The Law Commissions produced some draft clauses in January which they intend to include in a new Bill on insurance contract law later this year. Following further work, they have now published the remaining clauses for the Bill.
They intend that this Bill will follow the special Parliamentary procedure for uncontroversial Law Commission bills (in the hope, no doubt, that Royal Assent can be obtained before the next election in May 2015).
We set out below the key changes being introduced, as well as important details on contracting out, and how these changes might affect business insurers.
1) Warranties
It is proposed that all basis of the contract clauses will be prohibited (as is already the case for consumer contracts) and the Law Commissions have now confirmed (somewhat unexpectedly) that it will not be possible for business insurers to contract out of this particular change. This proposed change has, in any event been gaining increasing support in the market, with a recent AIRMIC campaign to persuade insurers to remove such clauses from their policies receiving approval from some leading insurers.
It is also proposed that all warranties will become "suspensive conditions", with the effect that an insurer will still be liable for losses under the policy prior to the breach of a warranty and also after the breach has been remedied. The Law Commissions have explained that this means that where, for example, an insured breaches a warranty that an alarm system will be inspected every six months, that breach will be "remedied" if the system is inspected after seven months and so coverage will be suspended for only one month in such circumstances.
Where a term (not just a warranty - this could include, for example, a condition precedent) is designed to reduce the risk of a particular type of loss, or the risk of loss at a particular time or in a particular place, a breach will only entitle the insurer to refuse claims for losses falling within that category of risk. So, for example, the breach of a warranty to install a burglar alarm would suspend coverage for loss caused by a burglar but not a flood. However, where there is a burglary, nothing is payable, regardless of whether the burglar alarm would have prevented the particular theft in question.
However, where a term is not designed to reduce a particular risk but is instead designed to delimit the scope of the insurance contract more generally, a breach will allow an insurer to reject a claim even if the loss was not caused by the breach. The example given by the Law Commissions is where a yacht-owner breaches a warranty forbidding the yacht to be used for commercial gain. The insurer in that case will be able to reject a claim arising out of (say) storm damage.
(2) Utmost good faith/non-disclosure
These proposed changes will apply only to business insurance (consumer insurance having already been dealt with in a recent 2012 Act). It is proposed that the duty to volunteer information will be retained (unlike the current position for consumer policies). An insured will have to make a fair presentation, which will include putting a prudent insurer "on notice" and giving sufficient "signposts". An example given is where an insured says he makes valves and then lists his 3 principal clients (all in the petrochemical industry). This would be sufficient to inform the insurer of the possible increased risks should the valves fail because they are being used in a combustible industry.
The Law Commissions also intend to target the practice of convoluted presentations and data dumping: "a lack of structuring, indexing and signposting may mean that a presentation is not "fair"". Hence, a proposed clause requires disclosure "in a manner which would be reasonably clear and accessible to a prudent underwriter".
When deciding what an insured knows, it is the knowledge of senior management or those responsible for arranging the insurance which matters. An insured must carry out a reasonable search for information, and what is reasonable will depend on the size, nature and complexity of the business.
An insurer "ought reasonably to know" something if it is known to an employee/agent who ought reasonably to have passed it on, or relevant information which is readily available. An insurer will also be presumed to know things which are common knowledge, or which an insurer offering insurance of the class in question to insureds in the field of activity in question would be expected to know in the ordinary course of business.
It will be possible to avoid a policy (and keep the premium) where the misrepresentation or non-disclosure was deliberate or reckless. In other cases, a scheme of proportionate remedies will apply: where the insurer would have declined the risk altogether, the policy can be avoided, with a return of premium; where the insurer would have accepted the risk but included a contractual term, the contract should be treated as if it included that term; and where the insurer would have charged a greater premium, the claim should be reduced proportionately (for example, if the insurer would have charged double the premium, it need only pay half the claim). This contrasts with some other jurisdictions, where only the additional amount of premium is payable to the insurer.
It is also worth noting that the test of what the insurer would have done had it known the true facts is entirely subjective. In practice, it will be hard for insureds to disprove that a particular insurer would have viewed a certain breach as so serious that he/she would not have written the risk at all. The issue will become one of credibility.
Our experience is that some brokers have recently been pushing for wider wording in relation to the inquiries which an insurer must undertake and the remedies available (for example seeking a clause providing that the only remedy available will be the additional premium which the insurer would have charged). So it is to be hoped that the finalisation of the Bill will indicate where the boundaries of change are now going to lie, thus introducing greater certainty for business insurers.
(3) Damages for late payment
The Law Commissions propose that it will be an implied term of an insurance contract that insurers will pay sums due within a reasonable time. Late payment will attract damages from the insurer. Insurers will be allowed a reasonable time for investigating the claim and reasonableness will depend on, amongst other things, the type of insurance and the size and complexity of the claim. Where an insurer can show reasonable grounds for disputing a claim, failure to pay the claim while the dispute continues will not be a breach of the implied term. An insured will also still be entitled to recover interest pursuant to the contract and/ or statute (eg section 35A of the Senior Courts Act 1981).
This proposal introduces a fair amount of uncertainty for insurers when deciding whether they can validly delay payment because of concerns regarding a claim. The safest course would be to carefully record all decisions regarding a claim in order to help support an argument that an insurer has acted reasonably in disputing coverage and delaying payment. What is likely to constitute a "reasonable time" for dealing with a claim is an issue which will most likely need to be tested before the courts.
(4) Good faith
In addition to the specific duty of good faith in relation to non-disclosure and misrepresentation, the Law Commissions have also dealt with the overarching principle of good faith, which applies to both the insured and the insurer. In particular, the Law Commissions have noted that where an insurer breaches this duty, the remedy of avoidance is unsatisfactory because the insured generally wants its claim paid. Accordingly, the Law Commissions propose abolishing the remedy of avoidance for a breach of the duty of utmost good faith. The Law Commissions do not suggest a remedy of damages instead (despite contemplating introducing that remedy in their sixth issues paper). Rather, they suggest that the courts will allow good faith to be used as "a shield rather than a sword", ie insurers may be prevented from exercising an apparent right if they have not exercised it in good faith. It is perhaps unclear, though, how a legitimate right can be exercised in a manner which amounts to bad faith (and the Law Commissions acknowledged in their sixth issues paper (at para 4.79) that there is conflicting case law on how far the courts will recognise this concept).
(5) Fraudulent claims
The Law Commissions propose retaining the rule that an insurer is not liable to pay a fraudulent claim and can recover any sums already paid in respect of it. It is proposed that the insurer will also have the option of terminating the contract from the date of the fraudulent act (not discovery), without any return of premium. The insurer can then refuse to pay any claims from that point onwards (but will remain liable for legitimate losses before the fraud).
Further provisions have now been proposed regarding group insurance claims, with the effect that, where a group member acts fraudulently, only that member would forfeit the entire benefit of the claim (and, at the insurer's option, any subsequent benefit) but the other group members would be entirely unaffected. However, the Law Commissions envisage that this proposal will apply only to consumer contracts (since the current position is that insurers do not treat, for example, policies taken out by a parent company for a number of group companies, as a "group insurance" policy).
Contracting out of the changes
The Law Commissions have confirmed that these proposals are only intended to be a "default regime" for non-consumer insurance. However, they have also said that they wish to discourage "boiler plate clauses which opt-out of the default regime as a matter of routine, particularly in the context of mainstream business insurance.... in sophisticated markets including the marine insurance market we expect contracting out will be more widespread". Where insurers do intend to opt out (and hence include a "disadvantageous term"), they must take sufficient steps to draw that to the insured's attention before the contract is entered into and the disadvantageous term must be "clear and unambiguous as to its effect".
In other words, business insurers (and query where the line will be drawn between mainstream and sophisticated business insurance) cannot expect it to be "business as normal" by simply inserting a clause into a policy to the effect that the changes in the new Act (when it is passed) do not apply. Instead, they will need to identify each and every change which they do not intend to apply and cater for an opt-out for each change separately in the policy. So, for example, if an insurer wishes to retain the right to rely on the breach of a condition precedent even where that breach has not contributed to the loss, that will have to be clearly and expressly stated in the policy (and drawn to the insured's attention prior to inception). Accordingly, very careful consideration will have to be given to the drafting of business insurance policies going forward.
Illustrations of the new requirements are included in the accompanying notes. So, for example, where a medium-sized enterprise buys insurance through a regional/non-specialist broker, where an insurer emails the broker a scanned copy of its standard conditions (and one term, which modifies an aspect of the default regime provisions, is marked with an asterisk), but does not mention that term during telephone conversations with the broker, that term will be effective (albeit that this is said to be "at the limit of what was sufficient to bring the term to the notice of the insured (through its agent)". Additional steps by the insurer would be needed where a small business purchases insurance online but, conversely, more leniency will be allowed where a sophisticated insurance buyer purchases cover at Lloyd's ("this is a fast-paced market, and we would not want to interfere unnecessarily with its operation").
It is perhaps worth noting that the Law Commissions' wish to discourage boiler plate clauses is not expressly catered for in the proposed Bill. Nevertheless, it might be envisaged that such clauses will be the subject of challenge before the courts in light of the Law Commissions' views and hence a safer strategy would be to pay careful attention to policy wordings going forward.
Furthermore, certain opt-outs will not be allowed at all.
As mentioned above, it will not be possible for business insurers to contract out of the prohibition for basis of the contract clauses (although they can, of course, still specifically agree a warranty in respect of any particular matter). Furthermore, although business insurers will be able to contract out of the proposals for damages for late payment of a claim, they will not be able to do so if their failure to pay a claim within a reasonable time was "deliberate or reckless" (eg where the insurer refuses a valid claim or fails to pay within a reasonable time either knowing or not caring that that was the case).
The contracting-out provisions will not apply to settlement agreements (and hence an insured will still be able to enter into a settlement on less favourable terms than the default rules) and the transparency requirements will not apply to cancellation clauses.
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.
