Reforming Insurance Contract Law: Draft Insurance Contracts Bill and the Law Commissions’ proposals in respect of business insurance
The Law Commission of England and Wales and Scottish Law Commission have recently published a complete draft of the Insurance Contracts Bill and a set of Explanatory Notes.
It is hoped by the Law Commissions that the Bill may become law via the special procedure for Law Commission Bills that was approved by the House of Lords in October 2010. The purpose of the consultation that was announced was to assess the general level of support for the Bill, rather than to invite comments on the substance of the Bill. The shortened procedure has been adopted in view of the limited Parliamentary time available in light of the election in May 2015.
The draft Bill follows on from the two sets of draft clauses that were released for consultation earlier this year on 28 January and 10 March 2014 (and in relation to which we have previously prepared briefing notes). This briefing note draws together the comments that were made in those earlier notes as they apply to the provisions of the new draft Bill.
The areas addressed in the draft Bill are as follows:
1. the duty of fair presentation;
3. Insurers' remedies for fraudulent claims;
4. terms as to payment of claims; and
5. good faith and contracting out of the legislation.
Before dealing with each of the specific areas covered by the draft Bill, we note that the draft Bill no longer seeks to draw a distinction between the “insured” and the “proposer”. This distinction was identified as potentially problematic during the consultation process earlier this year. For the purposes of the Bill, the definition of an “insured” party includes a party who would be the insured in the event a policy is issued.
1. Duty of Fair Presentation (Clauses 2 - 8)
The proposed new disclosure provisions would apply to all non-consumer insurances, and in respect of variations to such insurances. The law in relation to consumer insurances was reformed by the Consumer Insurance (Disclosure and Representations) Act 2012.
Any proposal for cover that is made to insurers will need to be a “fair presentation of the risk” (replacing sections 18-20 of the Marine Insurance Act 1906). Clause 3(3) defines what amounts to such a “fair presentation”:
it must disclose every material circumstance which the insured knows or ought to know; or
failing that it must give the insurer sufficient information in relation to those material circumstances as would put a prudent insurer on notice that it needs to make further enquiries (this essentially reflects the approach currently being taken by the courts e.g. CTI v Oceanus  1 Ll LR 476).
A circumstance is material for these purposes if it would “influence the judgment of a prudent insurer in determining whether to take the risk and, if so, on what terms”- i.e. a test that is similar to the existing law.
Disclosure must be made in a manner which is reasonably clear and “accessible” to that prudent insurer. This is aimed at the prevention of data dumping. In practice, of course, whether there has been a fair presentation is likely to be fact specific and as technology increasingly drives the insurance buying process, questions arise, for example, as to whether merely referring to a website can amount to a fair presentation.
Further, as part of a fair presentation, where any material representation is made as to something the proposer knows or ought to know, it has to be “substantially correct”. A representation will be “substantially correct” if a prudent insurer would not consider the difference between the representation and what is actually correct to be material (clause 7(5)). If the representation is as to something else other than what the proposer knows or ought to know, for example as to a matter of expectation or belief, as opposed to fact, it has to be made “in good faith” (clause 3(3)(c)).
Clause 7(4) identifies several matters which may amount to material circumstances including special or unusual facts relating to the risk; any particular concerns which led the insured to seek insurance cover for the risk; and anything which those concerned with the class of insurance and field of activity in question would generally understand as being something that should be dealt with in a fair presentation of the risks of the type in question.
Knowledge of the Proposer: Removal of common law rules of attribution
The main departure from existing law is the removal of the common law rules of attribution of knowledge by specifying whose knowledge is relevant for there to be actual knowledge (see clause 4). Clause 4 also sets out what is meant by “know” and “ought to know”.
Where the proposer is an individual, that individual will be taken to know anything known by the person or persons responsible for the insurance (typically the brokers/agents).
Where the proposer is not an individual, the proposer is deemed to have the knowledge of anyone who is part of its “senior management” or of anyone who is responsible for the proposer’s insurance (and this could embrace both a risk manager and outside insurance broker).
What an insured “ought to know” is defined as that which would have been discovered by a reasonable search of information that is available to the insured (whether in its own organisation or held by others e.g. an agent).
Although an individual’s knowledge is no longer expressly stated in the draft Bill to include ““blind-eye” knowledge” (as was the case in the earlier draft clauses), clause 6(2) confirms that knowledge includes information which the individual suspected and would have had, but for deliberately refraining from confirming it or enquiring about it. An issue in the earlier consultation was whether such knowledge should extend beyond matters which the Insured deliberately refrained from enquiring about; the Law Commission’s view is clearly that it should not.
By clause 6(3), knowledge does not include confidential information which has been acquired by an agent through a business relationship with someone other than the insured (and similarly, an insurer’s agent’s knowledge does not include confidential information acquired by an agent through a business relationship with someone other than the insurer). Commentators have queried whether this particular clause may be storing up more problems than it solves, creating the potential for arguments as to whether information received is confidential or not (and some such commentators suggest retention of the current ambit of the agent’s duty in accordance with section 19(a) of the Marine Insurance Act 1906 as interpreted in subsequent cases – the duty has been limited to knowledge that is acquired on behalf of the principal whose risk is proposed to be insured).
Exceptions and the Insurer’s Knowledge
Clause 3(5) identifies exclusions to the duty to disclose, including circumstances which the insurer knows, or in relation to which the insurer waives information. These exceptions include matters which not only ought reasonably to be known by the insurer but are presumed to be known. An insurer is to be presumed to know (clause 5(3)):
things which are common knowledge; and
things which an insurer offering insurance of the class in question to proposers in the field of activity in question would reasonably be expected to know in the ordinary course of business.
The draft clauses previously released for consultation continued further and provided a definition of “things”, which referred to “information and knowledge of any kind, including facts, rumours, expectations and beliefs”. Not unexpectedly, comment had been made on the uncertainty of such a definition, and the Law Commissions appear to have taken such considerations on board.
Knowledge of the insurer is defined as being that of the individual or individuals who participate on behalf of the insurer in the decision whether to take the risk and if so on what terms (i.e. the particular person(s) involved in the underwriting decision).
Provisions as to remedies for breach of the duty of fair presentation are contained in clause 8 and in the Schedule to the draft Bill and mirror the remedies that are available in relation to consumer insurance as set out in the 2012 Act. Currently an insurer’s only remedy against an insured for non-disclosure is avoidance, whilst the proposed new regime is more flexible and regarded as better suited to the modern commercial world.
An insurer will have a remedy against an insured for breach of the duty of fair presentation only if the insurer can show that, but for the breach, the insurer would either not have entered into the insurance at all, or would have done so but only on different terms. A breach of the duty of fair presentation for which the insurer has a remedy is termed a “qualifying breach”.
Where the qualifying breach is deliberate or reckless (matters which it is for the insurer to prove), avoidance of the policy is retained as a remedy. If the qualifying breach was neither deliberate nor reckless, the remedies are based on an assessment of what the insurer would have done had it received a fair presentation of the risk. This will include avoidance of the policy (and return of premium) if the insurer would not have entered into the policy on any terms had a fair presentation been made.
2. Warranties (Clauses 9 - 11)
The draconian way in which warranties and basis of contract clauses have operated in English insurance law has been much criticised by policyholder groups and the draft Bill attempts to address concerns that the UK may be losing insurance business as a result.
Subject to the contracting out provisions (which are discussed further below), the provisions of the draft Bill as to warranties are intended to apply to both consumer and non-consumer insurance contracts.
Clause 9 seeks to abolish “basis of contract” clauses in non-consumer insurance (thereby mirroring the provisions of the Consumer Insurance (Disclosure and Representations) Act 2012).
The prohibition on “basis of contract” clauses in non-consumer insurance contracts is one of the mandatory provisions of the Bill. That is to say, provisions under which representations made by an insured in connection with a proposal for insurance, or a proposed variation to an insurance contract, are converted into warranties by means of a provision of the policy are to be prohibited. It is important to note that it will still be possible under the Bill to include warranties in policies of insurance, but they will need to be expressly agreed with the insured.
Clause 10 addresses the consequences of breaches of warranty. Under the provisions of clause 10, breaches of warranty will now serve to suspend insurers' liability, rather than operate to discharge it (as is presently the position). Insurers’ liability will be suspended both for losses occurring after the breach (but before it has been remedied), and also for losses “attributable to something happening” during the period of breach. Clause 10(4) states that insurers’ liability can be restored if and when the breach of warranty is remedied.
Of course, breach of some warranties cannot be remedied. That said, clauses 10(5) and (6) of the Bill seek to allow breaches of some warranties to be remedied, even if the time for compliance with those warranties has passed and so, on the current law, breach cannot be remedied. A subsequent breach of warranty will not affect a prior claim.
Clause 11 is still subject to consultation with stakeholders. As currently drafted, it provides that, if a policy term goes to reduce the risk of a particular type of loss, or loss at a particular location or time, breach of that term cannot be relied on by an insurer to exclude, limit or discharge liability for loss of a different kind, or loss at a different time or location e.g. a term designed to reduce loss by fire, but the loss being occasioned by flood. There is a genuine concern that if enacted, this clause may lead to further satellite litigation.
3. Remedies for Fraudulent Claims (clauses 12 and 13)
The draft Bill provides that where an insured makes a fraudulent claim, the insurer will not be liable to pay the claim. Any monies paid out for that claim may be recovered. The terms “fraud” and “fraudulent claim” are left deliberately undefined, the Explanatory Notes clarifying that they should be determined in accordance with common law principles. The insurer may, by notice to the insured, treat the policy as having been terminated with effect from the time of the fraudulent act with no obligation to return premium. Notice does not expressly have to be in writing, although obviously it would be the best course of action for any such notice to be in writing. The result of such a termination is the forfeiture of any claim made after the date of the fraud, but the retention of any legitimate claims made before the fraud occurred.
In the second set of clauses released earlier this year, the Law Commission had proposed a further sub-clause which provided that a claim may either be fraudulent when it is made, or become fraudulent as a result of a later act (i.e. potentially clearly embracing the concept of fraudulent devices in support of an otherwise valid claim). This sub-clause is notably absent from the draft Bill. Having said that, the Bill does still refer to the “fraudulent act” as well as to the “fraudulent claim” , and and the Explanatory Notes to the Bill state that the two should be distinguished; the “fraudulent act” is the behaviour which makes the claim fraudulent, which may be after the submission of the claim. The example is given of a genuine claim being submitted in January with the addition of a fraudulent element in March (an additional, fabricated head of loss), with the result that the “fraudulent claim” is submitted in March. The question is if this amounts to fraudulent devices by the back door.
Incidentally, the Court of Appeal is currently considering the issue of fraudulent devices, in the appeal from the first instance decision in Versloot Dredging BV v HDI-Gerling Industrie Versicherung AG (“The DC Merwestone”).The outcome of that appeal should also serve to clarify the law on this issue.
Group Insurance Schemes
Under a group insurance scheme cover is obtained by a policyholder for the benefit of a group of scheme members who are not themselves policyholders (e.g. an employer obtaining a policy for the benefit of employees, or a landlord obtaining a policy for the benefit of tenants). These provisions are drafted on the basis that each of the scheme members are consumers.
If an insured under a group insurance scheme makes a fraudulent claim, the Bill provides that it will be treated as if the insurer and the fraudulent member entered into a separate insurance contract (i.e. the cover for the remaining members will be unaffected).
As far as the fraudulent claim is concerned, the insurer will have no liability to pay the fraudulent claim. The insurer will also have the choice of terminating its liability to pay the fraudulent member in respect of losses suffered after the fraudulent act (although it will remain liable for losses prior to the fraudulent act that are properly indemnifiable).
4. Late Payment of Claims (clause 14)
As with clause 11, clause 14 remains the subject of consultation with stakeholders.
The draft Bill as it stands proposes that it be an implied term of every insurance contract that claims are paid within a reasonable time of being made. A failure to meet this obligation will result in liability to pay damages to the insured for any foreseeable loss which results. This represents a significant departure from the law as it currently stands and enactment of the draft clauses will mean the end of the “hold harmless” principle which has previously applied, and which has prevented the recovery of damages for late payment of claims.
What is a reasonable time to pay a claim will be assessed by reference to all of the circumstances including the type of insurance, the size and complexity of the claim and the extent to which relevant factors are outside the insurer’s control.
Insurers will have a defence to an allegation of failure to pay a claim within a reasonable time if they can show they have acted reasonably, even if they have incorrectly refused to pay a claim. Though not stated as such specifically, taking legal advice might well exculpate an insurer in these circumstances.
An insured’s claim against an insurer for failure to pay a claim is likely to be a separate cause of action from the policy claim against the insurer itself, with its own separate limitation period (as is the case with Section 50 of Financial Services and Markets Act 2000). The date of commencement of such a limitation period may not be an easy matter to define with precision..
While this proposal is unlikely to lead to substantial claims against insurers for “Bad Faith”, we anticipate that insureds will make full use of this provision and insurers and their advisers will have to be seen to be proactive in handling claims.
Under the provisions of the Bill an insurer would not be able to contract out of this provision so as to place a consumer in a worse position than would have been the case under the draft Bill.
5. Good Faith and Contracting Out (clauses 15 - 17)
The draft Bill proposes that a breach of the duty of utmost good faith should not give rise to a remedy of avoidance (amending section 17 of the Marine Insurance Act 1906). Having said that, the Law Commission is keen to stress in its notes accompanying the draft Bill, that it considers the duty of utmost good faith to be important as a general interpretive principle and that it should remain part of insurance law.
Clause 16 of the draft Bill operates to prohibit contracting out of the default provisions of the Bill in a consumer context. The new provisions on warranties, remedies for fraudulent claims and late payment of insurance claims (and good faith) therefore apply to all consumer insurance contracts as a mandatory regime (provisions of the Bill in relation to the duty of fair presentation and the abolition of “basis of contract” clauses do not apply on a mandatory basis to consumer insurance, as those issues are already addressed by provisions of the Consumer Insurance (Disclosure and Representations) Act 2012).
Clause 17 sets out the Law Commissions’ proposal that the business insurance law reforms are to be a default regime that the parties should generally be able to contract out of. Certain provisions are still to be a mandatory minimum protection for insureds, though; notably parties cannot contract out of the abolition of “basis of contract” clauses (clause 9 of the draft Bill), and provisions relating to deliberate or reckless late payment of insurance monies.
If an insurer wishes to contract out of the provisions of the Bill, under the provisions of clause 18 (the transparency requirements) it will need to make sure that it takes sufficient steps to draw “the disadvantageous term” (i.e. the term which places the insured in a worse position when compared to the default provisions of the Bill) to the attention of the insured; further, “the disadvantageous term” must be clear and unambiguous as to its effect. When considering whether these provisions have been complied with, the court will look at the characteristics of the insured and the circumstances of the transaction (the relative sophistication of the insured and the involvement of a broker will be matters that are relevant).
The contracting out provisions (including the transparency requirements) will not apply to settlement agreements reached between insurer and insured.
Responses to HM Treasury
As mentioned at the outset, the Law Commissions are hopeful that, if there is a broad consensus of support for their draft, the Bill may become law via the special procedure for Law Commission Bills that was approved by the House of Lords in October 2010. In that regard, HM Treasury (which is to be the Bill’s sponsoring department) is consulting as to whether such broad consensus of support exists in relation to clauses 11 and 14 (in relation to which it is still consulting), and separately in relation to the other parts of the Bill. Responses to enable HM Treasury to assess whether the Bill has the necessary broad consensus were requested by 2 July 2014.
Even if the necessary broad consensus of support is present, the current Parliamentary session is a short one (ending on 30 March 2015) and it may be that time proves insufficient for the Bill to become law.
DWF continues to participate in the consultation process.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.