In Spring 2015, the Insurance Bill, which applies to business insurance and thereby reinsurance, is likely to be given royal assent. As there are no special rules relating to reinsurance, and it is possible to contract out of the new provisions, some might think that reinsurers will be able to continue as before and ignore the new regime. This article explains why this might not be the best approach.
The Consumer Insurance (Disclosure and Representations) Act 2012 came into force on 6 April 2013. The changes made in that Act in relation to consumer insurance have been the forerunners to many of the changes in the Insurance Bill relating to business insurance. However, consumer insurance is a long way from complex reinsurance arrangements between two large and sophisticated businesses.
Disclosure and misrepresentation
The key changes in the Bill relate to disclosure and misrepresentations. They can be summarised as follows:
- There is a duty on the insured to make a “fair presentation” of the risk. This is largely similar to the Courts’ current interpretation of the duty of disclosure.However, the insured only has to provide enough information to put a prudent insurer on notice that it needs to make further enquiries for the purposesof revealing material circumstances. This could be seen as a movement towards the insurer having greater responsibility for asking questions.
- There remains a duty on the insured to avoid any representation which is not substantially correct and made in good faith.
- Where these duties are breached:
- If the breach is deliberate or reckless, the insurer can avoid.
- Otherwise, the remedy will be “proportionate”. If the insurer would not have entered into the contract if it had known the information not disclosed, the insurer can avoid. If the insurer would have insisted on different terms, those terms will apply. If the insurer would have charged more premium, the quantum of any claim will be proportionately reduced.
So, what issues could this leave for reinsurers and reinsureds?
First, the shift in onus towards underwriters’ enquiries could leave reinsurers more reliant on their reinsureds’ underwriters to ensure that appropriate questions are being asked, particularly in relation to treaty reinsurance. Currently, if the underlying insured has made a material non-disclosure, the reinsured can avoid and the reinsurer will have no liability. If the underlying insured can successfully counter this by indicating that the reinsured did not ask the right questions, then the reinsurer will face a liability, even though the questioning by the reinsured is outside of the reinsurer’s control.
Secondly, where the underlying insured has made a material non-disclosure, the reinsurer’s liability could depend on the reinsured’s attitude towards the non-disclosed information. Currently, the situation would be simple: avoidance or cover. Under the reforms, the reinsurer’s position would depend on the attitude of the reinsured, and the attitudes of reinsurer and reinsured might not match. For example, suppose a reinsurer has a large layer in a catastrophe excess of loss tower. A non-disclosure relevant to the chances of a major catastrophe might have only a limited effect on the attitude of a reinsured (whose liability is effectively capped by the excess of loss reinsurance). It might lead to a change in premium only – so that there will still be cover for a proportion of the claim. However, the non-disclosed facts might well have been enough for the excess of loss reinsurer to refuse cover or to insist on a higher excess. Nevertheless, the reinsurer will be stuck with it.
Thirdly, and on the other hand, a non-disclosure could take the risk outside of the scope of the reinsurance, but the reinsured might still retain some liability. For example, a non-disclosed fact could take a risk outside of the scope of a reinsurance treaty which the reinsured thought would protect its exposure. However, if the reinsured might still have written the risk, but on different terms or on different premium, it will be left exposed.
The changes in relation to warranties that have made it into the Insurance Bill are limited. A warranty will be suspensory only – once it is remedied, there will be cover from that time.
While this provides increased fairness at an insurance level, many of the warranties contained in a reinsurance contract will not be capable of being remedied. For example, warranties in a reinsurance treaty as to the type of business which has been declared to the treaty will be breached if the wrong business is ceded to the treaty. However, the “excluded” cession might be difficult or impossible to undo.
It will be possible to contract out of some or all of the effects of the Insurance Bill. There are specific requirements as to clarity and transparency that any contracting out clauses must meet. In particular, the reinsurer must take sufficient steps to draw to the attention of the reinsured any terms which are more disadvantageous than the regime in the Bill. Any such terms must also be clear and unambiguous as to their effect. These requirements are unnecessarily cumbersome given that reinsurance contracts will be agreed between sophisticated parties. However, the practical effect is that careful drafting will be needed in order to avoid leaving room for potential challenge, particularly until case law and established market practice as to the application of the transparency requirements has developed.
Even aside from the transparency requirements, from a reinsurer’s perspective, it might not be possible to contract out of some of the effects of the Insurance Bill unless they are replicated in every policy issued by the reinsured. For example, if an underlying insured has failed to disclose a material fact but there is still cover because the reinsured would have written the cover anyway (on different terms or for different premium), the reinsurer cannot contract out of the effect of this on its liability. The reinsurer might have contracted out of proportionate remedies between it and the reinsured, so as to allow avoidance if the reinsured makes a material non-disclosure. However, the reinsurer cannot so easily contract out of the effect of the reforms at the underlying insurance level if the underlying insured makes a material non-disclosure.
The reforms in the Insurance Bill have been a long time in the making. However, they do not make any allowance for the particular subtleties of reinsurance and so issues such as those identified above will be left to the reinsurance industry to address. The first step is an awareness of how to contract out and the potential gaps and effects which might not have been at the forefront of reformers’ minds (and hence this article). The challenge then will be how best to address these once the Insurance Bill comes into force.