Having reformed insurance law for consumers with a new Act in spring 2012 the Law Commissions have been grappling with changing the law as it affects business insurance.
The principle drivers for reform are firstly, insureds say they struggle with fulfilling their obligations to disclose all material information that an insurer requires and, secondly, the current remedy available to an insurer to avoid an insurance policy for any material non-disclosure is perceived to be out-dated, one-sided, draconian and unfair.
The argument goes that the principles of the Marine Insurance Act may have been appropriate for a small specialist pre-WW1 marine insurance market where everyone knew everyone and everyone’s ‘word was their bond’, but we have allowed those principles to be embodied in the law applicable to all aspects of modern insurance business and the balance needs re-setting in favour of insureds. The proposals are for an easier, more collaborative disclosure regime and a set of ‘more proportionate’ remedies – i.e. make it easier not to commit the crime of non-disclosure and have lighter sentences for those who do. “Hear! Hear!” you might say, and you would be in good company - the majority of views gathered to date from all interested parties support the need for reform.
However, as is often the case, having reached something of a consensus on identifying the problem, views immediately diverge over the best solutions. Nevertheless, the Commissions’ proposals in relation to the new rules on non-disclosure are likely to make their way onto the statute books rather than into a third consultation.
Learn to live by the rules or build a different system?
One of the criticisms of the current regime is that insureds don’t always understand what is required of them or what to disclose. The current law obliges insureds to disclose all information that is material to the isk, but the test as to what is material is by reference to what a prudent insurer would want to know when deciding whether to write the risk or set the premium. It is argued that the situation is compounded by there being little obligation on the insured to ask questions or explain what it wants to see. So how does an Insured work out what’s material? The trite answer is that competent risk managers and brokers do this well so we should encourage better practice rather than change the rules, but most can see that we should be able to build a fairer system.
The Law Commissions’ answer is that the law should codify as far as possible what should and should not be disclosed, and that the law should state that where an insurer receives information which would prompt a careful insurer to make further enquiries, an insurer who fails to make those enquiries cannot have a remedy for non-disclosure of a fact that the enquiries would have revealed. Furthermore, it is suggested that guidance should be produced as to what is material for a given class of business or type of insured and reference can be made to that guidance when determining whether there has been a material non-disclosure.
There is no doubt that this would be an improvement for insureds – a re-balancing of the disclosure exercise in their favour – but probably not as much as it might seem. The codification is very likely to be a codification of what the relevant case law already provides, and guidance already exists, born out of good market practice. The real change is shifting the balance towards insurers having to make enquiries, but that opens a whole new evidential can of worms – what’s a ‘careful’ insurer? What question(s) should have been asked? What would the answer(s) have been?
A further complaint is that surveys show that many insureds do not understand how onerous the duty of disclosure is i.e. what the consequences for non-disclosure are. But is that a reason to change the consequences, or a reason for better education of insureds? Insurers will say that the consequences should be severe – insureds are looking to transfer risk out of their businesses, businesses which the insureds understand completely, so there is a need for the law to ensure that the incentive is there to make sure all material information is provided.
Overall, the proposed reform of the disclosure regime will make it harder for insurers to allege non-disclosure. We’ll have to wait and see whether that means it happens less often – I think it probably will.
A new disclosure regime may not be all good news for insureds. There is a cost to everything. Many are saying that the more collaborative disclosure regime and the removal of the right to avoid will force insurers to carry out more due diligence which will force up premiums, and/or brokers will have to do more, which pushes up their fees. If that is right, a well run insured coping competently with the current disclosure regime will see an increase in the cost of its cover for no greater benefit.
Letting the punishment fit the crime
The proposal as regards the consequences of non-disclosure is that the current remedy available to insurers of avoiding insurance policies entered into as a result of any failure to disclose material information will be replaced by a range of remedies said to be "proportionate" to the nature of the insured's breach.
Dishonest (which is likely to mean ‘deliberate or reckless’ rather than only ‘fraudulent’) non-disclosures will still allow insurers to avoid the policy.
Where the non-disclosure is negligent the insurer will be required to artificially re-do its underwriting of the risk on the basis of what would have happened had it known the undisclosed information, as follows:
- If the insurer would have increased the premium, it can reduce the claim it pays on a pro rata basis;
- If the insurer would have included a different term in the policy, the claim is treated as if the term applies - i.e. if the insurer would have excluded the cause of the claim, the claim wont be paid;
- If the insurer would have declined to write the risk, the claim will not be paid.
Despite the wringing of hands over the draconian remedy of avoidance, when put in the context of the amount of insurance business that is transacted, insurers rarely successfully avoid policies (95% of insureds in a recent AIRMIC survey had not been involved in non-disclosure litigation in the last 5 years). However, it can be a big stick in claims negotiations.
A Brave New World of remedies?
An insurer can opt out - the proposals are that the parties can contract out of the default regime by using clear unambiguous terms that are specifically brought to the attention of the other party. Are we back where we were when there was so much concern about the introduction of the Contracts (Rights of Third Parties) Act 1999, only for everyone to use a boiler plate exclusion? Maybe.
There are of course commercial issues. At present, a significant amount of business is done where insurers limit their ability to exercise avoidance, for example where the non-disclosure is innocent, and so it’s likely that a significant amount of business will be written without excluding the new regime. So if the new remedies regime will largely apply – is it that different?
Assuming there is a non-disclosure, an insurer who could choose to attempt to avoid a policy for non-disclosure under the old regime is just as likely to try to deny liability for a claim under the new regime. The old regime requires the un-disclosed information to have been objectively material, and for the actual underwriter to have been induced to write the business as a result. Under the new regime, if an insurer can prove its underwriter would have excluded the cause of the claim, or would not have written the risk at all, the insurer can successfully deny liability. So, different hoops to jump through, but ultimately the same result? Almost. The good news for insureds will be they will not see policies avoided “ab initio” (i.e. altogether) - insurers are likely to have to fight on a claim by claim basis.
A sting in the tail?
The proposals include a new remedy for insurers in that they can proportionately reduce claims if they would have demanded more premium but for the non-disclosure. Whilst purported avoidances are rare, arguments that a claim should be reduced, rather than denied completely, are the cut and thrust of any adjustment process. Insurers quite rightly use average clauses in instances of under insurance to proportionately reduce claims by reference to the correct level of insurance that should have been purchased. If insurers have a similar remedy based on a review of appropriate premium, surely that will also come into play on a regular basis? Will the reforms mean no more nuclear weapons, but an increase in conventional warfare?