The Law Commission and the Scottish Law Commission (the Commissions) have recently published the final consultation paper as part of their ‘Joint Insurance Contract Law Review 2006-2013’. The latest paper, ‘The Business Insured’s Duty of Disclosure and the Law of Warranties’ (the Paper), looks again at the concepts of non-disclosure and misrepresentation in business insurance, and warranties in both business and consumer policies, in the light of concerns raised by consultees following the Commissions’ 2007 paper on the same subject. The most recent Paper offers a different approach to some key areas of reform. This article addresses briefly the key “consultation” proposals of the Commissions and the likely impact on the insurance industry if the proposals are adopted.
Non-Disclosure and Misrepresentation in Business Insurance
The Marine Insurance Act 1906 (the MIA) and its common law application is the current position under English law in relation to non-disclosure and misrepresentation. The well- known Section 18 provides that an insured must disclose every material circumstance that it knows or ought to know in the ordinary course of its business. It defines a material circumstance as one “which would influence the judgment of a prudent insurer”. Further, under section 20, an insured must not make a material misrepresentation. These provisions state that the insurer’s remedy in the event of breach is avoidance of the contract.
The Commissions’ review has, from the outset, sought to reflect industry concerns that strict adherence to the MIA can in some circumstances produce manifestly unjust or inappropriate outcomes. Concerns over the application of sections 18-20 to consumer contracts have already been addressed by the Consumer Insurance (Disclosure and Representations) Act 2012 (the Consumer Insurance Act 2012), which is likely to come into effect next year, but the Commissions have yet to reach conclusions on the correct approach to reform in business insurance.
In the Paper, the Commissions abandon their 2007 proposal that a business insured need only volunteer facts which a reasonable insured would realise the insurer would want to know. Instead, the Commissions propose to retain the insured’s duty to disclose material circumstances which would be relevant to a reasonable insurer. This duty would be clarified by a new statutory definition of a ‘material circumstance’, which would be any circumstance “required to provide a fair presentation of the risk”. The Commissions suggest that a fair presentation would comprise the prospective insured providing information regarding: “(1) Any unusual or special circumstances which increase the risk; (2) Any particular concerns about the risk which led the policyholder to seek insurance; (3) Standard information which market participants generally understand should be disclosed”. These rules would be supplemented by industry guidance and protocols available to the insured to indicate what sorts of circumstances would be relevant to a fair presentation of the risk.
Although it is not currently clear whether the Commissions’ adoption of the concept of the “reasonable insurer” is distinct from or the same as the established concept of the “prudent insurer”, we believe that the term “reasonable insurer” will simply replace the term “prudent insurer” without consequence.
Remedies for non-disclosure and/or misrepresentation
As regards remedies, the Commissions propose that the insurer should only be entitled to avoid the policy where the insured’s non-disclosure or misrepresentation was dishonest. However, in this latest consultation phase the Commissions solicit views on how dishonest conduct should be defined; whether a similar definition of “deliberate or reckless” conduct as enacted in the Consumer Insurance Act 2012 should be the test applied, or whether the test should be the established common law test of fraudulent conduct.
If the insured’s non-disclosure or misrepresentation was merely innocent or negligent the Commissions’ propose that the insurer’s remedy would be proportionate to the breach. It is presently assumed that this would be determined having regard to the approach the “reasonable” as opposed to actual insurer would have adopted towards the risk had he been aware of the undisclosed or misrepresented material circumstance – i.e. a largely objective test will be applied. This can be described as follows:
- Where the insurer would have refused to write the risk altogether, the policy may be avoided, the claim declined and the premium returned.
- Where the insurer would have accepted the risk but subject to other contract terms (such as exclusions), the contract should be treated as if it had included that term(s).
- Where the insurer would have charged a greater premium, the claim should be reduced proportionately (for example, if the premium would have been 10% higher, the claim would be reduced by 10%).
This would become the accepted “test”, as applied to a reasonable insurer, although it is not entirely clear whether the present objective/prudent underwriter test would continue to be applied to all three criteria as some of them may well involve an element of a subjective approach.
The Commissions intend to codify two existing common law principles. First, they propose to enshrine an interpretation of section 18(3)(c) MIA which has evolved from case law. The section provides that “any circumstance as to which information is waived by the insurer” need not be disclosed to the insurer. The Commissions propose that “where the insurer receives information which would prompt a reasonably careful insurer to make further enquiries, [and the] insurer ... fails to make appropriate enquiries”, the insurer has waived disclosure of any circumstance which would have been revealed by those enquiries. Second, the Commissions endorse the inducement test, developed in Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co  3 WLR 677. Under the Commissions’ formulation of the rule, the insurer must show that “without the non-disclosure or misrepresentation it would not have entered into the contract at all, or it would have done so only on different terms”, and this to some extent pre-supposes the existing “prudent underwriter” test will also apply to the “reasonable insurer”, and also the requirement of “inducement”.
The Commissions also consider problems arising from the question of the insured’s knowledge. Under section 18 MIA, the insured need not disclose material information which it does not know. The Commissions approve of the uncertain but flexible common law notion that the individuals whose knowledge is treated as that of the company are those who constitute the “directing mind and will” of the company. But they supplement this test with the suggestion that the knowledge of the persons responsible for arranging the insurance, regardless of their seniority, should also be taken into account. Finally, the Commissions propose that the insured should be responsible for the disclosure of material information which would have been discovered through reasonable enquiries by the insured (or by the insured’s broker), or which was received or held by the insured’s broker in the course of acting for the insured.
The Commissions’ proposed reform of the law of warranties applies equally to business and consumer insurance contracts, with the exception that it would be open to parties to business policies to contract out of the regime.
Under section 33(3) MIA, a warranty is a condition which “must be exactly complied with, whether it be material to the risk or not”, and if the insured is in breach then the policy is cancellable from the date of the breach at the election of the insurer. This stark position has several undesirable consequences which the Commissions’ current consultation addresses: first the insured has no opportunity to remedy the breach, since cancellation is at the election of the insurer; second the insurer cancels the whole policy, not just the claim, so a lack of causal relationship between the loss and the breach is irrelevant.
In response to the first issue, the Commissions suggest treating warranties as suspensive conditions, thereby restoring the insurer’s liability once the breach has been remedied. In response to the second, the proposal is that where the insured is in breach of any term designed to reduce the risk of a particular type of loss, the insurer’s liability would only be suspended in respect of that type of loss (for example, where the insured fails to comply with an obligation to fit a functioning burglar alarm, the insurer’s liability is only suspended in respect of losses arising from theft, and not, say, fire). Interestingly, the Commissions step back from their 2007 “causal connection” test, under which an insurer would remain liable where the insured can prove the breach of warranty did not contribute to the loss.
The Commissions also plan to abolish the concept of “basis of the contract” clauses. These are provisions which convert the insured’s statements on the proposal form into warranties. They are obscurely worded and effectively operate as a trap, permitting the insurer to avoid the policy on the basis of minor and irrelevant errors and omissions.
As a whole, the Commissions’ proposals are intended to represent a more evolutionary approach to reform. Indeed, as regards pre-contract disclosure, the Commissions appear, for the most part, to favour a clarification of the existing position through clear statutory definitions and accessible industry guidance in order to assist the insured in discharging his existing duty. The proposed introduction of proportionate remedies perhaps represents the biggest shift from the current MIA and common law position, but it will not come as a complete surprise to the insurance industry. The Commissions have received evidence that some insurers already operate their own informal system of proportionate remedies. Furthermore, the Commissions recommend that their proposals with respect to proportionate remedies should not be mandatory and that the Commissions have no intention to interfere with parties’ freedom to contract.
The current suggestions for warranties should be met with approval insofar as they represent a simplification of the 2007 proposals. The decision to dispose of the causal connection test which enjoyed majority approval in 2007, may be less popular. The Commissions consider that it is more certain to measure whether the term breached was one which was intended to reduce the risk of the particular loss which occurred, than to explore whether the breach caused the loss.
There is wide consensus that law reform of business insurance law is necessary. While consumer reform was prioritized from the outset, in practice FOS procedures and FSA rules were an effective counterbalance to the most draconian effects of the MIA. Business insureds, especially those of medium size and above, receive little protection from regulators, and despite attempts being made by the Courts in England and Scotland to, where possible, alleviate the harshness of a strict interpretation of a warranty, where a warranty is clear and explicit, courts have not been able to do so.
The Commissions will be interested to hear whether consultees agree that the current proposals represent an appropriate framework to address these concerns. Responses to the Paper are requested by 26 September 2012.
A Final Report on ‘Post-Contractual Duties and Other Issues, Business Insurance Law: Pre-Contract Disclosure, Misrepresentation and Warranties’, will incorporate consultees’ responses to the Paper, as well as the Commissions’ conclusions on a wide variety of other proposed areas of reform. This is expected late 2013.