Australia: How does the Insurance Contracts Act affect insurers and what are the planned developments to the Act?

In brief - Insurers and brokers should be aware of reforms proposed by Bill

The Insurance Contracts Amendment Bill 2010 proposes to expand ASIC's powers, permit electronic communication of notices and other documents and make a number of other changes related to duty of disclosure, third party beneficiaries and subrogation.

Insurance Contracts Amendment Bill 2010 may amend Insurance Contracts Act 1984

The most likely future developments to the Insurance Contracts Act 1984 will arise from the Insurance Contracts Amendment Bill 2010 which the then federal government introduced into Parliament in March 2010. The Bill has not been further considered since the August 2010 federal election produced a hung parliament for the first time in Australia since 1940.

Contract of insurance based on utmost good faith

The duty of utmost good faith, as it exists at common law, and also pursuant to the Act, was given further attention and prominence by the High Court of Australia in the CGU Insurance Ltd v AMP Financial Planning Ltd case (August 2007).

Section 13 of the Act presently sets out that a contract of insurance is a contract based on the utmost good faith, and that there is implied in such a contract a provision requiring each party to act with utmost good faith towards the other party. It follows from the provision that a breach of the duty of utmost good faith is a breach of contract which gives rise either to damages or to an estoppel. It does not give rise to avoidance ab initio.

Although the proposed amendments in the Bill to Section 13 of the Act do not set out with any particularity exactly what falls within the scope of the duty of utmost good faith, it is now clear that a breach of the duty of utmost good faith is not only a breach of contract, but also a breach of the Act.

ASIC may initiate representative action for breach of duty of utmost good faith

Although there is no suggested offence or penalty imposed in the draft Bill, by a new Section 11F, where there has been a breach of the duty, the Australian Securities and Investments Commission (ASIC) will be able to initiate a representative action on behalf of an insured against an insurer. ASIC will also be able to impose other penalties, such as banning orders or suspension or cancelling of an insurer's financial licence.

The concept of duty of utmost good faith remains paramount under the Act, particularly in relation to post contractual obligations. The proposed amendments in the draft Bill will provide clarity as to the effect of a breach of the duty.

Consequences of ASIC's new powers for insurers and brokers

  • Insurers will need to be mindful of ASIC's new regulatory powers in the event that there has been a breach of the duty of utmost good faith.
  • It is unlikely that this change will have any material day-to-day effect as most insurers are already treating third party beneficiaries in the same way as they treat named insureds.
  • There may need to be some change to claim procedures regarding third party beneficiaries.
  • Insurance brokers will need to be aware of the new rights when representing the interests of third party beneficiaries.

Electronic communication of notices and other documents

Whether or not notices and other information under the Act can be delivered electronically has been open for debate for some time.

The Bill proposes that the current exclusion of the Act from the Electronic Transactions Act 1999 (Cth) be lifted so as to expressly permit the electronic communication of notices or other documents.

This is clearly a positive development for the insurance industry as allowing insurers to use electronic communications is likely to result in cost savings.

Insured's duty of disclosure of any relevant matter

Section 21 is one of the most important practical provisions of the Act.

The Act already draws a distinction between disclosure (which is a pre-contractual obligation imposed on an insured in Section 21) and the duty of utmost good faith (which is an implied term in the contract of insurance, and which operates both pre- and post-contractually).

Presently, under Section 21(1) of the Act: insured has a duty to disclose to the insurer, before the relevant contract of insurance is entered into, every matter that is known to the insured, being a matter that:

(a) the insured knows to be a matter relevant to the decision of the Insurer whether to accept the risk and, if so, on what terms; or

(b) a reasonable person in the circumstances could be expected to know to be a matter so relevant.

Therefore, the present test includes both subjective elements (namely what the insured knows to be relevant to the insurer's decision) and objective elements (what a reasonable person in the circumstances could be expected to know would be relevant to the insurer's decision).

It was considered important to lay down a clear test which could be applied consistently by the courts.

Following its deliberations, a Review Panel concluded that section 21(1)(b) imposed an undue burden on consumer insureds, but that the law works satisfactorily in the context of commercial insurance. The Review Panel recommended that the test in Section 21(1)(b) remain an objective test but that it should be applied by reference to more certain considerations.

Initial proposal to make significant changes to Section 21

Initially, quite significant changes had been proposed to section 21 of the Act. Thus a 2007 draft Bill set out a list of objective matters to be taken into account when considering what a reasonable person in the circumstances could be expected to know would be a relevant matter to an insurer, when considering whether to take on a particular risk. These included:

  • The nature and extent of insurance cover to be provided under the relevant contract of insurance
  • The class of persons for whom that kind of cover is provided in the ordinary course of the insurer's business
  • The circumstances in which the relevant contract of insurance is entered into, including the nature and extent of any questions asked by the insurer

This clarification of the objective test resulted from a perception, by the Review Committee, that section 21 had not been applied consistently by the courts.

However, the 2010 Bill has only added the first of those additional criteria to section 21(b) so that the objective test now reads:

...a reasonable person in the circumstances could be expected to know to be a matter so relevant, having regard to factors including, but not limited to, the nature and extent of the insurance cover to be provided under the relevant contract of insurance.

Effect of change to section 21 now unlikely to be substantial

It is not entirely clear why the Bill has not provided detail of the other factors to be taken into account as had previously been proposed in 2007. However, it may be because it was considered that there would be a danger that the courts would place too much emphasis on those criteria, if they were set out, rather than considering wider issues. Therefore, the effect of proposed change in the Bill is in our view unlikely to be substantial.

The Bill also includes new provisions in relation to eligible contracts (eg. motor, home contents and travel insurance etc) and provides a similar regime for the duty of disclosure. These are beyond the scope of this paper.

Insurers' obligations regarding disclosure

The proposed amendments in the Bill also provide more detail regarding the obligations on an insurer to inform an insured of the duty of disclosure.

Presently, section 22(1) of the Act requires insurers to "clearly inform the insured in writing of the general nature and effect of the duty of disclosure", failing which the insurers may not exercise any right in respect of a failure to comply, unless the insured was fraudulent.

The Review Panel drew attention to the fact that there is often a lengthy period between the giving of the warning and the making of the contract.

The changes which have been proposed by the Bill seek to ensure that, where there is a delay between the initial disclosure and the policy commencing, the insured is well aware of the continuing duty of disclosure. In this regard:

  • There will be a new Section 22 Notice, which takes into account the new disclosure obligations.
  • The new Notice must explain that the duty applies up until the time when the proposed policy is entered into.
  • If there is a delay of more than two months between the insured's most recent disclosure and the date the proposed contract is entered into (or a counter-offer is made by the insurer) then the insurer must provide the insured with a further reminder of the ongoing duty of disclosure until the contract is entered into.

Insureds will be more fully aware of ongoing disclosure obligations

Consequently, insurers will need to prepare a new Section 22 notice once the new example notice has been released in the Regulations and new procedures will need to be put in place regarding reminder notices, taking into account the two month time frame.

Although these amendments will provide an additional onus on insurers (and brokers), it will clearly help to ensure that insureds are fully aware of their ongoing obligations.

Third party beneficiaries to have same rights and benefits as insureds

Currently, the concept of a third party beneficiary is only referred to in section 48 of the Act, which sets out the entitlements of such persons to claim under the Policy.

The proposed amendments in the Bill include a new definition of "third party beneficiary" as it is now used in a number of provisions, not just in section 48. The new definition refers to a person who is not a party to the contract, but who is specified or referred to in the contract as a person to whom the insurance cover provided by the contract extends (section 11(1)).

Accordingly, third party beneficiaries which are named on or within an insurance policy would then enjoy the same rights and benefits enjoyed by the insured (which has paid the premium). A common example of this is the naming of a financier as an interested party in an insurance policy.

Other changes related to third party beneficiaries

Other changes in the Bill related to third party beneficiaries include:

  • As discussed earlier, insurers will owe third party beneficiaries the same duties, including the same duty of good faith. New Sections 13(3) – (4) extend the insurer's post contractual duty of utmost good faith to third party beneficiaries. Therefore, claims handling and other obligations by insurers to an insured under Section 13 would be extended to beneficiaries. (Note that the duty only extends to post contractual obligations – pre contractual obligations would have been too impractical.)
  • Section 41 of the Act (which deals with circumstances in which an insured can require an insurer to elect to inform the insured whether the contract applies to the claim) will be extended to include third party beneficiaries.
  • Similarly, by reason of the proposed amendments to section 51, which deals with the rights of a third party to recover against the insurer, a third party beneficiary would be able to sue an insurer directly. However, if the insurer has a defence against the named insured, the same defence could be raised against the third party beneficiary.

Insurers will need to check policy wordings and may need to amend claims procedures

Insurers will need to fully understand the rights and obligations of third party beneficiaries, when compared with the rights and obligations of the contracting insureds. Otherwise insurers and brokers may be exposed to disputes.

In relation to sections 41 & 51, insurers will need to check that liability policy wordings are not inconsistent with the proposed changes and amend claims procedures where appropriate.

In general, one could say that, if these amendments proceed, noting a person's interest in an insurance policy will have the same effect as naming them as an insured under the policy. A possible consequence will be that insurers will need to consider increased premiums or amended terms if the inclusion of third party beneficiaries would alter the risk profile under the policy.

Subrogation - new rules to replace section 67

Section 67 of the Act currently sets out the rights of the insurer and the insured regarding subrogation.

The Bill would replace section 67 by rules which apply where an insurer that is liable under a general insurance policy in respect of a loss has a right of subrogation in respect of the loss and an amount is recovered (whether by the insurer or the insured or jointly) in respect of the loss.

The new rules have been revised to reflect the wording of a draft provision dealing with subrogation proposed by the Australian Law Reform Commission in its review of the Marine Insurance Act 1909.

The new rules have also been extended to apply to third party beneficiaries.

As a result, insurers will need to consider their current practices having regard to these new default rules and amend their policies and procedures where applicable. Insurance brokers will need to consider how any such changes will impact on their client's rights.

ASIC's power to intervene and be represented in proceedings

Presently, ASIC has the broad responsibility for the general administration of the Act.

However, as discussed earlier, a new section 11F will be inserted by the Bill that gives ASIC powers to intervene and to be represented in proceedings.

ASIC can intervene in matters concerning the Act. The provision is similar to the power which ASIC has to intervene under the Corporations Act. ASIC can also intervene in matters concerning Part 3 of the Medical Indemnity (Prudential Supervision and Product Standards) Act 2003.

This new provision provides the regulator with another power for the purposes of its regulation of the financial services / insurance sector.

Insurers need to be aware of ASIC's new powers to intervene and also to pursue an insurer for breach of section 13 of the Act.

Other changes which could be introduced by the Bill

Other changes which could be made by the Bill:

  • Mixed workers compensation and common law personal injury cover would be excluded from the Act.
  • However, other types of bundled insurance contracts that include Act type cover and non-Act type cover are subject to new rules that effectively split them into separate contracts for the purposes of the Act.
  • There could also be a number of significant changes made to life insurance products in the areas of non-disclosure, cancellation and the rights of the third party beneficiaries.

Patrick Monahan Patrick Tuohey
Insurance and reinsurance
Colin Biggers & Paisley

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Patrick Tuohey
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