In the 2015 summer edition of the Middle East Insurance Review, we wrote about the implications for Middle East insurers of the Insurance Act 2015 (the Insurance Act), which is due to come into force on 12 August 2016.
While fundamentally reforming a number of aspects of English insurance law, one issue of concern for insurance and reinsurance buyers is not addressed in the Insurance Act: the right of policyholders to pursue contractual remedies (including damages) in the event of late payment or an unreasonable refusal by insurers or reinsurers to pay insurance claims.
Matters have progressed since then. Part 5 of the Enterprise Act (the Enterprise Act), which received Royal Assent on 4 May 2016, provides for the insertion into the Insurance Act of clause 13A, requiring insurers and reinsurers to pay insurance claims within a reasonable time.
This obligation will apply to insurance and reinsurance contracts entered into after 4 May 2017.
This new obligation and the associated remedies available to policyholders are likely to be of interest to insurers operating in the Middle East who reinsure their exposures into the London market.
In this article, we:
• provide a brief overview of the current legal position in relation to the late payment of insurance proceeds and the reasoning behind reform in this area; and
• summarise clause 13A and address likely areas of uncertainty and (potentially) dispute in connection with this new provision.
The current position and reasons for reform
The normal position in English contract law is that where one party suffers loss because the other party has failed to meet its contractual obligations, the innocent party may claim damages for the loss suffered (Hadley v Baxendale (1854) EWHC J70).
The English courts have, however, held that (re)insurance contracts fall outside this rule.
A (re)insurer is not liable for any loss caused by its delay or failure to pay a valid claim. This is based on the legal fiction that the (re)insurer’s contractual obligation is to prevent the loss occurring (or to “hold the insured harmless”) rather than to pay out a claim.
As a result, claims payments are considered to be damages. Where payment is late, there can be no remedy (other than interest on the amount outstanding) as English law does not allow damages for late payment of damages (The President of India v Lips Maritime Corporation (The Lips) (1988) AC395).
The operation of the “hold harmless” principle is clearly illustrated in the case of Sprung v Royal Insurance (UK) Limited [1999] 1 Lloyd’s Rep 111. In that case, the insured was unable to finance the repairs to his factory after his insurer denied liability for the damage caused during a break-in.
As a result, after a few months, the insured was forced to wind up his business. He brought proceedings against his insurer and managed to recover the amount of his claim under the policy together with interest, but the court held that he could not recover a further loss representing the amount for which he could have sold his business had the delayed payment by the insurer been made in good time and the business been kept open.
Reason for review
During the consultation process which preceded the Enterprise Act, a number of reasons for changing the unfairness illustrated by Sprung were identified, including the following:
• The notion that a (re)insurer’s primary obligation under a contract of indemnity is to prevent the insured loss from occurring does not reflect commercial reality. Policyholders expect to have a contractual right to a payment in the event of a loss;
• The current position unfairly favours the interests of (re)insurers and their failure to make a timely payment risks prejudicing the very purpose for which insurance is purchased; and
• The English law position is inconsistent with that of a number of other jurisdictions, and less protective of policyholders. This, among other things, poses risks to the competitiveness of the UK insurance market.
The Government believes that this change in the law will incentivise (re)insurers to pay claims promptly.
The Enterprise Act
Clause 13A makes it an implied term of every contract of insurance that, following a claim, the (re)insurer must pay sums due under a policy “within a reasonable time”. Failure by the (re)insurer to do so will entitle the policyholder to pursue the remedies available under contract law, including damages, and those remedies shall be separate to the policyholder’s existing rights to recover the sums due under the policy together with interest on those sums.
It is a defence to a claim for breach of the implied term if a (re)insurer can show that there were reasonable grounds for disputing a claim or its quantum. The (re)insurer will not be held to have breached the implied term merely due to non-payment while a dispute is ongoing.
However, a court may take into account the conduct of a (re)insurer in handling the claim when deciding whether a breach has nonetheless occurred.
It will be possible to contract out of the obligation imposed by clause 13A, although any attempt to do so will be invalid if the (re)insurer has committed a deliberate or reckless breach of the implied term.
Any attempt to contract out is subject to compliance with the transparency requirements contained in the Insurance Act (see point 3. below).
If a policyholder wants to bring a claim for a breach of the implied term, they will have to do so within one year following the payment by the (re)insurer of sums due under the relevant policy.
Likely areas of uncertainty
1. What is a “reasonable time”?
This was one of the key areas of concern for (re)insurers, given the difficulty of specifying a single standard for a “reasonable time” within which to pay a claim. Clause 13A simply provides that it includes “reasonable time to investigate and assess a claim”, and states that what is “reasonable” will depend on all the relevant circumstances, including the following:
• the type of insurance involved;
• the size and complexity of the claim;
• compliance with any relevant statutory or regulatory rules or guidance; and
• factors outside the insurer’s control.
By way of example, some types of insurance, such as business interruption, are likely to take longer to assess than simple claims for property damage. Factors beyond the (re)insurer’s control might include delays to an investigation due to the failure of a third party to supply relevant information, or where a market follower in a subscription market is dependent upon a decision or action of the lead (re)insurer.
2. The (re)insurer’s defence
Establishing coverage under a (re)insurance policy often turns on subtle arguments relating to the interpretation of policy wordings and/or the results of a careful investigation into the circumstances of a loss. It therefore seems reasonable that a (re)insurer should be afforded an appropriate amount of time to be able to properly investigate the claim (including its quantum), and that it should not be penalised for withholding payment until the claim is determined or agreed to be valid and its amount established.
The English courts will have to decide what should constitute reasonable grounds for disputing a claim, as well as the types of conduct by the (re)insurer and any other factors which could negate the defence.
3. Has a (re)insurer successfully contracted out?
Another area of uncertainty, and therefore one which is likely to be disputed, is whether the parties to a (re)insurance contract have effectively contracted out of the remedies available under clause 13A.
Pursuant to clause 16A (also introduced by the Enterprise Act) and clause 17 of the Insurance Act, a (re)insurer attempting to include a term in a policy which puts a policyholder in a worse position than the default position set out in clause 13A must comply with the following transparency requirements:
• It must take sufficient steps to draw the disadvantageous term to the policyholder’s attention before the contract is entered into; and
• The term must be clear and unambiguous as to its effect.
A court must take into account the characteristics of the type of policyholder involved, and the circumstances of the transaction in determining whether these requirements have been met.
The drafting of any term in a (re)insurance policy purporting to contract out of the remedies in clause 13A will no doubt be carefully scrutinised in the event of a dispute. Further, while a policy may contain a term which purports to allow the (re)insurer to contract out, if that (re)insurer deliberately or recklessly breaches clause 13A then its attempt to contract out will be ineffective.
Conclusion
The change to English insurance law described in this article is favourable to (re)insureds and is likely to be welcomed by insurers seeking to reinsure their risks under English law governed reinsurance contracts.
Among other things, it places the onus on re(insurers) to streamline their claims investigation processes where previously the pressure to respond to claims in a timely fashion was largely commercial.
That being said, any fundamental reform of a relatively settled area of law will throw up a number of issues and uncertainties. As discussed above, the introduction of an obligation on (re)insurers to pay sums due under insurance policies within a reasonable time (within the context of the wider reforms introduced by the Insurance Act) is no different.
These issues and uncertainties will have to be addressed over time by the courts, legal practitioners and the market, and in the meantime policyholders should obviously monitor any consequential changes to the wordings of policies they purchase.
Ms Susan Dingwall is Partner and Mr Martin Schneider is Associate, both of Norton Rose Fulbright LLP.