On 12 February 2015, the UK parliament passed the Insurance Act 2015 (the Act) which, when it comes into force in August 2016, will substantially reform a number of fundamental principles of English insurance law (some of which date back to the 18th century).
It could be argued that principles of law which have survived so long have done so because they are clear and provide certainty for parties to insurance contracts. However, there has been pressure for insurance law reform for some time now on the basis that the perceived current imbalance in the law in favour of insurers has put the London market at a competitive disadvantage.
This article focuses on the changes in the law addressed by the Act in the following areas:
• the insured’s duty of utmost good faith;
• warranties; and
• the insurer’s remedies for fraudulent acts committed by or on behalf of the insured.
These changes will be relevant, in particular, to those Middle East insurers whose reinsurance arrangements are governed by English law.
Presentation of the risk on placement
It is a long-established principle of English law that contracts of insurance are contracts of utmost good faith. This means that an insured must, on presentation of the risk to the insurer (and on renewal of a policy), voluntarily disclose all material facts relating to that risk.
The insured also has a duty not to make any material misrepresentations relating to that risk. Material facts or representations are those that would influence a prudent underwriter in fixing the amount of premium or deciding whether or not to accept the risk.
While the principle of utmost good faith will continue to apply to insurance contracts after the Act comes into force, the Act imposes changes to the duties of the insured which ease what has been widely perceived as an onerous obligation to disclose all material facts. Given the huge quantities of data created and stored by today’s businesses, the lack of awareness by prospective insureds as to what might be “material”, and the severity of the consequences of non-disclosure or misrepresentation (dealt with below), insureds have taken to sending insurers masses of information in an unstructured way (a practice known as “data dumping”). This has only served to lengthen the placement process and led to concerns that the presentation of the risk was not fair.
Under the Act, an insured will have to make a “fair presentation” of the risk to the insurer at the time of placement and at each renewal. The duty of fair presentation has three aspects:
1. Duty of disclosure
This duty requires the insured to either:
• disclose every material circumstance which it knows or ought to know; or failing that,
• give the insurer sufficient information to put a prudent insurer on notice that it needs to make further enquiries with the purpose of revealing those material circumstances.
The first aspect of the duty of disclosure essentially mirrors the current statutory position. A commercial insured will be deemed to know that which is known to its senior management and to its risk manager or other employees who are responsible for the business’s insurances. An insured “ought to know” what would have been revealed by a reasonable search for information available to the insured. This would include information held by an agent of the insured.
The second aspect of the duty of disclosure is a change in the law. The idea that the insured should give the insurer sufficient information to put a prudent insurer on notice that it needs to make further enquiries with the purpose of revealing material circumstances is intended to address the current criticism that the insurer can adopt a passive role in the placement process and ask questions subsequently when a claim arises. Under the Act, the onus is on the insurer to ask any such questions during placement.
2. Duty of fair presentation
This relates to the manner of disclosure by the insured. In an effort to avoid data dumping, the insured is required to disclose information in a reasonably clear and accessible way to a prudent insurer.
3. Duty not to make misrepresentations
The insured must ensure that every material representation as to a matter of fact is substantially correct, and that every material representation as to a matter of expectation or belief is made in good faith.
The Act contains various exceptions to the insured’s duty of disclosure. In the absence of enquiry, the insured will not be required to disclose a circumstance if:
• it diminishes the risk;
• the insurer knows it;
• the insurer ought to know it;
• the insurer is presumed to know it; or
• it is something as to which the insurer waives information.
For commercial insurance, the changes introduced by the Act in relation to the duty of fair presentation are a default regime. If an insurer proposes to alter the default regime with any term which would have a more disadvantageous impact on the insured, the term must be sufficiently drawn to their notice.
Proportionate remedies
Under the existing law, the only remedy for a breach of the duty of utmost good faith is avoidance of the policy. This was considered to be a draconian remedy that did not differentiate between innocent and deliberate or reckless misrepresentations or non-disclosure.
The Act introduces remedies which are proportionate to the breach of the duty to make a fair representation. Only if the misrepresentation or non-disclosure is deliberate or reckless may the insurer avoid the policy, refuse all claims and retain the premiums paid. In such a case, the burden of proof is on the insurer to demonstrate that the misrepresentation or non-disclosure was deliberate or reckless.
If the misrepresentation or non-disclosure was not deliberate or reckless but had the insured not been in breach, the insurer would not have underwritten the policy on any terms, then the insurer may avoid the policy and refuse all claims. However, it will be obliged to return the premium paid.
If the misrepresentation or non-disclosure was not deliberate or reckless, and the insurer would have underwritten the policy anyway but on different terms, then the insurer may treat the policy as having included those different terms from the outset. If the insurer would have underwritten the policy but only at an increased premium, then the insurer may reduce the amount of the insured’s claim proportionately by the percentage of the additional premium that would have been charged.
Warranties
Under the existing law, a breach of a warranty in an insurance policy automatically terminates the contract from the date of the breach (notwithstanding that the breach might be immaterial to the insured risk), leaving the insured without cover. This remedy is considered particularly harsh, and has been addressed by the changes being implemented in the Act.
Firstly, the Act abolishes “basis of contract clauses” in proposal forms or policies, which have the effect of converting representations made in the proposal form into warranties. This provision of the Act which cannot be contracted out of.
Secondly, a breach of warranty will no longer automatically terminate the insurer’s liability from the date of the breach, but will only have a suspensory effect on that liability. If the insured is able to and does remedy the breach, the insurer will again be on risk and liable for a future loss.
Thirdly, the Act provides that, where a term (including a warranty) of a policy is breached which is designed to reduce the risk of a loss of a particular kind or at a particular location or at a particular time, an insurer will not be able to rely on the breach to reject a claim if the insured can prove that the breach would not have increased the loss which actually occurred.
Fraudulent claims
The current remedies of avoidance and forfeiture are replaced in the Act by the introduction of a new statutory regime for fraudulent claims. This provides that an insurer will not be liable to pay a fraudulent claim. The insurer can elect to terminate the policy and refuse to pay claims relating to losses suffered after the fraud. However, in a change to the current law, the insurer will remain liable for all legitimate losses incurred before the fraud.
Commentary
The Act has been welcomed as a much-needed modernisation of the law. It also addresses the perceived imbalance in the law in favour of insurers. It is to be hoped that the Act will introduce greater certainty although it is likely that, at least initially, disputes may arise over the scope and application of the provisions which change the current law.
Although the Act does not come into force for more than a year, and will then only apply to new policies or variations to existing policies, it is imperative that Middle East insurers who reinsure under English law governed reinsurances are aware of the changes introduced by the Act and that they carefully consider how best to structure their underwriting presentations so that they comply with the new duty of fair presentation.
Ms Susan Dingwall is a Partner and Mr Martin Schneider is an Associate with Norton Rose Fulbright LLP.