1.1 On 12 February 2007, the Federal Government released the long awaited exposure draft of the Insurance Contracts Amendment Bill 2007 which contains proposed amendments to the Insurance Contracts Act 1984 (Cth) (the Act).
1.2 The release of the exposure draft of the amendment bill follows a lengthy review process, involving all aspects of the insurance industry, which began back in 2003. The review process was conducted in two stages. The first addressed issues surrounding Section 54 of the Act; the second looked at other proposed reforms of the Act.
1.3 The exposure draft contains some significant changes to the Act. This paper outlines the important changes proposed and looks at the implications these will have for insurers and insureds if the legislation as proposed is passed by Parliament.
2 The Long And Winding Road – History Of The Review Process So Far
2.1 for Revenue and the Assistant Treasurer, Senator Coonan, announced that the Government would be undertaking a comprehensive review of the Insurance Contracts Act.
2.2 Mr Alan Cameron and Ms Nancy Milne were appointed to head the Review Panel, supported by a secretariat located within the Office of the Treasury. The overall objective of the review process was to consult with the industry in order to make recommendations aimed at improving the overall operation of the Act through correcting identified deficiencies and clarifying ambiguities in its operation.
2.3 The review was conducted in two stages. The first stage examined the operation of Section 54 of the Act, whilst the second stage reviewed the remainder of the Act. The final report by the Review Panel on Section 54 was provided to the Government on 31 October 2003 and released publicly on 18 November 2003.
2.4 A draft of proposed legislative amendments regarding Section 54 was released for public comment on 8 March 2004. The Review Panel reported to the Government on the results of the public consultation on 28 May 2004.
2.5 For the remainder of the Act, the Review Panel sought submissions from the industry on issues other than Section 54 in November 2003. After considering those submissions, the Review Panel released an issues paper for comment on 24 March 2004.
2.6 Following consideration of written submissions and meetings the Review Panel held with various stakeholders, a proposal paper on the balance of the Act was released on 25 May 2004. The Review Panel delivered its report on the remainder of the Act on 30 June 2004, after taking into account further comments made by industry representatives on the proposals paper.
2.7 The Panel delivered its final report, making various recommendations, to the Government in January 2005.
2.8 A period of more than two years passed until the exposure draft of the Insurance Contracts Amendment Bill 2007 was released to the public on 12 February 2007. The proposed amendments to Sections 40 and 54 contained in the draft legislation differ to the original proposals in the first draft legislation in these sections released in March 2004.
2.9 The Government required any submissions to be made on the proposed draft bill to be submitted by 23 March 2007. Once the Government has considered submissions on the draft legislation, a decision will be made upon the final form of the legislation to be introduced into Parliament. It is expected that given the length of time this has taken and the extensive consultation to date, the legislation will be passed in substantially the same form as the draft bill.
Analysis Of The Proposed Amendments
3 Duty of Good Faith (Section 13)
3.1 Section 13 of the Act deals with the statutory duty of utmost good faith. It implies a duty of utmost good faith into all contracts of insurance, requiring that each party to the contract act towards each other in respect of all matters arising under or in relation to the contract, with the utmost good faith.
3.2 The amending legislation provides that a breach of this duty will be considered a breach of the Act. Offending the duty of good faith will now be not only a contractual offence but also a statutory offence.
3.3 According to the Explanatory Memorandum, the proposed amendment to Section 13 is primarily designed to allow ASIC to commence or continue representative actions on behalf of an insured against an insurer pursuant to Section 55A of the Corporations Act (Cth) 2001. It will enable ASIC to access various remedies under that Act in relation to Australian Financial Services Licences, including a banning order under Section 920A or suspension or cancellation of the insurer’s financial services licence.
3.4 Of note is the fact that pursuant to proposed subsection 13(4), the amending legislation extends the duty of utmost good faith to third party beneficiaries. This is consistent with a raft of other proposed changes enhancing the position of third party beneficiaries under insurance contracts in the amending legislation. We discuss these further below at Section 11.
4 Power Of ASIC To Intervene (section 11F)
4.1 Following on from the proposed changes to Section 13, the new Section 11F provides power to ASIC to intervene in any proceedings relating to a matter arising under the Act. If ASIC intervenes, it has all the rights, duties and liabilities if any such party.
4.2 Part of the reasoning for providing ASIC with this power is that litigation for some insureds may prove too expensive and does not provide any long term solutions to systematic breaches of the duty of utmost good faith.
4.3 The insertion of Section 11F provides the regulator with another power in relation to the regulation of insurance/financial services providers. The provision is in similar form to the existing power that ASIC has to intervene in matters arising under the Corporations Act (Section 1330).
5 Application Of The Act To Contracts With Foreign Insurers (Section 8(1A))
5.1 Section 8 of the Act currently provides that the Act applies only to those contracts of insurance the ‘proper law’ of which is that of an Australian State or Territory, as determined by principles of private international law.
5.2 The proposed sub-section 8(1A) extends the application of the Act to contracts of insurance entered into the persons who are domiciled in Australia and to which the Act extends, irrespective of where the risk is located, and to contracts that cover risk of loss and damage occurring in an Australia State or Territory to which the Act extends. Comment
5.3 This amendment has a potentially significant impact upon international insurers doing business in Australia. The proposed new sub-section would appear, on its face, to capture policies underwritten by off-shore insurers with no presence in Australia, such as a branch office, so long as the risk or the insured are located in Australia.
5.4 This itself raises the issue of whether or not international insurers will, for practical purposes, submit to the provisions of the Act. In the event that insurers resist, we might be left with situations where Australian insureds are forced to attempt to enforce judgments against international insurers in foreign jurisdictions. There is then the risk that foreign courts will not give effect to the proposed new subsection 8(1A).
5.5 We are aware that the insurance industry, particularly international insurers, are concerned about the possible reach of this proposed amendment and the problems that it might create. The Review Panel also raised the issue in its Explanatory Memorandum.
6 Changes Of The Duty Of Disclosure (Section 21)
6.1 Section 21 of the Act is one of the most important provisions of the Act, setting out the statutory basis for an insured’s duty of disclosure. Currently, Section 21(1) of the Act provides for a subjective/objective test of disclosure. An insured must, prior to commencement of the policy, disclose to the insurer:
- all matters which the insured knows to be relevant to the decision of the insurer whether to accept the risk and if so, on what terms; or
- all matters which a reasonable person in the circumstances could be expected to know to be a matter so relevant.
6.2 In the draft legislation, the objective test in subsection (b) is replaced with a new subsection purporting to clarify the objective test by reference to certain nonexclusive criteria. The proposed Section 21(1)(b) provides that a reasonable person needs to disclose all matters having regard to factors including:
- the nature and extent of the insurance cover to be provided under the relevant contract; and
- the class of persons for whom that kind of insurance cover is provided in the ordinary course of the insurer’s business; and
- the circumstances in which the relevant contract of insurance is entered into, including the nature and extent of any questions asked by the insurer.
6.3 According to the Explanatory Memorandum, the ‘clarification’ of the objective test contained in Section 21 grew out of the perception by the Review Panel that the mixed subjective/objective test had not been applied consistently. Accordingly, it was thought that specifying factors to which the court may have regard would help clarify this aspect.
6.4 The proposed amendments to the section may add little to the judicial interpretation of Section 21. The proposed amending legislation specifies only three non-exclusive factors which the court may have regard to in determining whether or not the objective test of disclosure has been satisfied. These factors alone will not govern whether or not a breach of Section 21 will be found. There is, however, a danger that courts may place too much emphasis on the factors specified in the proposed section, rather than considering other wider issues which traditionally have assisted the courts. It will, therefore, be of interest to see if the courts change their approach to interpreting matters involving Section 21.
7 Changes To The Duty Of Disclosure In Relation To Eligible Contracts Of Insurance (Section 21A)
7.1 Section 21A of the Act supplements the general provisions regarding the duty of disclosure in relation to ‘eligible contracts of insurance’. These contracts are defined as those providing general insurance cover commonly sought by consumers such as motor vehicle, home contents and travel insurance.
7.2 The current provisions require an insurer to ask the insured specific questions prior to the contract commencing in relation to the risk in order to rely upon those answers so far as disclosure is concerned. However, it is also permissible for the insurer to ask the insured a ‘catch all’ question which requires an insured to disclose ‘exceptional circumstances’ that a reasonable person could be expected to know.
7.3 The amendments to Section 21A propose two essential changes to the current regime.
7.4 First, the amended section removes the ‘catch all’ question and the ability of insurers to rely on this for disclosure. Accordingly, for eligible contracts, unless the insurer requests the insured to answer specific questions, the insurer is taken to have waived compliance by the insured with its duty of disclosure in relation to such matters.
7.5 Second, the amendments extend this disclosure regime to include renewals, variations and reinstatements. Under the current provisions, this disclosure regime applies only to eligible contracts prior to commencement of the policy.
7.6 The proposed amendments to Section 21A not only erode some of the insurer’s rights and remedies under the Act but also place more onerous administrative obligations on insurers – at least so far as eligible contracts of insurance are concerned.
7.7 As proposed, non-disclosure can only be relied upon in relation to answers to specific questions. There will be no ability for insurers to rely upon ‘catch all’ questions.
7.8 Second, the extension of these obligations to renewals, variations and reinstatements will place more administrative obligations on insurers. At renewal, for example, the insurer will be required to again ask all of the relevant questions it wishes to, otherwise it will not be able to rely upon any non-disclosure made by the insured on renewal, variation or reinstatement.
8 New Requirements For Informing Insureds About The Duty Of Disclosure (Section22)
8.1 Section 22 of the Act requires an insurer to provide the insured with a general explanation of the meaning and effect of the insured’s duty of disclosure before the contract is entered into.
8.2 There are four proposed changes in the new draft legislation.
8.3 First, an insurer is required to inform the insured in writing that the duty of disclosure applies from the date the information is received by the insured until the proposed contract is entered into. This further obligation on the insurer flows from recognition that where long term contracts of life insurance are involved, there may be significant time lag (i.e. months) between the time a prospective insured submits information to an insurer and the time the policy commences.
8.4 Second, the insurer will be required to inform the insured of the general nature and effect of Section 21A (if the contract is an eligible contract of insurance) and the effect of Section 31A (if the contract is a contract of life insurance).
8.5 Third, if there is a two month delay before the acceptance of the offer or a counter offer for cover by the insurer, the insurer has to provide the insured with a further reminder of the duty of disclosure.
8.6 A failure by an insurer to comply with these sections will mean that an insurer cannot rely upon a failure to comply with the duty of disclosure unless that failure by the insured is fraudulent.
8.7 Fourth, the proposed Section 22(2) extends the insurer’s duty to inform all life insureds under a contract of life insurance of the duty of disclosure. A life insured under a contract of insurance may include persons that are not the insured and therefore are not subject to the duty of disclosure under the current law. Accordingly, the life insurer must now also, before the contract is entered into, clearly inform all persons, other than the insured, who, and under the contract, would become a life insured, of the duty of disclosure.
8.8 The proposed amendments to Section 22 of the Act appear to place more onerous obligations on insurers in relation to contracts of life insurance and in relation to eligible contracts of insurance (motor vehicle, home and contents).
8.9 In practice, however, it is our experience that many insurers already include in their standard policies a statement that the insured’s duty of disclosure continues up until the contract is entered into.
8.10 Nevertheless, insurers need to be vigilant if there is more than a 2 month gap between offer and acceptance of a policy. An extra administrative obligation is imposed on insurers to again inform the insured of the relevant duty of disclosure.
9 Life Insurance – Unbundling Of Contracts And New Remedies For Non-Disclosure And Misrepresentation (Sections 27, 28, 28A and 29)
9.1 The position in relation to life insurers under the Act is different to that of general insurers, particularly in relation to remedies for non-disclosure and misrepresentation.
9.2 The proposed amending legislation contains some important changes so far as life insurers are concerned.
‘Unbundling’ of contracts
9.3 The proposed Section 27A seeks to ‘unbundle’ those life insurance contracts that combine more than one type of life insurance cover (i.e. death, TPD or trauma benefits). This will mean that different remedies for non-disclosure and misrepresentation will apply in relation to each particular type of cover. This will involve important considerations for life insurers, as we discuss below.
Remedies for non-disclosure and misrepresentation
9.4 Section 29 of Act governs the remedies that may be applied by life insurers in relation to misrepresentation/non-disclosure. The provisions differ from those available to general insurers. Most notably, a life insurer is not able to reduce its liability to the amount it has been prejudiced by innocent non-disclosure or misrepresentation if that occurs after 3 years from commencement of the policy. After 3 years, the life insurer has to prove fraud in order to benefit from any remedy under the Act.
9.5 The proposed amendments seek to alter life insurers’ rights in relation to certain contracts of life insurance.
9.6 The remedies available under the current Section 29 will still apply but only in relation to those contracts of life insurance whose primary purpose is to provide cover in respect of death or a contract that has a surrender value.
9.7 Otherwise, the remedies available to life insurers under other types of policies will be governed by the new proposed Section 28A. The most significant proposed amendment is that in addition to an ability to avoid the contract for fraudulent non-disclosure, a life insurer will be given the remedy currently available to general insurers to reduce its liability to the amount that would place the insurer in a position in which it would have been if the innocent nondisclosure/ misrepresentation had not occurred. Accordingly, unlike Section 29, there is no 3 year time limit proposed where the misrepresentation or nondisclosure is innocent.
9.8 In relation to life policies with a death benefit, there is also an important change proposed to sub-section 29(3). In the case of actionable innocent non-disclosure or misrepresentation, an insurer can currently only avoid the policy if it would not have been prepared to enter into ‘a contract’ on any terms with the insured if it was aware of the details not disclosed. It is proposed to change the reference to ‘a contract’ to ‘the contract’, meaning that the insurer can potentially avoid the policy if it would not have entered that particular contract, as opposed to any other standard life insurance contract.
9.9 According to the explanatory memorandum, the change responds to a concern that on one interpretation of the current subsection, the insurer can only avoid a contract for innocent non-disclosure/misrepresentation if they could show that they would not have been prepared to enter into any contract.
9.10 Overall, life insurers should benefit from the proposed changes to the legislation so far as their remedies for non-disclosure/misrepresentation are concerned. The fact that life insurers do not have the same remedies for innocent non-disclosure and misrepresentation available to general insurers under the Act appears to be anomalous. Life insurers are saddled with the higher onus of establishing fraudulent non-disclosure after 3 years have elapsed. Given the difficulties in establishing fraud, life insurers are therefore often left with no remedy for innocent non-disclosure.
9.11 The proposed changes ‘unbundling’ life insurance contracts means that life insurers need to be vigilant in dealing with issues of non-disclosure under life policies. For example, many life policies provide for both TPD and death benefits. The life insurer’s remedy for non-disclosure in relation to each particular risk will be different. TPD claims will be governed by the new Section 28A whilst disclosure in relation to death claims remain to be dealt with under Section 29.
10 New Relief For Innocent Non-Disclosure/Misrepresentation (Section 31)
10.1 Section 31 of the Act provides the court with power to disregard an avoidance of the contract on grounds of fraudulent non-disclosure/misrepresentation in certain circumstances – that is, if it would be harsh and unfair not to do so.
10.2 The proposed legislation extends the court’s discretion in this regard to cases where an insurer has ‘significantly’ reduced its liability, including being reduced to nil, on grounds that the insured has made an innocent non-disclosure or misrepresentation.
10.3 The court may disregard the avoidance or the reduction of liability if it would be ‘harsh and unfair’ not to do so.
10.4 The proposed subsection (31(3)(b)) further provides that in making such a determination, the court must: ‘weigh the extent of the cupulability of the insured in relation to the failure or misrepresentation against the magnitude of the loss that would be suffered by the insured if the avoidance or reduction of liability were not disregarded’.
10.5 The proposed amendment to Section 31 might have significant implications for insurers in terms of disputes with insureds. Cases where liability is reduced for innocent non-disclosure by insurers are more common than claims where policies are avoided for fraudulent non-disclosure.
10.6 The proposed amendment provides another means for insureds to challenge an insurers denial for innocent non-disclosure/misrepresentation. In litigation involving cases where insurers have reduced their liability, it is reasonable to anticipate that insureds will invariably plead the new Section 31 as another factor to be considered by the courts. This section could therefore be the subject of some considerable legal debate.
11 Changes To The Definition, Rights And Obligations Of Third Party Beneficiaries Under Insurance Policies (Sections 11, 41, 48, 48AA, 48A and 51)
11.1 The proposed amending legislation contains a raft of changes regarding the rights and obligations of third party beneficiaries under insurance contracts.
11.2 A definition of a third party beneficiary has been added to the definitions section (Section 11(1)). It picks up the language currently used in Section 48 of the Act. It defines a third party beneficiary as ‘a person who is not a party to the contract but is specified or referred to in the contract, whether by name or otherwise’.
11.3 Section 41 of the Act gives an insured a right to require the insurer to inform them in writing as to whether or not the insurer admits indemnity in relation to the claim and if so, whether the insurer intends to conduct the proceedings in respect of that claim on behalf of the insured.
11.4 The legislation will be amended to extend this right to third party beneficiaries under contracts of insurance.
11.5 Similarly, amendments are proposed to Section 74 to allow third party beneficiaries, in addition to insureds, the right to request in writing a statement which sets out all the provisions of the relevant contract of insurance. It is an offence for the insurer to fail to provide such a statement.
Section 48 and 48AA
11.6 Section 48 of the Act deals with the entitlements of third parties to claim against insurers and the defences available to insurers in those circumstances.
11.7 The proposed legislation amends Section 48(1) and (2) to use the term ‘third party beneficiary’, but the substance of the subsections remain unchanged.
11.8 Section 48(3) is, however, amended to provide that one of the defences available to insurers includes defences relating to the conduct of the insured, whether that conduct occurred before or after the contract was entered into.
11.9 According to the Review Panel this amendment was prompted by perceived uncertainty as to whether an insurer might raise pre-contractual conduct, such as breach of the duty of disclosure, in assessing claims by a third party beneficiary. The intent of the amendment is to make this defence available to an insurer in the circumstances.
11.10 Proposed changes to Section 48AA make similar changes regarding contracts of life insurance offered in connection with Retirement Savings Accounts (RSAs). 11.11 The rationale behind Sections 48 and 48AA is that third party beneficiaries should be in no better a position, in terms of their ability to claim, than the insured.
11.12 Section 48A applies to contracts of life insurance that are effected on the life of one person, but expressed to be for the benefit of another (a third party beneficiary). This, for example, includes contracts relating to death benefits payable to beneficiaries on the death of the life insured.
11.13 The proposed changes to Section 48A are to:
- introduce the term ‘third party beneficiary’ in place of the current reference to a ‘third party’;
- allow a third party beneficiary who has a claim over moneys payable under the contract of life insurance to bring an action against the insurer in respect of that claim, without the intervention of the policyholder; and
- provide that in relation to such claims, the third party beneficiary has the same obligations to the insurer as an insured under the contract (for example, the obligation to comply with the duty of utmost of good faith).
11.14 The most important proposed change to Section 48A is the creation of a right for third party beneficiaries to bring a direct action against an insurer to recover money payable under a contract expressed to be for the benefit of that beneficiary. This right is not currently available under Section 48A.
11.15 Section 51 of the Act deals with the rights of third parties (rather than third party beneficiaries) to recover directly against insureds where the insured under a contract of liability insurance is liable in damages to a third party. It provides that where an insured has died or cannot be found, the third party may bring an action against the insurer directly.
11.16 The proposed amendments to Section 51 allow such an action to be taken by a third party against a third party beneficiary (as opposed to only an insured) when the third party beneficiary is liable under the contract but cannot, after reasonable enquiry, be found.
11.17 The other major amendment is to provide a right of action for the third party to recover against the insurer where the third party has obtained a judgment against the insured/third party beneficiary in respect of the liability and the execution or other process issued on the judgment is returned unsatisfied.
11.18 This latter amendment was deemed by the Review Panel to be necessary to plug a gap existing in the current legislation – that is, where the insured is alive and can be found, but does not have sufficient assets to meet a judgment against it.
12 Changes To Sections 40 And 54 – Claims Made And Claims Made And Notified Policies
12.1 The interpretation of Sections 40 and 54 of the Act have been responsible for a significant volume of judicial reasoning over the last 15 to 20 years. In particular, the issue which has attracted much attention is whether Section 54 applies to exclude certain omissions of insureds pursuant to claims made and notified policies.
12.2 The issues surrounding Sections 40 and 54 were deemed by the industry and the government to be so significant that they were the subject of the first and separate consideration of proposed reforms by the Review Panel.
Section 40 – Proposed Changes
12.3 Section 40 of the Act deals with claims under ‘claims made and notified’ policies. These policies, common in the professional indemnity arena, cover insureds when a claim is made against them during the policy period and the insured notifies the insurer of the claim during the policy period.
12.4 Section 40(3) of the Act currently provides that if an insured notifies the insurer of facts that might give rise to a claim during this period, but the claim is actually made outside the period, the claim is ‘deemed’ to have been made during the policy period. This ‘statutory deeming provision’ mirrors similar contractual ‘deeming’ provisions often contained in such policies.
12.5 The amendments provide firstly for a more comprehensive definition of ‘claims made and notified’ policies. The new Section 40(1) provides that the section applies to both claims made and claims made and notified policies.
12.6 Second, the new Section 40(3) introduces an extended reporting period of 28 days for ‘claims made and notified’ policies. In the event that the insured/third party beneficiary becomes aware during the policy period of facts that might give rise to a claim and gives notice in writing to the insurer of those facts as soon as practicable but not later than 28 days after the insurance cover expires, the insurer cannot deny indemnity on the basis that the claim is not made during the policy period.
12.7 Accordingly, it will be permissible for insureds to give notice of facts that might give rise to a claim up to 28 days after the policy period has expired and any subsequent claim will be deemed to have been made during the policy period.
12.8 Finally, the proposed Section 40(4) provides that the insurer must inform the insured of the effect of failing to give notice of circumstances as described above not later than 14 days before the insurance cover expires.
Section 54 – Proposed Changes
12.9 Section 54 of the Act provides that an insurer may not refuse to pay a claim (but may reduce payment by reason of any prejudice suffered), by reason of any act or omission by the insured after the contract commences.
12.10 The proposed changes to Section 40 interact with the proposed amendments to Section 54 of the Act. As a result of a long line of judicial authority, culminating in the High Court decision in FAI v Australian Hospital Care, the current position is that, provided a claims made and notified policy contains a ‘deeming’ provision, then an insured’s failure to notify an insurer of facts that might give rise to a claim is excusable as an omission pursuant to Section 54 of the Act.
12.11 The new proposed Section 54A of the Act specifically excludes from the operation of Section 54 omissions in relation to contracts to which Section 40 applies. The result is that an insurer may be able to refuse to pay a claim if the insured, pursuant to a claims made or claims made and notified policy, became aware of facts which might give rise to a claim during the policy period but did not notify the insurer in writing of those facts during the policy period or within 28 days after that cover has expired.
12.12 The combined amendments to Sections 40 and 54 are effectively the legislative response to overturn the current position on this issue as determined by the High Court in FAI v Australian Hospital Care.
12.13 The proposed amendments to Sections 40 and 54 of the Act will at least provide some legislative certainty to the legal position on this issue which has plagued the Courts for decades, culminating in the Hospital Care decision.
12.14 From an insurer’s perspective, whilst the amendments to Section 54, effectively carving out of the operation of that section the failure to notify circumstances, are to be welcomed, they might be of little effect. Following the Hospital Care decision, many insurers simply removed ‘deeming’ provisions from most claims made and notified policies so that insureds could not rely upon Section 54 of the Act to excuse any such failure to notify.
12.15 Further, the proposed Section 40(4) heaps another administrative obligation upon the insurer to inform the insured of the effect of failing to notify circumstances. Of course, pursuant to Section 40(2), notice as to the effect of this section is required to be given by an insurer prior to the contract being entered into.
12.16 The utility of the further 28 day period under Section 40(3) is also questionable, given that at renewal, an insured has a duty of disclosure and almost invariably in relation to professional indemnity policies, have to complete a proposal which specifically asks whether the insured is aware of any facts that might give rise to a claim. These documents are usually provided to an insurer in the months or weeks prior to renewal. As such, the requirement that insurers provided insureds with yet another notice 14 days before the policy expires is probably an unnecessary burden in the circumstances.
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.