From 4 May 2017, damages can be recovered from risk carriers that have not paid valid claims in a “reasonable time”. This is by virtue of an implied term that is incorporated by Section 13A of the Insurance Act 2015 (the "Act") into all new polices of insurance and reinsurance contracts to enable (re)insureds to seek damages for breach of contract.
The section is a response to arguments that the pre-Act rule under English law, as represented by the case of Sprung v Royal Insurance (UK) Ltd (1999), is an anomaly which places England and Wales out of step with many other jurisdictions (including Scotland). This rule is based on a legal fiction that an insurer's primary obligation under an indemnity insurance contract is to "hold the indemnified person harmless against a specified loss or expense" (see Lord Goff's speech in The Fanti (1991)) – in other words, to prevent the event that is insured against from happening. Accordingly, insurance payments were not debts due under a contract but were instead damages for breach of contract, and English law did not recognise a claim for damages for the late payment of damages.
This rule was widely criticised. The new clause 13A of the Act will bring the law into line with other jurisdictions and with general contract law principles.
What does the clause prescribe?
The clause provides that it is an implied term of every insurance contract that an insurer must pay any sums due in respect of a claim made by the insured "within a reasonable time" (which will include a "reasonable time" to investigate and assess the claim).
Reasonableness will depend on all the relevant circumstances, including the size and complexity of the claim, the type of insurance and factors outside of the insurer’s control.
It is unclear what would be considered "reasonable" by the courts when determining whether insurers were unreasonable in declining to pay a claim. The phrase used clearly suggests that an objective test will be applied and it is likely to be fact specific. It has been suggested that the courts will look at applying a standard somewhere between surviving an application for summary judgment and proving you were right at trial on the balance of probabilities. However, it might be worth noting that the FOS (which hears complaints from consumers and microbusinesses) already applies a remedy of damages for late payment, with broad acceptance from the industry. Consumers and micro-businesses are, in any event, far more likely to sustain losses as a result of late or non-payment of a claim than larger businesses, which in general will have better cash flows to cope with delayed insurance claims.
"Reasonable" test in contested claims
There is no guidance in section 13A for what is "reasonable" in contested claims. Here, the main issue will be whether or not there were reasonable grounds for denying the claim, taking into account the conduct of the insurer, even if the objective test above is met.
Examples of conduct could include:
- Conducting investigations slowly
- Refusal to engage in ADR
- Failure to make interim payments, especially where the whole claim is not in dispute
- Breaches of the CPR which cause delay
The scope of conduct under scrutiny is unclear as the section does not state whether it is the insurer’s conduct in denying the claim or its conduct in the litigation or both.
How will damages be assessed?
The remedies for breach of the new implied term include damages (in addition to having the claim paid and interest). Normal contractual principles will be applied, namely, that the purpose of contractual damages under English law is to put the innocent party in the position in which it would have been had the relevant contract not been breached. In order to prove its damages, a party must demonstrate that its loss was reasonably foreseeable at the time the relevant contract was entered into (not at the date of breach). Questions to be resolved include how much the severity of the insurer’s conduct will impact on damages given, and how foreseeable it was that the insured would suffer the losses claimed. A key point is whether the insurer was aware that the insured would be relying on the insurance monies to reinstate its facilities and resume normal production. However, on the issue of consequential damages, we anticipate that the courts will likely be insurer-friendly.
Any such claims must be brought within one year of an insured receiving payment of the insurance claim. This is reflected in an amendment to the Limitation Act 1980.
Section 16A of the Insurance Act 2015 does envisage that insurers will be able to contract out of these changes (although not for consumer insurance). However, contracting out will not be valid where there has been a deliberate or reckless breach by the insurer. Recklessness in this context means where the insurer did not care whether or not it was in breach. The general contracting out rules set out in the Act will apply to terms in non-consumer policies relating to non-deliberate/reckless breaches.
Areas where damages for late payment could have an impact
Risk carriers facing complex property and extended business interruption claims are particularly alert to the new challenges this change will mean for them and for their (re)insureds. SMEs or sole traders, for example, may not have the ability to take out significant lines of credit to cover them until the insurance pays out. A typical scenario might be an SME or sole trader with weak cash flow who suffers a catastrophic fire at its premises. The insurer suspects arson, given the known financial difficulties. As a result, there is a long investigation and, in the meantime, the business collapses. If the claim was genuine then the insurer will be exposed to a claim for damages for late payment. A similar scenario arises in relation to one ship companies where the insurer suspects that the ship has been scuttled. These types of cases are notoriously difficult to prove and, as such, may take a long time to resolve and expose insurers to damages for late payment claims.
Perhaps more straightforward is the application of the late payment damages provisions to a typical BI cover scenario: if the insurer had paid the property loss promptly, the insured would have been able to rebuild its facilities and resume normal production within, say, nine months. Due to the delay in payment, it took 18 months so the insured may seek damages for the six months of BI that fell outside the 12 month maximum indemnity period. The energy sector, where claims are often very complex in nature and can take a considerable amount of time to investigate and adjust, may also be more vulnerable to claims for damages; these are commonly seen in other jurisdictions where this line is written. This will only be a concern where the insured actually suffers foreseeable consequential loss.
Practical points to consider
The late payment provisions require insurers to look at how they handle claims. A few practical points to consider when reviewing your organisation's process are as follows:
- Deal with claims as promptly as possible
- Have a written record showing how the claim is being progressed
- Be mindful that disputes between layers will likely not be considered a reasonable reason why payment was delayed
- Be aware that it may be necessary to disclose underwriting files in order to establish reasonableness in subsequent proceedings
- Be aware that you may need to waive privilege in respect of legal advice received to demonstrate reasonableness
- Consider making a partial payment on an uncontroversial element of the claim under a reservation of rights for the disputed element
For more analysis of the late payment provisions and the Insurance Act as a whole, please see our detailed report on the Act: 'Insurance Act 2015: Shaking up a century of insurance law‘.