Since the Law Commission and Scottish Law Commission’s (the Commissions) joint review of insurance contract law began in January 2006, we have regularly reported on its progress. In this article we provide an update on the Commissions’ work with respect to the law on disclosures and representations in the context of both consumer and commercial insurance contracts.
Consumer Insurance Contracts
In March 2010 we reported that the Consumer Insurance (Disclosure and Representations) Bill (the Bill) had been published (http://www.eapdlaw.com/newsstand/ail. aspx?news=1843). The Law Commissions’ recommend¬ations were accepted by the Government and the Bill is currently progressing through Parliament following the procedure for uncontroversial Law Commission Bills.
The Bill is designed to address the Commissions’ finding that the current law treats consumers unfairly. During the consultation process, it was widely felt that the duty imposed on consumers by the Marine Insurance Act 1906 (MIA) to inform insurers everything which would influence the judgement of a prudent underwriter was too onerous, and the penalties for non-compliance with this standard too harsh.
The Bill aims to bring the consumer law into line with pre-existing accepted good practice within the insurance industry and the standards which are already applied by the Financial Ombudsmen Service (the FOS’s compulsory jurisdiction is limited to awards of less than £100,000 and it declines to hear cases requiring cross-examination). It applies only to consumers and deals with the issue of what a consumer must tell an insurer before entering into or varying an insurance contract.
Clause 2 of the Bill abolishes the consumer’s duty to volunteer any facts a prudent insurer would consider relevant. Instead, consumers must take reasonable care to answer the insurer’s questions fully and accurately. If consumers do volunteer information they must take reasonable care to ensure it is not misleading.
A misrepresentation for which the insurer has a remedy against the consumer is referred to in the Bill as a “qualifying misrepresentation”. These are defined in Clause 5 as misrepresent¬ations which are “deliberate”, “reckless” or “careless”.
Where a consumer has made such a misrepresentation, the insurer’s remedies are then prescribed in Schedule 1 according to the state of mind of the consumer: where it was careless the remedy is compensatory (for example the extra premium which the insurer would have required); and where it is deliberate or reckless, the insurer may avoid the policy and retain the premium paid (except if it would be unfair to retain the premium). It is worth noting that an insurer may still avoid a contract where the misrepresentation is only careless if it can be shown that they would not have entered into the contract on any terms, had the misrepresentation not been made. An honest and reasonable misrepresentation is not qualifying and so no remedy is available under the Bill.
Clause 6 abolishes “basis of contract” clauses, which currently operate to convert answers given to questions on proposal forms into contractual warranties, thus entitling the insurer to avoid the policy if they are breached.
The Bill also establishes a statutory code for determining whom an intermediary (agent or broker) is acting for when arranging insurance (Clause 9) and prevents insurers from contracting out of the new statutory regime (Clause 10).
Commercial Insurance Contracts
However, criticisms of the existing law on non¬disclosure and misrepresentation have not been confined to the consumer sector. Whilst consumers are understandably considered more vulnerable to unfairness in the law, a number of the concerns which have lead to reform in consumer insurance have also been expressed by buyers of commercial insurance.
The Commissions last addressed this issue in October 2008 when they published the responses to a July 2007 Consultation Paper entitled “Misrepresentation, Non-disclosure and Breach of Warranty by the Insured”. The responses were considerably more mixed than the consultation on consumer insurance with, perhaps unsurprisingly, noticeably divergent responses from insurers and insureds. The paper made the following findings, amongst others:
- The majority of consultees agreed that the duty of disclosure should continue to apply to business insurance although a number suggested that this would lead to harsh results for ‘unsophisticated’ businesses unless other changes were made to the law.
- The majority of consultees agreed with the principle that a business insured is only responsible for disclosing facts which it knew or ought to have known (s.18(1) of the MIA).
- The consultees were evenly divided as to whether the current test for materiality of a misrepresentation or non-disclosure (ss. 18 and 20 of the MIA) ie. in the eyes of a prudent insurer, should be retained or replaced with a “reasonable insured” test, ie. what a reasonable insured in the circumstances would think was relevant to the insurer.
- The majority of consultees welcomed drawing a distinction between negligent and dishonest non-disclosures/ misrepresentation, in terms of the remedies available. However, a number of insurers pointed out practical problems in providing a proportionate, compensatory remedy and considered that it would provide too much protection for businesses.
This divergence of opinion led to the Commissions prioritising the passing of the Bill, where there was both greater consensus and a greater sense of urgency. A policy paper on commercial insurance with recommendations is now expected later this year. Whether these will be in favour of reform, and whether such reform will address some or all of the above points, is currently unclear.
In the meantime the UK Association of Insurance and Risk Managers in Industry and Commerce (Airmic) has issued a research paper which includes a draft clause for insertion in insurance and reinsurance contracts addressing non¬disclosures and mis representations. Airmic represents the insurance buyers and risk managers of about 75% of the UK FTSE 100 group of companies. Airmic contributed to the Commissions’ consultation described above, arguing in favour of reform.
The Airmic paper asserts that the remedy of avoiding the contract as if it never existed is only warranted where (i) the non-disclosure is fraudulent; or (ii) if the insurer would not have written the business on any terms had the information been disclosed. In all other situations the clause operates as a waiver of the insurer’s right to avoid the policy under sections 18 - 20 of the MIA.
Airmic adopts a similar position for business insurance contracts as that contained in the Bill, such that “any remedy should be proportionate to the nature of the non-disclosure and the circumstances that gave rise to that non¬disclosure”. However, the emphasis is slightly different. The clause provides that:
“3. If the Insurer would have underwritten this insurance on different terms (as to premium and/or otherwise) had the material fact been disclosed or not misrepresented, the Insurer shall not be entitled to avoid this insurance but:
(1) in the event the Insurer would have underwritten this insurance on different terms only as to premium, the Insured shall be liable for such additional premium as would have been charged had the material fact been disclosed or not been misrepresented;
(2) in the event that the insured would have underwritten this insurance on different terms in any respect other than in relation to the premium, the Insurer shall, in addition to any premium adjustment pursuant to sub-clause 3(1), be entitled to impose such terms on this insurance as would have been imposed at inception of this insurance if the material fact had been disclosed or had not been misrepresented by giving written notice of the term to the insured...”
Airmic also adopts a three tier approach but unlike the Bill, focuses on what effect the non-disclosure or misrepresentation would have had on the underwriter’s judgement, rather than focussing on the state of mind of the insured. In terms of drawing the balance between protecting the interests of insurers and of insureds, this represents a middle ground between the current law and the Bill.
It will be interesting to compare Airmic’s clause with the Commissions’ proposals, once they are published. It is perhaps unsurprising that the clause seeks to redress the balance of the law in favour of insurance buyers, although there does appear to be mounting support within its membership in favour of moving towards a more compensatory approach to the remedies for non¬disclosure and misrepresentation. This would bring insurance contracts into line with other contracts in the eyes of the law. It should also be noted that several insurers were in favour of compensatory remedies in their responses to the Commissions.
However one problem with the draft clause is that it may be difficult to establish retrospectively the “different terms” on which an insurer would have written the risk had it known the material fact. Imposing such a clause, otherwise than a simple increase in premium, is something of a fiction and may prove problematic in practice. Of course, whether such a clause is used in policies will surely depend on the relative bargaining powers of the parties. It is unlikely that insurers will voluntarily relinquish the protection they are currently granted in the law without an economic incentive. For this reason the onus remains on the Commissions, but whether or not they can build a consensus as to reform remains an open question, and without diluting the essential features that the commercial insured, who is likely to be advised by brokers, is required as a duty to disclose facts and circumstance material to the risk. It is the perceived absence of this long established duty that is likely to cause problems for the insurance market.