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Focus: UK insurance contract law reformed

15 December 2009

In brief: Draft legislation to reform the UK's insurance contract law has been published, which could have considerable significance for the UK insurance market and for international markets that have dealings with it. Partners Oscar Shub (view CV) and Matthew Skinner (view CV) and Senior Associate Philip Hopley look at the draft legislation in light of their experience with insurance law reform in Australia and report.To hear Philip Hopley discuss the reform with Boardroom Radio, go to the Allens website.

How does it affect you?

  • The draft Consumer Insurance (Disclosure and Representations) Bill covers the reform of certain pre-contractual conduct relating to consumer insurance. It is intended to be non-controversial and largely reflects the current approach of the Financial Ombudsman Service (FOS).
  • It is proposed that insurers will no longer be able to rely on pre-contractual non-disclosure by an insured as a reason to avoid paying claims. Instead, insurers would only to be able to deny or reduce their liability to pay a claim where an insured makes a misrepresentation in response to a question asked during the proposal process. There will however be no remedy where a misrepresentation is made by a consumer acting with reasonable care.
  • The new laws are intended to be mandatory for all consumer insurance contracts (irrespective of the value or nature of the insured risk). Insurers will not be permitted to contract out of the new regime unless their policies are worded in such a way as to leave consumers in a better position in relation to pre-contractual misrepresentation.
  • Although, at this stage, the draft Bill applies only to consumer insurance, it is an important signal of the approach the Law Commissions are likely to take in reforming business insurance law, which will be the subject of further policy work next year. The experience of insurance reform in Australia has shown that once legislation of this nature is introduced, the approach shifts from it only being consumer-related to also being business-related.

Background

Since 2006, the English and Scottish Law Commissions have been engaged in an extensive review of the law governing insurance contracts in the UK and how it might be improved. Among other things, this review has involved an analysis of Australia's experience of reforming largely the same laws 25 years ago in the Insurance Contracts Act 1984 (Cth) (the ICA).

On 15 December 2009, the two Law Commissions published their final recommendations and draft Bill to reform the law relating to pre-contractual matters for consumer insurance.1 A separate set of final recommendations and draft legislation dealing with warranties for consumer insurance and business insurance is expected to follow sometime next year.

If passed, the draft Bill will represent the first substantive legislative change to the UK law on insurance contracts since the Marine Insurance Act 1906, and will bring the law for consumer insurance largely into line with the current system of regulation and industry practice.

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The current law on pre-contractual non-disclosure

At present, the law places the onus on an insured to disclose every material fact to an insurer before entry into a policy, including facts that it has not been specifically asked to provide. A material fact is one that, had it been disclosed, would have influenced a hypothetical prudent insurer's assessment of the insured risk.

The current penalties for non-disclosure are harsh. An insurer is entitled to avoid a policy – that is, to treat it as if it had never existed – if it can show that it would not have agreed to the policy on the same terms, or at all, had the material fact been disclosed.

The law on non-disclosure has been criticised as unfair for many years. Consumers currently enjoy some degree of protection from its strict operation as a result of the complaints resolution service provided by the FOS for claims worth £100,000 or less. To a lesser extent, rules passed by the industry regulator, the Financial Services Authority (the FSA) also influence insurers' attitudes towards non-disclosure. However, not all insurers adopt as best practice the FOS's approach and few consumers complain to the FSA.

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The current law on pre-contractual misrepresentation

Insureds are currently obliged to ensure that every representation of fact made to an insurer is true. Similarly, statements of opinion must be honestly believed to be true.

A pre-contractual misrepresentation will entitle an insurer to avoid the policy concerned if it is material, even if the consumer did not behave fraudulently or negligently. A misrepresentation will be material if it would have influenced the judgment of a hypothetical prudent insurer to enter into the policy, even if it would not have had a decisive influence on the acceptance of the risk or the premium charged.

Again, consumers are protected to a degree from the harshness of the law by the FSA rules and the approach of the FOS, which do not generally allow insurers any remedy where a misrepresentation is made innocently. An inadvertent misrepresentation gives an insurer the right to reduce the amount paid if it can demonstrate that, for example, it would have charged a higher premium or inserted an exclusion clause. Insurers retain the ability to avoid a policy for misrepresentations that are made fraudulently or deliberately.

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Summary of the main proposed reforms

  • A 'consumer insurance contract' is to be defined as a contract of insurance entered into by an individual that is wholly or mainly for purposes unrelated to the individual's trade, business or profession. In a departure from current FOS practice, mixed use contracts that cover both private and business use will be covered by the draft Bill if the main purpose of the insurance is for private use.
  • A consumer's duty to volunteer information and the law on non-disclosure are to be abolished. Instead, consumers will have a duty to take reasonable care not to make a misrepresentation to an insurer. Insurers will therefore be obliged to ask consumers specifically about any material facts they wish to know.
  • The focus is now on misrepresentation as the sole remedy for insurers. While the current law on what amounts to a misrepresentation is to remain unchanged, the draft Bill proposes the following changes to the remedies for pre-contractual misrepresentation:
    • for deliberate or reckless misrepresentations (which includes fraud), insurers will retain the right to avoid a policy and keep premiums. The draft Bill defines a misrepresentation as being deliberate or reckless where a statement is made by an insured who either knows it to be untrue and misleading and relevant to the insurer's decision to accept the risk, or does not care whether or not it is untrue and misleading and relevant to the acceptance of the risk;
    • for careless misrepresentations, which are defined as misrepresentations that breach the duty to take reasonable care but which fall short of deliberate or reckless conduct, insurers will be entitled to a remedy that puts them in the position they would have been had the true facts been known. For example, an insurer will be able to reduce a claim by the amount of the extra premium that would have been charged; and
    • for innocent misrepresentations – that is, where a misrepresentation is made by an insured acting with reasonable care – insurers will have no remedy.
  • Whether or not a consumer has taken reasonable care to avoid making a misrepresentation is, in general, to be determined objectively by reference to the standard of a reasonable consumer and taking into account all relevant circumstances.
  • Insurers will no longer be required to demonstrate that a misrepresentation was 'material' in the sense that it would have been relevant to a hypothetical prudent insurer. It will be enough for an insurer to show that it was induced to enter into the contract with the insured as a result of the misrepresentation, and that a reasonable insured would have provided the information. This change is designed to assist insurers who develop niche markets by selecting risks that may be regarded by other insurers as irrelevant.
  • Basis of the contract clauses are to be abolished. These are contractual devices where an insured signs a declaration that warrants the accuracy of all of the answers given in a proposal form. The legal effect of this declaration is that an insurer is then entitled to avoid the policy for any mistake made in the proposal form, regardless of its importance or relevance to the insured risk.
  • Members of group schemes of insurance, such as those that provide life cover, will be entitled to the same remedies as consumers where they make a pre-contractual misrepresentation.
  • The role of intermediaries in the pre-contractual process is to be clarified. The draft Bill sets out the circumstances where an intermediary is to be treated as acting for the insurer or the consumer for the purpose of allocating the risk of the intermediary making a misrepresentation.

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How does Australian law differ from the UK's proposals?

If enacted, the proposed reforms of the UK's consumer insurance law will bring it more closely into line with the practical effect of the law of misrepresentation in Australia that applies to general insurance.

However, there will still be some important differences between the two jurisdictions when considering the remedies available for misrepresentation. For example, although the remedies for deliberate and careless misrepresentation will be similar, the draft Bill does not contain any equivalent provision to section 31 of the ICA, which gives Australian courts a discretion to disregard an insurer's right to avoid a policy for fraudulent misrepresentation where the fraud is deemed to be minor and no significant prejudice is caused.

On the other hand, insureds in the UK will enjoy more protection from the effect of innocent misrepresentations under the draft Bill, since Australian insurers are permitted by s28(3) of the ICA to reduce their liability by an amount that places them in the position they would have been had the innocent misrepresentation not been made.

The proposed abolition of the law of non-disclosure in the UK also goes further than the law in Australia where this is in place under s21 of the ICA. However, this difference is unlikely to affect the majority of consumers because most insurers usually ask set questions in proposal forms and so will rely principally on the remedies available for misrepresentation.

In addition, while Australian law excludes any term of a policy that provides any remedies for non-disclosure and misrepresentation that are inconsistent with the ICA (s33 of the ICA), the draft Bill will not prevent UK insurers from wording their policies to further limit their available remedies for misrepresentation.

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What happens next?

The Law Commissions' view is that the draft Bill should be introduced to Parliament as a matter of urgency, and there appears to be clear industry and government support for this.

The publication of the draft Bill and its progress through the UK Parliament may provide a further opportunity for insurers to make representations regarding the operation and effectiveness of this proposed new law. While these amendments relate only to consumer insurance, it is important that insurers involved more broadly in general insurance should take the time to consider how these changes could affect them if they are later introduced into business insurance. If you would like further information on this, or any other matter, please contact any of the people below.

Footnotes
  1. See the report Consumer Insurance Law: Pre-Contract Disclosure and Misrepresentation (Law Com No 319, Scot Law Com No 219) published on 15 December 2009. See also the publications Consultation Paper, published in July 2007, and Responses to Consultation Paper (consumer insurance) published in May 2008 here.

For further information, please contact:

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