Insurance/PI: Proposed Insurance Law Reforms

On Tuesday, the Law Commission and Scottish Law Commission published a joint consultation paper setting out provisional proposals for the statutory reform of insurance contract law in England, Wales and Scotland. The paper draws together comments made by the industry in three areas of insurance law, previously the subject of issues papers published over the course of the last year, namely misrepresentation/non-disclosure, warranties and intermediaries. The Commissions’ intentions are that a reforming bill will be presented to Parliament to approve in 2010.

The proposed law reforms are radical and affect three principal areas:

• Consumer business - the Commissions are clearly driven to bring the current law in line with the guidelines and practices adopted/currently in use by the FSA and FOS. For example, "basis clauses" are effectively to be outlawed.

• Business insurance – this will also be affected by the Commissions’ proposals, particularly the ability to rely on the right to avoid against insureds where intermediaries are alleged to have failed to disclose or have misrepresented material facts. They propose a narrowing of the duty of disclosure with a shift from "prudent insurer" to "reasonable insured."

• Repositioning the agency relationship of brokers, so that they become predominantly the agent of insurers.

The Commissions seek responses to their proposals by 16 November 2007, then intend to issue a final report. The ABI’s Stephen Haddrill has already said that more law is unlikely to provide a better deal for customers and that the real challenge is for the industry and the FSA to make a success of principles-based regulation. It remains to be seen how welcome the new proposals will be for the market as a whole.

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The Commissions are critical of the existing law of insurance saying that the Marine Insurance Act 1906 is no longer appropriate to a modern insurance market, and that the current law weighs in favour of insurers and can be overly harsh against those applying for insurance. Underlying the Commissions’ proposals is the belief that it is unfair that an insurer has a right to avoid a policy and can refuse to pay all claims in situations where an insured may have innocently or even negligently (but not deliberately) failed to disclose something before the policy was entered into, or the right to avoid arises because of some act or omission on the part of an intermediary. The intention of the paper is for the law to move away from the body of principles that have built up gradually over the past 100 years towards a more insured focus in the context of policy or other disputes.

The Commissions focus first on consumer insurance and, building on those proposals, on business insurance and the agency status of intermediaries.

Consumer Insurance:

The Commissions have made radical proposals which are intended to be mandatory for consumer contracts of insurance (such as motor, travel, household and critical illness). In particular, the reforms contemplated are intended to remove the remedy of avoidance where a consumer has failed to disclose information honestly, reasonably or innocently. Under the proposals:

• Insurers would ask questions about what they want to know from potential policyholders and would not be able to avoid a policy for non-disclosure where no question had been asked. An insurer would still have a remedy where it can show that the consumer made a misrepresentation which induced the insurer to enter into the contract but only where a reasonable person in the circumstances would not have made the misrepresentation. The Commissions suggest that the remedy which the insurer receives would depend on the consumer’s degree of fault: where the consumer has made a deliberate or reckless misrepresentation, the insurer would be entitled to avoid the policy, whereas if the consumer has behaved negligently, the remedy would aim to put the insurer into the position it would have been in had it known the true facts i.e. a compensatory remedy instead of automatic avoidance.

• If the consumer has acted honestly/reasonably/innocently, the insurer would be required to pay claims under the policy. The rest of reasonableness would take into account the type of policy, the way the policy was advertised/sold and the normal characteristics of consumers in the market but would not take into account consumers’ individual circumstances, unless the insurer knew about them. If the insurer can show that he would have declined the risk altogether, he will be allowed to avoid the policy and refuse to pay the claim.

• In life insurance, the Commissions propose imposing a five year cut-off period for bringing a case against an insured for negligent misrepresentation. This was increased from their proposal of three years following comment from the industry following one of the issue papers.

• The Commissions propose to abolish "basis of the contract" clauses to bring the law into line with recognised good practice. Where a consumer makes a statement of past or current fact before entering into an insurance contract, it should be treated as a representation rather than a warranty. The effect of this is that if a policyholder were to sign an incorrect statement, the insurer would not have an automatic right to avoid the policy. Instead its remedy would depend on whether the incorrect statement was made recklessly, negligently or innocently.

Business Insurance:

The Commissions propose a default regime with the option for the parties to contract out or come to alternative, business-focussed arrangements to suit individual needs. The Commissions have abandoned the proposal previously floated that small businesses should be treated as consumers under the reforms. They do not envisage businesses will be legally permitted to employ blanket opt out clauses in contracts: they wish the focus instead to be in the imposition of specific fact warranties. The main proposals, which relate to reinsurance as well, are:

• The duty to disclose in a business insurance context should be narrowed. The current law states that the insured is required to disclose anything that it knows, or should know in the ordinary course of business, if it "would influence the judgement of a prudent insurer in fixing the premium, or determining whether he would take the risk". This well known principle of law would be replaced with a new legal test to allow the insurer to avoid: the insurer would have to show either that a reasonable insured in the circumstances would have appreciated that the factual question was one the insurer would want to know about, or that the insured actually knew the fact was one that the insurer would want to know about. The Commissions see this as a flexible test and expect "almost no difference" between the existing and the proposed law where both the insurer and insured are experts or professionally represented.

• The insurer would need to show that the business made a misrepresentation which induced the insurer to enter into the contract and which a reasonable business in the circumstances would not have made. An insured who has acted honestly and reasonably would not lose cover unless that is specifically agreed in the contract and reasonableness will depend on the type of market, whether the business received professional advice and the clarity of questions asked.

• Finally, the Commissions believe there is a need to change the default rules regarding warranties in business insurance as set out in the current law. They believe that the current law is out of line with the expectations of an international market place and that the UK is lagging behind on reform in this area. They propose that a warranty should be set out in writing; a business should be paid a claim if it can prove on the balance of probabilities that the event or circumstances constituting the breach did not contribute to the loss; and a breach of warranty would not automatically discharge the insurer from liability but would instead give the insurer the right to terminate cover for the future.

Brokers/Intermediaries:

• The law should clarify that where an intermediary would normally be regarded as acting for the insurer in obtaining pre-contract information, it should remain the insurer’s agent while completing the proposal form.

• Views are sought as to whether Section 19(a) of the Marine Insurance Act 1906 should be repealed. This states that an agent placing insurance must disclose every material circumstance that the agent knows, whether or not the insured knows it. If the agent fails to do so, the insurer may avoid the policy against the insured even though the insured is innocent of wrongdoing. For business insurance, the proposal is that breach should give the insurer a right in damages against the intermediary, rather than the right to avoid the policy against the insured. For the errant broker, he would still be subject to legal action (although from the insurer) but clearly the Commissions’ driver in this area is the belief that the (innocent) insured will not be left out of pocket for the length of time that can currently occur in avoidance disputes where the broker is found to be culpable.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 20/07/2007.