After eight years of consultation, the English and Scottish Law Commissions have now submitted the Insurance Bill for parliamentary review.
The Bill had its second reading in the House of Lords on 30 July and has now been committed to a Special Public Bill Committee. The Law Commissions hope that the Bill will follow the procedure for uncontroversial Law Commission bills, going through Parliament before the current session ends on 30 March 2015. It is rumoured that the Bill may come into force in April 2016.
The Bill updates the statutory framework for insurance contracts in the following areas:
- disclosure and misrepresentation in business and other non-consumer insurance contracts;
- insurance warranties; and
- insurers' remedies for fraudulent acts.
The Bill also amends the Third Parties (Rights Against Insurers) Act 2010 with a view to the 2010 Act finally being brought into force.
Due to a lack of consensual support across the insurance market, some of the Law Commissions' recommendations addressed in previous versions of the Bill have been dropped. This includes the clause providing for damages for late payment of claims and the clause addressing warranties (and other terms) relating to particular types of loss. The Law Commissions' expressed hope is that these points will be agreed and codified at a later date.
We set out below a brief summary of the Bill as currently drafted. The Bill when in force will have an impact on all participants in the insurance market. If you would like to hear about the changes in more detail please speak to your normal HSF insurance contacts.
1. Disclosure in business and other non-consumer insurance contracts
Fair presentation of the risk
Under the new Bill, the insured has a duty to make a "fair presentation of the risk" to the insurer. The duty applies to pre-inception disclosure as well as variations of non-consumer insurance contracts (in which case the "risk" means "changes in the risk relevant to the proposed variation"). The duty of fair presentation comprises of three elements.
The first element is the insured's duty of disclosure. The insured must either (i) disclose every material circumstance which it knows or ought to know (which is based on the current legal position as codified in the Marine Insurance Act 1906). A business insured is taken to "know" what is known to the insured's senior management and individuals responsible for the insured's insurance (which encompasses risk managers and any employee who assists in the collection of data or negotiates the terms of the insurance). An insured "ought to know" what would have been revealed by a reasonable search of information available to the insured; or (ii) failing that, give the insurer sufficient information to put a prudent insurer on notice that it needs to make further enquiries for the purpose of revealing those material circumstances. This represents a change from the current law and is intended to combat the perceived current risk of an insurer taking a passive role in the disclosure process and only asking questions when the insured makes a claim under the policy.
The second element of the fair presentation of risk requires the insured to make the disclosure in a manner which would be reasonably clear and accessible to a prudent insurer. It is hoped that this will discourage "data-dumping" (bombarding the insurer with vast swathes of material whether relevant or not). In particular, the Law Commissions have suggested that a lack of structuring, indexing and signposting may mean that a presentation is not “fair” but at the other end of the spectrum, neither would "an overly brief or cryptic presentation".
Lastly, the duty of fair presentation includes the duty not to make misrepresentations (currently set out in section 20 of the 1906 Act).
The Bill contains various carve-outs to the insured's duty of disclosure, some of which are already codified in the 1906 Act. In particular, the insured is not required to disclose material circumstances which the insurer knows, ought to know or is presumed to know. The insurer "knows" what is known to the individuals involved in that particular underwriting decision. The insurer "ought to know" information which is readily available to the underwriters or is known by an employee or agent of the insurer who ought reasonably to have passed it on. The insurer is "presumed to know" matters it ought to know in the ordinary course of its business, such as industry knowledge (but only to the extent that the industry knowledge is relevant to the type of insurance provided by the insurer).
At present, the sole remedy for a breach of the duty of good faith is avoidance of the policy. The Law Commissions have recognised that in most instances this is a draconian remedy which does not adequately distinguish between innocent and deliberate or reckless mistakes.
The Bill provides for a range of proportionate remedies. Unless the breach is deliberate or reckless (in which case the remedy of avoidance would still be available), the onus is on the insurer to show what it would have done had it received a fair presentation of the risk:
- the insurer will still be entitled to avoid the policy if it can show that had it received a fair presentation of the risk, it would not have entered into the contract; but
- if the insurer shows that it would have entered into the contract but on different terms, then the insurer may treat the policy as having included those different terms from the outset. This could result in the addition of warranties or exclusions which affect the recoverability of claims; or
- if the insurer would have entered into the contract but only at a higher premium, the insurer may reduce the amount to be paid on a claim proportionately. For example, if the insurer can show that had it known about the non-disclosed risk it would have charged a premium of £400,000 rather than £300,000, claims paid by the insurer could be reduced proportionately by 25%.
The duty of good faith (as codified in Section 17 of the 1906 Act) will remain as a general interpretative principle. However, a breach of this duty will no longer automatically entitle the insurer to avoid the policy and will instead be subject to the range of proportionate remedies set out above.
The current law provides that a breach of warranty will discharge the insurer's liability under the contract in its entirety, even if the breach is only trivial or does not in any way relate to the insured's loss. Under the new Bill, a breach of warranty will no longer automatically take the insurer off risk. The Bill will make warranties "suspensive conditions"; the insurer's liability will be suspended while the insured is in breach of a warranty but can be restored if the breach is subsequently remedied.
This change is consistent with the Law Commissions’ characterisation of warranties as “risk control measures”. Therefore if for example the owner of a factory fails to install a burglar alarm system by a certain time in breach of a warranty in their property insurance, it is possible for the risk to be restored to the state it would have been in had the breach not taken place (i.e. the insured can install the burglar alarm at a later stage).
"Basis of the contract" clauses
The Bill abolishes "basis of the contract" clauses, which operate to turn the insured's pre-contractual representations (including answers to questions on a proposal form) into warranties. The Law Commissions make clear in their guidance notes to the Bill that if an insurer requires a warranty in respect of a particular matter, this should be expressly agreed between the parties in the insurance contract.
Warranties to reduce particular risks
Earlier drafts of the Bill provided that where a warranty or other term relating to a particular kind of loss or loss at a particular location or time is breached, the insurer's liability should only be suspended in relation to that type of loss or loss at that particular time or place.
This provision has been removed from the Bill due to a lack of general market consensus.
3. Insurer's remedies for fraudulent claims
The draft Bill replaces the current co-existing remedies of forfeiture (under common law) and avoidance (under the 1906 Act) with a statutory regime for fraudulent claims.
This provides that the insurer (i) will not be liable to pay fraudulent claims; (ii) can elect to terminate the contract and refuse to pay claims relating to losses suffered after the fraud; but importantly, (iii) will remain liable for all legitimate losses suffered before the fraud.
Fraudulent claims by members of group insurance policies
The Bill provides that where a beneficiary makes a fraudulent claim under a group insurance policy, the insurer (i) has no liability to pay the fraudulent claim; (ii) has the option to terminate its liability to pay out in respect of losses suffered after the fraudulent act, but only as regards the fraudulent claimant and (iii) remains liable for legitimate losses suffered by the fraudulent claimant before the fraudulent act.
The fraudulent claimant and the insurer are treated as though they had entered into a separate insurance contract between them, meaning that innocent group members are not unfairly prejudiced.
4. Amendments to the Third Parties (Rights against Insurers) Act 2010
The Third Parties (Rights against Insurers) Act 2010 aims to simplify and modernise the procedure for third party victims to seek compensation from an insurer in circumstances where the insured has become insolvent or ceased to exist.
The Bill corrects defects in the 2010 Act (which failed to cover the full range of insolvent or defunct wrongdoers) such that it can now be brought into force. For further information on the 2010 Act, please click here.
5. Contracting out
It is intended that the Bill will be a default regime for non-consumer insurance contracts. However, the Law Commissions recognise that some provisions may not be suitable for all markets and commercial parties. The Bill therefore allows parties to non-consumer insurance contracts to contract out of the default regime (with the exception of the prohibition on "basis of the contract" clauses) as long as any “disadvantageous term” (which puts an insured in a worse position than that under the default regime) meets the “transparency requirements”:
- the insurer must take sufficient steps to draw the disadvantageous term to the insured’s attention before the contract is entered into or the variation agreed; and
- the disadvantageous term must be clear and unambiguous as to its effect.
In determining whether the transparency requirements have been met, the characteristics of the insured and the circumstances of the transaction should be taken into account. For example, an insurer will have to do less to bring the provision to the attention of a large sophisticated company which is advised by experienced lawyers and brokers than it would for a sole trader buying “off the shelf” insurance online.
The Law Commissions have recognised that “[f]or many years, the courts have attempted to moderate the harshness of the law with creative reasoning”. Whilst the changes may result in litigation as to how the new provisions should be applied, the Law Commissions hope that the Bill will introduce greater certainty in the long-term. The Law Commissions' aim being to also redress the perceived current imbalance in favour of the insurer which “puts the English market at a competitive disadvantage against other jurisdictions”.
The Law Commissions' hope is that rather than adopting boiler plate clauses which opt-out as a matter of routine, both insurers and insureds will give careful consideration as to how the new regime might best apply to their commercial insurance contracts.
It is clear that the Law Commissions have been forced into a pragmatic approach. They have long stated a desire to adopt the fast track parliamentary route for uncontroversial bills. Plainly modifications have had to be made to satisfy that criteria, but the prize of a relatively quick amendment to the current laws regarding the duty of good faith was clearly seen as worth it.