The Law Commissions' Issues Paper on insurance warranties
In November 2006 the English and Scottish Law Commissions (the Law Commissions) published their second “Issues Paper” outlining proposals for reform of the law relating to warranties. The Law Commissions consider that there is potential for the law relating to breach of warranty to cause considerable unfairness to policyholders by allowing insurers to avoid paying claims on a technicality, especially in circumstances where there is no connection between a breach of warranty and the loss that has arisen. The proposals therefore aim to bring warranties to the insured’s attention and to limit insurers’ rights to reject claims where a breach of warranty has no causal connection to the claim.
The case for reform
The Law Commissions’ criticisms are primarily that the current law does not provide a fair balance between the interests of insurers and insureds and therefore policyholders’ reasonable expectations may not be met. They do not, for example, consider that policyholders would expect a claim to be rejected on the ground of a breach of warranty that has no connection with the loss or a breach that the policyholder rectified before the claim arose.
The Law Commissions have analysed how the courts, as a matter of construction, have found creative ways to protect the policyholder from an unfair outcome. The net effect however is that the law becomes uncertain, thereby requiring repeated litigation. For consumer insureds there is in theory additional protection provided by the Financial Services Authority Rules, the Financial Ombudsman Service and the Unfair Terms in Consumer Contacts Regulations 1999. In practice however there are inconsistencies between these legislative bodies.
The Law Commissions’ objective is therefore to create a uniform legal framework to provide certainty so that policyholders’ reasonable expectations can be better met.
The proposed reforms
The Law Commissions consider that the proposed reforms should apply to both insurance and reinsurance contracts. They look firstly at “basis of the contract” clauses (whereby answers on a proposal form may be converted into warranties), secondly at warranties as to past or existing facts and thirdly at warranties as to future conduct. The proposals may be summarised as follows:
- Basis of the contract clauses
In consumer insurance, basis of the contract clauses should be abolished. For business insurance a basis of the contract clause in the proposal form should no longer be effective to turn the statements made by the proposer into warranties. Each statement warranted should be set out either in the policy or in some document incorporated by reference to the policy.
- Warranties as to past or existing facts
In consumer insurance all statements of existing fact should be treated as representations rather than warranties. In business insurance the same should apply, or in the alternative, if warranties of past or existing facts are to be permitted, each statement warranted should be set out in writing and included in the policy document.
- Warranties of future conduct
A claim should only be refused in circumstances where the insured has failed to comply with a contractual obligation, provided that the obligation is set out in writing and was sufficiently brought to the insured’s attention.
Causal connection & the Australian and New Zealand position
The Law Commissions conclude that the reforms should provide policyholders with protection against claims being denied where there is no connection between the breach and the loss. They have analysed how this has been achieved in other jurisdictions and in particular through statutory changes in Australia and New Zealand.
Adopting the New Zealand position, the view of the Law Commissions is that the policyholder should be entitled to be paid a claim if it can prove on the balance of probabilities that the event or circumstances constituting a breach of warranty did not contribute to the loss. If the claim is for partial loss, the law should provide that if a breach contributes to only part of a loss the insurer may not refuse to pay the part not related to the breach.
If, however, the insurance relates to one purpose, activity or place, and the loss arises from another purpose or activity or in another place the loss should not be paid. For example, the Law Commissions do not think that a 20-year-old owner could reasonably expect to be covered by a policy limited to those over 30, whilst a car owner would expect to be covered for a car with broken headlamps that was driven during the day.
Implications for the insurance industry
There is no doubt that insurance contract law in the UK is in need of reform, since as long ago as 1980 the Law Commission proposed reforms which at the time were considered long overdue. The final report will be not be published before 2009 which provides the insurance industry with an opportunity for constructive debate. It then remains to be seen whether parliamentary time will be made available to legislate the proposed reforms.
Central to the debate is the issue of insurance fraud, which is estimated at £1.5 billion per annum. One might ask who is paying for the problem. Of course the answer will always inevitably be the honest policyholder. If, therefore, the Law Commissions’ proposals go through in their current form, it is probable that premiums will increase to cover the cost. It seems further analysis of the European, Australian and New Zealand positions is required to determine to what effect their reforms have had on insurance contracts generally and in particular on premiums.
Currently warranties provide insurers with a mechanism to reject suspicious claims for a breach of warranty rather than having to prove fraud. If insurers are required to prove fraud, the costs will often become disproportionate to the claim. It is questionable to what extent it can be said that insureds may not get what they bargain for. Perhaps the sensible approach is to keep the reforms simple, thereby allowing the parties to contract on whatever terms they choose, subject, to (a) procedural safeguards such as the giving of notice and (b) legal safeguards, which may be along similar lines to the Unfair Contract Terms Act.
For present purposes, the Law Commissions’ series of issues papers and seminars provide the insurance industry with an opportunity to have a voice in what may seem to be a long walk to any reforms.