Treasury released an exposure draft Bill1 on 30 July 2019 to extend unfair contract terms to insurance contracts. Consistent with the Hayne Royal Commission recommendation, the Bill applies a broad scope to the test, and it has been fit within the terms of the existing ASIC Act provisions with very little tailoring.
So, what is the test?
The legislation will make the term of an insurance contract unfair if:
- it forms part of a standard form contract;
- the insured is a consumer or small business;
- it would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
- it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term (ie. the insurer); and
- it would cause financial or other detriment to a party (ie. the insured) if it were to be applied or relied on.
The test will not apply to terms which:
- define the main subject matter of the contract;
- set the upfront price payable under the contract; or
- are required or expressly permitted by law.
Finally, in determining whether a term is unfair, a court must consider the extent to which the term is transparent and the contract as a whole.
There are several important points to be considered in relation to the proposed test.
Standard form contract
The Bill does not include any additional terms regarding which insurance contracts will be taken to be in "standard form". The Explanatory Memorandum to the Bill does help a little, by stating an intent that insurance contracts will remain in standard form despite giving the customer various options "such as levels of premium, excess or sum insured". Presumably, this would also apply to optional extensions to cover and the like, provided those are not individually negotiated.
Main subject matter and upfront price
The unfair contract term provisions will not apply to the "main subject matter" of an insurance contract. After many years of debate as to how this should be interpreted, the Bill has landed on a narrow definition. Only terms that "describe what is being insured" will be exempt. For instance, for a motor vehicle policy, this would include only the details of the vehicle being insured. Terms describing the scope of cover for that vehicle and exclusions to that scope will be subject to the unfair contract terms test.
How the Main Subject Matter exemption is to be defined has been one of the most controversial aspects of applying the unfair contract terms legislation to insurance. The insurance industry has raised strong concerns in the past about having terms which effectively set the scope of cover subject to review and potentially rendered void. To do so exposes the insurer to a risk that it has not priced the cover into its premium and that it may not have obtained adequate reinsurance protection. Assuming the Bill is passed, insurers will need to consider how they can best mitigate these risks.
The Bill states that the unfair contract term provisions will also not apply to the "upfront price". This will apply, of course, to the insurance premium. It will also apply to any excesses or deductibles, provided those are "transparent" and disclosed to the customer at or before entry into the contract. In order to safely rely on this second part of the provision, therefore, insurers will need to make sure that the terms of excesses and deductibles in their insurance contracts are clear and prominently displayed to their customers before purchase.
A term will not be unfair if it is reasonably necessary in order to protect the legitimate interests of the insurer. The Bill provides no guidance on how this part of the test will be applied. The Explanatory Memorandum does acknowledge that many terms of an insurance contract will be "reasonably necessary", however offers only a single example of where that will be the case – where a life insurer includes a term that allows it to increase premiums and then uses that term to respond to a change in the actuarial price of the risk.
Previous proposals, for instance that a term will be reasonably necessary if it reflects the underwriting risk accepted by the insurer and does not disproportionately or unreasonably disadvantage the insured, have not been included in the Bill or the Explanatory Memorandum.
The uncertainty in this area of the test will likely be of considerable concern to insurers. Where there is a risk that a term in an insurance contract may be found to be unfair, insurers will need to carefully consider whether that term is necessary and how they might prove that is the case, if they are challenged to do so. Undoubtedly, that will be an easier task if consideration is given at an early stage to evidence that might be helpful in proving the term's necessity and how that might be documented.
The draft Bill does not include any insurance specific examples of terms which could be found to be unfair, though there is some commentary in the Explanatory Memorandum on that topic. The three examples given are:
- a term that allows an insurer to elect to settle a property claim with a cash payment based on the cost of the repair to the insurer rather than how much it would cost the insured to make the repair (an example referred to in the Royal Commission);
- a term that is linked to another contract (for example a credit contract) which limits the insured's ability to obtain a premium rebate on cancellation of the linked contract; and
- a term that would allow the insurer to require the insured to pay an excess before the insurer pays the claim.
While useful, these of course to do not limit the way in which the unfair contract terms provisions will ultimately be applied to insurance. A term is less likely to be found to be unfair if it is transparent, which the ASIC Act defines as being expressed in "reasonably plain language", legible, presented clearly and "readily available" to affected parties.
This element goes to the heart of many of the challenges with insurance contracts – how to make sure that customers understand the terms of the cover they are purchasing. In this case, insurers should consider whether at risk terms have been made sufficiently clear and prominent for customers to understand them. There are a range of ways in which this could be done, for instance in the Product Disclosure Statement, associated documentation such as the Schedule or covering letter, or in the sales process itself.
Standing to bring an action
As for other contracts, ASIC and parties to the contract (ie. the insured) have standing to bring an action under the unfair contract terms provisions. In addition, the Bill will give third party beneficiaries standing to bring an action.
The Bill includes an 18-month transition period after Royal Assent, which is an increase on the 12-month period proposed by Treasury in its 2018 Proposals Paper, though less than was requested by the insurance industry. The transition period operates so that only contracts entered into on or after its end will become subject to the new provisions. The Bill therefore provides 18 months for product issuers to review the terms of their insurance contracts, apply any changes and to take any other actions that they consider necessary.
Submissions and further action
Treasury has sought submissions on the draft Bill by 28 August 2019.
Given the extensive debate that has already occurred on this topic, the strength of the recommendations by the Royal Commission and other enquiries and the short timeframe afforded, it seems unlikely that there is much scope for movement on the Bill's substantive terms.
While the increased transition period will be of some comfort to those with insurance products in the market, it will be important that issuers are thinking now about how any changes that might need to be made should be coordinated with other product related changes, for instance to meet the requirements of the Product Design and Distribution requirements and potential General Insurance Code of Practice changes.
A link to the draft Bill and Explanatory Memorandum can be found here: https://treasury.gov.au/consultation/c2019-t372650