Did the insured contract on the insurer’s “written standard terms of business”?
- Does a standard term purport to give the insurer greater rights than the default regime to refuse claims for a failure to provide accurate precontractual information?
- If the insurer were allowed to rely on such a term, would it defeat the insured’s reasonable expectations of cover?
Pre-contract information: group insurance, co-insurance and insurance on the life of another
The Commissions are proposing to clarify the law in relation to group insurance. At present if one member misrepresents a fact, the status of the entire policy is at risk. The proposal is that a misrepresentation made by a group member should be treated as if the member were the policyholder. This means that:
- it would have consequences only for the cover of that individual; and
- if the insurance would have been consumer insurance had the policyholder arranged it directly, any dispute about a misrepresentation would be determined according to our proposals for consumer insurance.
The Commissions propose to review co-insurance in their second consultation paper. For life insurance taken out on the life of another person the Commissions propose that representations by the person whose life is insured should be treated if they were misrepresentations by the policyholder. An insurer can then apply the appropriate remedy according to whether the misrepresentation was deliberate, reckless or negligent.
Warranties as to the future
It is the Commissions’ proposal to reform the current law in relation to warranties which allow insurers to avoid claims for breaches which bare no relation to the loss in question. The proposal would bring the law into line with current accepted good 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 business insurance the 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. The parties could agree other consequences if they wished (subject to controls on standard term contracts).
- 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 ask in the consultation ask whether an insurer who terminates future cover should normally provide a pro-rata refund of outstanding premiums, less damages and reasonable administrative expenses.
The Commissions also propose to deal with standard term business contracts that defeat the reasonable expectations of insureds. In some instances insurers will 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
In many circumstances insurance is bought using intermediaries. Intermediaries assist in the application for insurance and pass on the relevant information regarding the risk to insurers. In most circumstances the intermediary is the agent for the insured. A mistake made by the intermediary is taken as the insured’s mistake under the law of agency. In the current market it is frequently very unclear to proposers whether the intermediary is acting for the insurer or for themselves. 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. In order to test whether an intermediary is independent would be to determine whether they conduct “a fair analysis” of the market. A test 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 the 16 November.
For further information on the details of the consultation paper: Law Commission Consultation Paper 182 (PDF 1.73MB)