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Reforming Insurance Contract Law: The Law Commissions’ Proposals in Respect of Business Insurance

The Law Commission of England & Wales and Scottish Law Commission have recently published a set of draft clauses for inclusion in the proposed Insurance Contracts Bill.  This marks the final stages of the long consultation process that has been on foot since the commencement of the law reform project in 2006.

The draft clauses and accompanying notes were released on 28 January 2014 and the Law Commissions have invited comments on the basis of a limited consultation.

The clauses have been described as a "first draft". However, while there will undoubtedly be alterations and further drafts, it is understood that as regards the main substance of their content, they represent and embody the feedback already received by the Law Commissions.

The draft clauses relate to the following areas:

  1. Fair presentation of risk (disclosure and representations) in business insurance;
  2. Insurers’ remedies for fraudulent claims;
  3. Damages for late payment of claims;
  4. Good faith

The topics “warranties” and “contracting out” are still being worked on by the Law Commissions. Similarly, consumers’ disclosure obligations have already been addressed in the Consumer Insurance (Disclosure and Representations) Act 2012 and so do not form part of the draft clauses. The governing principle for disclosure as set out in the 2012 Act is that a consumer must take reasonable care not to make misrepresentations.

Before dealing with the four areas covered by the draft clauses, it should be noted that the Definition section (Clause 1) makes a differentiation between the “Insured” and the “Proposer”. “Insured” is defined as “the party to a contract of insurance who is the insured under the contract” and “proposer” is defined as “the party to a contract of insurance who is the insured under the contract, or would be if the contract were entered into”. There has been comment in the consultation discussions that have taken place so far that this may cause issues in relation to disclosure/the attribution clauses/fraud and it has to be looked at carefully in the context of composite insurances.  For example, in D&O Insurance each director and officer may be treated as an insured under the policy but not qualify as such under the draft Bill. 

 1.       Duty of Fair Presentation (Clauses 2-8)

The disclosure proposals cover all non-consumer insurances, from micro businesses to multi-national corporations and they specifically embrace both marine insurance and reinsurance.

What is a fair presentation?  What has to be disclosed and how should it be disclosed?

The draft clauses require any proposal that is made to insurers to be a “fair presentation of the risk”. Clause 4(1) defines what amounts to such a “fair presentation”:

  • It must disclose every material circumstance which the proposer knows or ought to know; or
  • Taking the information provided by the proposer “in the round”, it must give the insurer sufficient information in relation to those material circumstances as would put a prudent insurer (note: the old concept of the prudent insurer is retained) on notice that it needs to make further inquiries.  This reflects the approach currently being taken by the courts e.g. CTI v Oceanus [1984] 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. 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 since the insurer has to be in a position readily to access what is necessary, rather than having to sift through masses of irrelevant information. 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.  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 4(6) identifies several things which may amount to material circumstances including special or unusual facts relating to the risk; any particular concerns which led the proposer 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. The Law Commission has stated that the last of these may be a cause for concern and hopes that insurers and insureds will work together to develop guidance and protocols over what a standard presentation of a risk should include.

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 5).  This can be traced back to the representations made by AIRMIC during the consultation process relating to knowledge in large, multi-department, often multi-national policyholders. This is perhaps the most difficult section of the draft and has led to much discussion in the consultation process particularly in relation to fraud situations.  In practice, the problems identified by AIRMIC can often already be addressed by specific drafting in policy wordings to define who has to have the necessary knowledge (e.g. Group Legal Department).  

Clause 5 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 a proposer “ought to know” is defined as that which would have been discovered by a reasonable search of information that is available to the proposer (whether in its own organisation or held by others e.g. an agent).

Under Clause 2(2) an individual’s knowledge is stated specifically to include “blind-eye” knowledge, that is, information the individual suspected and would have had but for refraining from confirming it or inquiring about it.  Questions have been raised in the consultation discussions so far as to whether this should be limited to deliberately turning a blind-eye or to reasonable suspicions.

Exceptions and the Insurer’s Knowledge

Clause 6(1) 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: 

  1. Things which are common knowledge; and
  2. 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 provide that “things” refer to “information and knowledge of any kind, including facts, rumours, expectations and beliefs”.  Not unexpectedly, comment has been made in the discussions so far on the vague concept of  “rumour” being brought in as something an insurer is deemed to know. The Law Commission’s 2012 proposals simply referred to matters of common knowledge and market practice.

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).

Remedies

Remedies are contained in Clause 7 and in the Schedule to the draft clauses and mirror the remedies available in consumer insurance as set out in the 2012 Act.  Currently an insurer’s only remedy against an insured for non-disclosure is avoidance, and the proposed new regime is more flexible and 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. Remedies for Fraudulent Claims (clauses 10 and 11)

The draft clauses provide that a fraudulent claim (deliberately not defined) made by an insured party will lead to forfeiture of the whole claim to which the fraud relates. The important point is that fraudulent devices (basically false evidence to support what may or may not be an otherwise valid claim) have not been specifically addressed in the draft, but left for judge-made law.

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. The result of such termination being forfeiture of any claim made after the date of the fraud, and the retention of any legitimate claims made before the fraud occurred.

The Law Commission has also decided against introduction of a statutory right for insurers to recover the cost of investigations where fraud is discovered. Presently, these can only be claimed in an action for deceit.

The Law Commission is recommending special provisions to address fraud committed by a member of a group policy so the insurer has remedies against the fraudster, not the policyholder.  This has not yet been included in the draft. The Law Commission apparently does not intend to legislate on the scenario of joint insurance where one insured commits a fraud.

3. Late Payment of Claims (clause 12)

The draft clauses propose 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 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 S 50 of FSMA 2000). The date of commencement of such a limitation period may not be an easy matter to define with precision.

While insurers should not think that the late payment clauses (if enacted) will expose them to a “Bad Faith” American style culture,  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. 

Though not stated in the clauses, the accompanying notes state that the Law Commission intends to prohibit contracting out in relation to late payment in consumer contracts. 

4. Good Faith (clause 13)

The draft clauses propose that a breach of the duty of utmost good faith should not give rise to a remedy of avoidance (amending S 17 of the Marine Insurance Act 1906). Having said that, the Law Commission is keen to stress in its notes accompanying the draft clauses, 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.

 Responses to the Law Commission

As part of its limited consultation, the Law Commission has asked for comments on the draft clauses by 21 February 2014.  Responses should be emailed to:  commercialandcommon@lawcommission.gsi.gov.uk

DWF Fishburns is participating in the consultation process and any readers of this Briefing Note who have views on the draft clauses are invited to contribute to the response.

 

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.

Jacquetta Castle

I specialise in insurance coverage and professional liability, particularly for lawyers, brokers and financial professionals. I work for many of the major insurers.

Robert Goodlad

Senior Associate

My work involves commercial insurance issues and the investigation and resolution of professional indemnity/professional negligence claims (the majority of which are construction related).