In general contract law, where one party breaches a contract the other party may claim damages for the loss suffered. In order to be awarded damages, the claimant must prove that actual, financial loss was incurred consequent upon the breach of contract, establish that the loss was foreseeable at the time the contract was entered into and show that reasonable steps have been taken to mitigate the loss.
The position in insurance contract law is, however, different. The English courts have consistently said that no additional damages are allowed. The insured may recover up to the sum insured (or may recover the agreed value in those marine cases where the policy provides for it), together with discretionary interest and costs, but nothing further. The reason for this is the curious rule of English insurance contract law that an insurer’s obligation is not to compensate the insured for its loss but to prevent the loss from occurring. The law regards the payment of insurance claims not as debts due under the contract but as damages for breach of contract.
The Commissions’ view is that the unavailability of damages for the late payment of insurance claims is “unprincipled and unfair”. They propose the following changes to the law:
- It should be an implied term of an insurance contract that insurers will pay sums due within a reasonable time. An insured who suffers loss as a result of breach of that term should be able to recover contractual damages from the insurer.
- “Reasonable time” should be assessed by reference to all the circumstances, including the size and complexity of the claim and any matters beyond the insurer’s control. A “reasonable time” should always include time to investigate and assess the claim.
- Insurers should have a defence to a claim for late payment damages where they incorrectly refuse to pay a claim but can show that they acted reasonably in doing so.
- The normal limitation rules should apply. The limitation period for insurance claims will continue to run from the date of the original loss, while the period for late payment claims should run from the point at which the obligation to pay within a reasonable time is breached.
While many insurers will agree that the current law has produced some harsh results (perhaps most notably in the case of Sprung v Royal Insurance  Lloyd’s Rep IR 111), they will understandably be wary of any move towards punitive damages awards such as are regularly made in the USA against insurers found to have acted in ‘bad faith’. The Commissions’ proposals contain a number of safeguards against that possibility. In particular, it is an express provision of the draft clauses they have produced that a “reasonable time” will always include a reasonable time for investigating and assessing a claim. They also provide that where an insurer can show that it had reasonable grounds for disputing the validity or quantum of a claim, failure to pay the claim while the dispute is continuing does not in itself amount to breach of the implied term. Should the proposals come into force, however, disputes as to what was “reasonable” in any particular case seem inevitable.
The proposals also create potential liabilities for professional advisers, in circumstances where they advise an insurer client that it has a good defence to a claim but that defence is not subsequently upheld by the court.