Insurance Act receives royal assent

The Insurance Act yesterday received royal assent, paving the way for the most significant change to English insurance contract law in over 100 years. The Act will come into force in August 2016 following an 18-month lead in period.

The Act aims to address the perceived current imbalance in the law in favour of insurers which is said to put the English market at a competitive disadvantage. In particular, it updates the statutory framework for insurance contracts in the following areas:

• disclosure and misrepresentation in business and other non-consumer insurance contracts;
• insurance warranties; and
• insurers' remedies for fraudulent acts.

The Act also amends the Third Parties (Rights Against Insurers) Act 2010 so that the 2010 Act can finally be brought into force.

Insurance and reinsurance disputes partners David Reston, Paul Lewis and Alex Oddy give a summary of the Act and its implications below.

Earlier iterations of the Insurance Bill included a clause providing for damages for late payment of claims. This clause was dropped as due to a lack of consensual support across the market it was deemed unsuitable for the Law Commission uncontroversial bill procedure.

Disclosure in business and other non-consumer insurance contracts

Fair presentation of the risk

Under the new Act, the insured has a duty to make a "fair presentation of the risk" to the insurer. The duty applies to pre-inception disclosure as well as variations of non-consumer insurance contracts (in which case the "risk" means "changes in the risk relevant to the proposed variation"). The duty of fair presentation comprises of three elements.

The first element is the insured's duty of disclosure. The insured must either (i) disclose every material circumstance which it knows or ought to know (which is based on the legal position as codified in the Marine Insurance Act 1906 ("1906 Act")); or (ii) failing that, give the insurer sufficient information to put a prudent insurer on notice that it needs to make further enquiries for the purpose of revealing those material circumstances. In respect of the first limb of the test, a business insured is taken to "know" what is known to the insured's senior management and individuals responsible for the insured's insurance (which encompasses risk managers and any employee who assists in the collection of data or negotiates the terms of the insurance). An insured "ought to know" what would have been revealed by a reasonable search of information available to the insured.  The second limb of the duty of fair presentation represents a change from the existing law and is intended to combat the perceived risk of an insurer taking a passive role in the disclosure process and only asking questions when the insured makes a claim under the policy.

The fair presentation of risk also requires the insured to make the disclosure in a manner which would be reasonably clear and accessible to a prudent insurer. It is hoped that this will discourage "data-dumping" (bombarding the insurer with vast swathes of material whether relevant or not). In particular, it has been suggested that a lack of structuring, indexing and signposting may mean that a presentation is not “fair” but at the other end of the spectrum, the Explanatory Notes to the Act make clear that neither would "an overly brief or cryptic presentation".

Lastly, the duty of fair presentation includes the duty not to make misrepresentations (currently set out in section 20 of the 1906 Act).

The Act contains various carve-outs to the insured's duty of disclosure, some of which are already codified in the 1906 Act. In particular, the insured is not required to disclose material circumstances which the insurer knows, ought to know or is presumed to know.  The insurer:

• "knows" what is known to the individuals involved in that particular underwriting decision,
• "ought to know" information which is readily available to the underwriters or is known by an employee or agent of the insurer who ought reasonably to have passed it on,
• is "presumed to know" matters it ought to know in the ordinary course of its business, such as industry knowledge (but only to the extent that the industry knowledge is relevant to the type of insurance provided by the insurer).

Proportionate remedies

Under the 1906 Act, the sole remedy for a breach of the duty of good faith is avoidance of the policy. It was recognised that in most instances this was a draconian remedy which did not adequately distinguish between innocent and deliberate or reckless mistakes.

The new Act provides for a range of proportionate remedies. Unless the breach is deliberate or reckless (in which case the remedy of avoidance would still be available), the onus is on the insurer to show what it would have done had it received a fair presentation of the risk:

• the insurer will still be entitled to avoid the policy if it can show that had it received a fair presentation of the risk, it would not have entered into the contract; but
• if the insurer shows that it would have entered into the contract but on different terms, then the insurer may treat the policy as having included those different terms from the outset. This could result in the addition of warranties or exclusions which affect the recoverability of claims; or
• if the insurer would have entered into the contract but only at a higher premium, the insurer may reduce the amount to be paid on a claim proportionately. For example, if the insurer can show that had it known about the non-disclosed risk it would have charged a premium of £400,000 rather than £300,000, claims paid by the insurer could be reduced proportionately by 25%.

The duty of good faith (as codified in Section 17 of the 1906 Act) will remain as a general interpretative principle. However, a breach of this duty will no longer automatically entitle the insurer to avoid the policy and will instead be subject to the range of proportionate remedies set out above.

Warranties

Suspensive conditions

Under the 1906 Act, a breach of warranty discharges the insurer's liability under the contract in its entirety, even if the breach is only trivial or does not in any way relate to the insured's loss. Under the new Act, a breach of warranty will no longer automatically take the insurer off risk. The Act makes warranties "suspensive conditions"; the insurer's liability will be suspended while the insured is in breach of a warranty but can be restored if the breach is subsequently remedied.

This change is consistent with the Law Commissions’ characterisation of warranties as “risk control measures”.  If, for example, the owner of a factory fails to install a burglar alarm system by a certain time in breach of a warranty in their property insurance, it is possible for the risk to be restored to the state it would have been in had the breach not taken place (i.e. the insured can install the burglar alarm at a later stage).

"Basis of the contract" clauses

The Act abolishes "basis of the contract" clauses, which operate to turn the insured's pre-contractual representations (including answers to questions on a proposal form) into warranties.

Terms to reduce particular risks

If an insured makes a claim, the Act provides that an insurer may not rely on the insured's breach of a term to avoid paying that claim if the breach could not have increased the risk of the loss. This applies to breaches of warranties and other terms which would tend to reduce the risk of loss of a particular kind or loss at a particular location or time. However, the Act makes clear that this provision does not apply to terms which define the risk as a whole.

Insurers' remedies for fraudulent claims

The Act replaces the current co-existing remedies of forfeiture (under common law) and avoidance (under the 1906 Act) with a statutory regime for fraudulent claims.

This provides that the insurer (i) will not be liable to pay fraudulent claims; (ii) can elect to terminate the contract and refuse to pay claims relating to losses suffered after the fraud; but importantly, (iii) will remain liable for all legitimate losses suffered before the fraud.

Fraudulent claims by members of group insurance policies

The Act provides that where a beneficiary makes a fraudulent claim under a group insurance policy, the insurer (i) has no liability to pay the fraudulent claim; (ii) has the option to terminate its liability to pay out in respect of losses suffered after the fraudulent act, but only as regards the fraudulent claimant; and (iii) remains liable for legitimate losses suffered by the fraudulent claimant before the fraudulent act.

The fraudulent claimant and the insurer are treated as though they had entered into a separate insurance contract between them, meaning that innocent group members are not unfairly prejudiced.

Amendments to the Third Parties (Rights against Insurers) Act 2010

The Third Parties (Rights against Insurers) Act 2010 aims to simplify and modernise the procedure for third party victims to seek compensation from an insurer in circumstances where the insured has become insolvent or ceased to exist. The Act corrects defects in the 2010 Act (which failed to cover the full range of insolvent or defunct wrongdoers) such that it can now be brought into force.

Contracting out

It is intended that the Act will be a default regime for non-consumer insurance contracts. However, it was recognised that some provisions may not be suitable for all markets and commercial parties.  The Act, therefore, allows parties to non-consumer insurance contracts to contract out of the default regime (with the exception of the prohibition on "basis of the contract" clauses) as long as any “disadvantageous term” (which puts an insured in a worse position than that under the default regime) meets the “transparency requirements”:

1. the insurer must take sufficient steps to draw the disadvantageous term to the insured’s attention before the contract is entered into or the variation agreed; and
2. the disadvantageous term must be clear and unambiguous as to its effect.

Comment

In determining whether the transparency requirements have been met, the characteristics of the insured and the circumstances of the transaction should be taken into account. For example, an insurer will have to do less to bring the provision to the attention of a large sophisticated company which is advised by experienced lawyers and brokers than it would for a sole trader buying “off the shelf” insurance online.

The Act has been strongly welcomed by industry players as bringing commercial insurance law up-to-date with the realities of the modern world and heralded as a tool to combat the perceived imbalance in the law in favour of insurers.  It is hoped that in the long-term the Act will introduce greater certainty although it seems inevitable that at least initially there will be disputes over the scope and application of some of the provisions as these are tested in practice.

All those involved in the placing and underwriting process – risk managers, brokers and (re)insurers – will face challenges in adapting to the new law if they are to realise the full benefits that the new Act confers.

One of the criticisms of the existing law is that underwriters have traditionally been able to adopt a passive approach during the underwriting process.  Under the Act, the insured will have complied with its duty of disclosure if it gives the insurer sufficient information to put a prudent insurer on notice that it needs to make further enquiries for the purpose of revealing any material circumstances. Underwriters will, therefore, need to be more proactive and searching during the underwriting process.

Policyholders will need to consider how to best conduct a reasonable search for material information. This will be challenging in instances where there has been a change of broker or a change in personnel. There will be a greater onus on record-keeping and verification of information included in the underwriting submission (which must be carried out prior to each renewal). Policyholders should consult their brokers and, if possible, agree with insurers in advance what would constitute a "reasonable search" in order to avoid any future disputes.

Following the introduction of a range of proportionate remedies insurers will no longer be able to rely on the draconian remedy of avoidance in relation to an insured's innocent non-disclosure.  The onus is on the insurer to show what it would have done had it received a fair presentation of the risk.  Insurers will need to think about their underwriting guidelines and how best to document underwriting decisions in order to be able to take advantage of the remedies available under the Act.  Policyholders will need to consider how best to structure underwriting presentations going forward so that they provide a "fair presentation of the risk".  In recent years, some policyholders have deluged insurers with electronic information on the risk in the expectation that "material circumstances" would be found somewhere within it. It is questionable whether such an approach will be adequate in the future. The Law Commissions' guidance notes encourage the use of structuring, indexing and signposting in order to highlight the key information to underwriters. This will be particularly important when a large volume of data is provided in support of the submission.

The Act has an 18-month lead in period before it is in force but some insurers have already indicated that they are willing to reflect the reforms in the language of their policies before the Act comes into force and policyholders (in conjunction with their brokers) might consider seeking policies that implement these changes now.