UK: The English And Scottish Law Commissions' Proposals For Reform

CONTENTS

• First Joint Consultation Paper (July 2007)
• Issues Paper 4: Insurable Interest (published January 2008)
• Issues Paper 5: Micro-Businesses (published April 2009)
• Consumer insurance law: joint report and draft Bill (published December 2009) and the Consumer Insurance (Disclosure and Representations) Bill (May 2011)
• Issues Paper 6: Damages for Late Payment and the Insurer's Duty of Good Faith (published March 2010)
• Issues Paper 7: The Insured's Post-Contract Duty of Good Faith (published July 2010)
• Issues Paper 8: The Broker's Liability for Premiums – Should Section 53 be Reformed? (published July 2010)
• Issues Paper 9: The Requirement for a Formal Marine Policy: Should Section 22 be Repealed? (published October 2010)
• Critical issues arising out of the proposals
• The Commissions' timetable

Introduction

The perceived need for reform

The Law Commissions are currently undertaking a joint review of key aspects of insurance contract law. Their stated aim is "to ensure that the law balances the interests of insured and insurer, reflects the needs of modern insurance practice and allows both insured and insurer to know their rights and obligations". Their view of the law as it presently stands is that in specific areas it is failing to deliver and that reform is urgently required. They disagree that self-regulation or the Ombudsman's involvement are suitable substitutes for law reform.

Past history of attempts to reform

This is by no means the first time that there have been calls for reform and, in their current deliberations, the Commissions have looked in some detail at the recommendations made since 1957, particularly those made in the English Law Reform Committee Report of 1957, the National Consumer Council Report of 1997 and the British Insurance Law Association (BILA) Report of 2002. A useful summary of the recommendations made in these earlier reports, along with the industry's and Government's responses, is set out in Appendix A of the First Joint Consultation Paper.

The structure of the Law Commissions' review

In January 2006, the Commissions issued a joint scoping paper which explained that they would be considering the law of misrepresentation, non-disclosure and breach of warranty and asking interested parties whether they believed that any other areas of the law were in need of reform. Responses received indicated a strong desire for a wide-ranging review. Between September 2006 and March 2007 the Commissions proceeded to publish three Issues Papers considering misrepresentation and non-disclosure, warranties, and intermediaries and pre-contract information respectively. Each was followed by a series of seminars and meetings, the feedback from which resulted in the modification of the Commissions' proposals and in the production of the First Joint Consultation Paper in July 2007. A summary of responses to the proposals made in the consumer context was published in May 2008, with the equivalent in the business context published in October 2008. In January 2008, the Commissions published a fourth Issues Paper, considering insurable interest, and in April 2009 published a fifth Issues Paper concerning micro-business. This was followed by the publication of the responses to the fifth paper.

On 15 December 2009 the Commissions published a report and draft Bill designed to implement their recommendations regarding new legislation covering the issue of what a consumer should tell their insurer before taking out insurance. The Consumer Insurance (Disclosure and Representations) Bill is currently under consideration by the Government. In 2010, the Commissions published Issues Paper 6, "Damages for late Payment and the Insurer's Duty of Good Faith" and Issues Paper 7 concerning the insured's post-contract duty of good faith, followed by Issues Paper 8 "Broker's Liability for Premiums – Should Section 53 be Reformed" and Issues Paper 9 "The Requirement for a Formal Marine Policy: Should Section 22 be repealed?".

Driving force behind and aims of the project

From the Commissions' perspective, insurance contract law has not kept pace with the times and can produce results that fail to meet the expectations of the market. The Commissions acknowledge that for consumer insureds, there is a further degree of protection in the form of the Statements of Practice (originally issued by insurers in 1977, updated in 1986), the rules of the Financial Services Authority (FSA) which regulate the conduct of insurance companies and the provision by the Financial Ombudsman Service (FOS) of a dispute resolution service that makes decisions based on the criterion of what is "fair and reasonable".

However, the Commissions argue that these different layers of law, regulation and guidance make it difficult for both insurers and customers to understand the scope of their rights and obligations. The FOS does not, for instance, publish its decisions and many cases fall outside its jurisdiction (including claims over £100,000 and those requiring witnesses to be crossexamined). The Statements of Practice and the FSA rules do not apply to businesses and only those businesses with a turnover of less than £1 million are entitled to bring cases to the FOS.

The Commissions highlight the fact that aspects of the Marine Insurance Act 1906 (MIA) have previously been described as "unfair" because they defeat policyholders' reasonable expectations. If this persists, then, they argue, confidence in the market will be undermined both in the consumer and business markets. There is also the possibility that in the future the European Community will take steps to harmonise insurance contract law across Europe. Although this is not an imminent prospect, the Commissions have argued that the UK should aim to influence such a drive and that it will only be able to do so if the law in this jurisdiction ceases to be viewed as unfair and unusual.

Treatment of reinsurance

The Commissions' current position is that there is no need to create separate legal regimes for marine, aviation and transport classes or reinsurance. All, therefore, fall within the ambit of the Commissions' proposals as considered below.

First Joint Consultation Paper (July 2007)

The First Joint Consultation Paper is a substantial document containing numerous proposals and requests for further views from interested parties. We therefore concentrate on those that we consider to be most significant, before looking at the key proposals made in the fourth Issues Paper and raising a number of critical issues especially likely to affect reinsurance business in the London market. These include: misrepresentation and non-disclosure, warranties and intermediaries and pre-contract information.

A distinction is drawn between consumers and businesses in the Paper. Consumers are defined as "individuals who take out insurance for purposes wholly or mainly unrelated to their businesses". A new mandatory regime is proposed for consumer insurance, based largely on existing FOS guidelines. For business insurance, a new default regime is proposed, based on good practice. The Commissions acknowledge that these default rules could be altered by contractual terms, provided that the alterations are made clear to the business.

Pre-contract information: Misrepresentation and Non-Disclosure (Issues Paper 1, published September 2006)

The existing law relating to the "duty of utmost good faith", upon which insurance contracts are based, is comprehensively examined elsewhere in this text. In summary, the MIA explains the meaning of the duty and sets out the applicability of the principle in two areas: disclosure of material circumstances and the making of material misrepresentations (prior to the conclusion of the contract). The MIA specifies the remedy for breach, namely, avoidance of the contract, irrespective of whether the breach was made innocently, negligently or fraudulently. The definition of materiality is therefore crucial. Pan Atlantic Insurance Co. Ltd v Pine Top Insurance Co. Ltd [1994] 2 Lloyd's Rep 427 (HL) defined the test as follows: (1) A material circumstance is one that would affect the judgment of the (re)insurers in assessing the risk even if, in the end, it would not have a decisive effect on the (re)insurer's acceptance of the risk or on the amount of premium charged; but (2) Before a (re)insurer can avoid a contract it must be shown that the misrepresentation or non-disclosure in question actually induced the underwriter to subscribe to the contract on the relevant terms.

In the consumer context, some have considered this to be unfair (although, as described above, the strict legal position has been tempered in practice and many insured consumers do not therefore experience the full rigour of the law). The FOS currently determines disputes by looking to the mind of the policyholder at the time of the non-disclosure/misrepresentation. If the action was deliberate or reckless, the FOS permits avoidance. In cases of what the FOS terms "inadvertence" by the policyholder, the FOS may rewrite the terms of the contract to reflect those which would have been on offer had the insurer known the true position. Finally, if the policyholder's action was innocent, avoidance is prohibited.

The Commissions conclude that the FOS offers an accessible and fair method of consumer redress but that this cannot be a substitute for law reform for a number of reasons. Amongst these are the fact that some consumers and small businesses do not take their cases to the FOS and some insurers continue to ignore the Statements of Practice. In addition, there are significant inconsistencies between the applicable rules and regulations and the FOS's practice. For example, the FSA's Insurance Conduct of Business sourcebook requires that the consumer be warned about the duty to disclose, while the FOS puts the onus on the insurer to ask the correct questions.

The Commissions' most significant recommendations in the consumer context are: (a) The abolition of the duty of disclosure: the consumer should not be required to disclose matters about which no questions have been asked. Where the insurer asks general questions, it should have no remedy in respect of an incomplete answer unless a reasonable consumer would understand that the question was asking about the particular information in issue.

(b) Distinguishing the consequences of honest/reasonable failures to disclose/misrepresent from deliberate and reckless ones: a consumer's duty should now be to take reasonable care not to make misrepresentations to the insurer. The insurer may only avoid where it can demonstrate that: (i) the consumer made a misrepresentation in breach of its duty to take reasonable care; and (ii) the misrepresentation induced the insurer to enter the contract on the terms agreed.

(c) Making the remedy depend upon the proposer's state of mind: where the consumer has made a "deliberate or reckless" misrepresentation, the insurer may avoid. Where the consumer was careless only, the insurer should be put in the position it would have been in had the consumer complied with its duty to take reasonable care. If the consumer acted reasonably, the insurer should have no remedy.

In the business context, the Commissions propose a default regime whereby:

(a) The duty of disclosure continues to apply so that the proposer must disclose every material circumstance that is known to it (and is deemed to know every circumstance that, in the ordinary course of business, ought to be known to it). However, to avoid the policy for non-disclosure the insurer must either show: (i) that a "reasonable insured" in the circumstances would have appreciated that the fact was one that the insurer would have wanted to know; or (ii) that the proposer actually knew the fact was one that the insurer would want to know. Further, the non-disclosure must have induced the insurer to subscribe to the contract on the relevant terms.

(b) For any actionable misrepresentation, the insurer must show that: (i) the business insured made a misrepresentation; (ii) the misrepresentation induced the insurer to enter the contract; and (iii) the misrepresentation was one that a reasonable person in the circumstances would not have made. The Commissions also query whether the remedy of avoidance should be reserved for dishonest conduct or retained, in addition, for negligent non-disclosures and misrepresentations

Warranties and Basis of Contract Clauses (Issues Paper 2, published November 2006)

Warranties in (re)insurance contracts are considered in more detail elsewhere in this text. A key feature is that breach of a warranty, whether of existing fact or regarding future conduct or circumstances, automatically discharges an insurer from any further liability under a policy from the time of breach, irrespective of whether the insured acted fraudulently, negligently or innocently and regardless of whether or not the breach was subsequently remedied. The use in proposal forms of "Basis of the Contract" clauses sees the applicant warranting the accuracy of all answers in the proposal form, and so agreeing that those answers form the basis of the contract, elevating all statements in the proposal form into contractual warranties. The effectiveness of such clauses in the consumer context has been negated since the implementation of the ABI's Statements of Practice.

The Commissions call for the abolition of the Basis of the Contract clauses. They propose that fact warranties be treated as representations so that the insured cannot automatically avoid the contract and the available remedy depends on whether the breach was made recklessly, negligently or innocently.

As regards warranties as to future conduct or circumstances, the Commissions observe that existing law is at odds with civil law systems and many common law jurisdictions. In the consumer context, they propose that an insurer may refuse a claim for breach of warranty only if it had taken sufficient steps to bring the requirement to the consumer's attention and the consumer should be entitled to be paid a claim if it can prove, on the balance of probabilities, that the event or circumstances constituting the breach did not contribute to the loss.

The key proposal in the business context is that a business insured should be entitled to be paid a claim provided it can prove, on the balance of probabilities, that the event constituting the breach did not contribute to the loss. This would bring the law into line with the civil law systems.

Intermediaries and Pre-Contract Information (Issues Paper 3, published March 2007)

The Commissions have identified three main issues. First, if at the pre-contract stage the intermediary fails to disclose or misrepresents material information received from an applicant, what should the consequence be and who should be held to account? Second, if the intermediary enters incorrect information on a proposal form that is then signed by an applicant should the intermediary continue to be treated as the agent of the applicant and the applicant be bound by its signature? Third, section 19 of the MIA imposes an independent duty of disclosure on an insurance agent. Does the scope of the duty or the remedy for its breach need to be re-examined?

The consequences that flow from a pre-contractual non-disclosure or misrepresentation by an intermediary depend upon for whom the intermediary is acting – the insurer or the applicant. If for the insurer, the insurer will be deemed to have knowledge of the material information; if for the applicant, the insurer will not and will be entitled to avoid the policy. However, it can be very difficult to determine into which camp an intermediary falls. Most commonly they are viewed as agents of the insured. Equally commonly they are remunerated by the insurer. In addition, intermediaries can and do act in a dual capacity in dealing with any placement. There is even more scope for confusion at the reinsurance level where the broker may take on a multitude of roles for a variety of entities.

The Commissions have deemed the current position "unsatisfactory" for the consumer. Referring to instances where consumers have pursued lengthy claims against an insurer only to be told that they should have been pursuing the intermediary, they conclude that the insurance industry is being brought into disrepute. They state that the law (and the FOS's practice) must meet the reasonable expectations of the consumers. The Commissions propose that the intermediary should be regarded as the insurer's agent for the purpose of obtaining pre-contract information, unless the intermediary is genuinely searching the market on the insured's behalf.

Single-tied and multi-tied agents are to be deemed agents for the insurer. The insurer's remedy for their fraudulent/negligent acts would be against their agent rather than avoidance of the policy. Defining concepts such as "multi-ties" and "searching the market" may also prove a challenge. The Commissions have questioned if an intermediary should be compelled to inform a consumer whether its advice is based on a "fair analysis" (as defined by the Insurance Mediation Directive 2002/92/EC). This would entail the intermediary confirming that the policy in question was recommended as meeting the applicant's needs following an analysis of a "sufficiently large" number of insurance contracts available on the market.

The proposal is to treat small businesses in the same way as consumers but to maintain the status quo as regards the business insureds. There are a number of reasons for this: the sophistication of the (larger) business insured; the fact that such business contracts are rarely sold through tied or multi-tied agents; and the reality that brokers are frequently the ones who conceive of and sell the insurance product in question to both the insurer and insured. In such circumstances it would be unfair automatically to attribute the misdeeds of the broker to the insured or the insurer.

The Commissions question whether an intermediary who would normally be regarded as acting for the insurer in obtaining pre-contract information should remain the insurer's agent while completing a proposal form. They propose that the insured's signature on an erroneous proposal form should not be regarded as conclusive evidence of the insured's dishonesty in the way that the proposal form was completed. The burden would, however, remain on the insured to establish that the error on the form was the fault of the intermediary. The Commissions propose that the same changes should be made vis-à-vis business insureds. However, the latter proposal should not reduce the effect of a warranty of fact given by a business insured.

Section 19(a) of the MIA imposes an independent duty on agents effecting insurance to disclose every material circumstance that is known to them and they are deemed to know every circumstance that in the ordinary course of business ought to be known by or communicated to them. The insurer's remedy for breach is avoidance of the policy. The Commissions consider this wrong in the consumer context because the remedy lies against the innocent insured rather than the perpetrator of the breach. They propose that this section ceases to apply to consumer policies or, in the alternative, that the current remedy be replaced with a remedy in damages against the intermediary. The Commissions acknowledge that the point may be of academic importance only: they have found no examples of an insurer relying on section 19(a) in a consumer case.

In the business context, the Commissions likewise suggest the replacement of the insurer's right to avoid with a right to claim damages from the agent. They question whether the right to such damages should apply whenever insurance contracts are placed within the UK, or only where the contract is subject to the law of a part of the UK. The Commissions raise several other interesting questions: whether producing brokers should be obliged to pass relevant information up the chain to placing brokers and whether the law should specifically state that an intermediary is not required to disclose information given to it in confidence by a third party. Section 19(b) of the MIA requires the agent to disclose every material circumstance which the insured is bound to disclose, unless it came to the insured's knowledge too late to communicate it to the agent. The Commissions question the usefulness of this provision given that the only remedy available to the insurer is avoidance of the policy, a remedy that would be available to it because of the insured's non-disclosure in any event.

For further discussion on the status of intermediaries, please click here to access our article "Statutory code plan intermediary status clarification system", first published in Insurance Day on 1 May 2009.

Cost/benefit analysis

The Commissions have confirmed their intention to provide an analysis of the costs and benefits of their recommendations in their final report. In the meantime, they have commissioned an independent economic consultancy firm, London Economics, to develop a possible methodology for assessing the impact of the Commissions' proposals. London Economics' report is appended to the First Joint Consultation Paper. It concludes that:

The Commissions do, however, concede that they do not currently have sufficient robust data to quantify the effects of their proposals with precision.

Issues Paper 4: Insurable Interest (published January 2008)

The Commissions' fourth Issues Paper contains their proposals for the reform of the law of insurable interest in relation to both indemnity and non-indemnity insurance. We consider both in turn below.

Indemnity insurance

The "indemnity principle", which under English law is applicable to all policies of indemnity insurance, states that a policyholder is only entitled to compensation for a loss that it has actually suffered. The compensation cannot exceed the quantum of the loss. The policyholder must therefore have an interest in the subject matter of the insurance at the time the loss occurs. If the policyholder does not have this interest, the policy will be valid but the policyholder will not be able to recover under it.

The indemnity principle is legally distinct, but not always easily distinguishable from the need for an insured to show an "insurable interest". The Commissions explain that this requirement originates from 18th century legislation, designed to help define insurance contracts and distinguish them from other, morally questionable transactions, principally gambling. Another motive was to protect against moral hazard (the incentive to deliberately destroy the insured subject matter).

Over the years, case law has attempted to establish what does or does not amount to an insurable interest. This varied according to what was being insured. Following the decision in Feasey v Sun Life Assurance Co. of Canada [2003] Lloyd's Rep IR 637 the Commissions suggest that the strict requirement for a policyholder to demonstrate an interest in the insured subject matter has been interpreted more leniently.

On 1 September 2007 the Gambling Act 2005 came into force. In light of this legislation, the fact that a contract relates to gambling no longer prevents its enforceability. The Commissions are of the opinion that the Act has inadvertently changed the law in respect of insurance contracts and that they may now be enforceable even if there is no insurable interest. There is, however, no suggestion that the Act dispenses with the indemnity principle.

The Commissions have queried whether the requirement for insurable interest for indemnity contracts is necessary. Would the "reintroduction" of this requirement serve any further legitimate purpose? Given the blurred, often indistinguishable line between what is required to satisfy the indemnity principle and what amounts to an insurable interest, the Commissions tentatively conclude that no benefit would be gained from its reintroduction. The Commissions considered whether an insurable interest is necessary to identify insurance for regulatory and other purposes. Responses received from financial and regulatory bodies suggest it is not. There are a range of other identifiers that are currently applied to distinguish insurance from other contracts.

A further query raised by the Commissions is whether a legal requirement should be introduced on insurers to check that policyholders have an expectation or a chance of loss at the outset of the contract. Insurers raised a number of concerns about this issue during the consultation process and queried how it would work in practice.

Non-indemnity insurance

The most common forms of non-indemnity insurance are life, critical illness and personal accident (referred to here as life business). With these types of cover, policyholders are entitled to payment of an agreed sum upon the occurrence of a defined event, ie, the death of, illness or accident involving the policyholder.

Life business continues to be governed by 18th century legislation, namely the Life Assurance Act 1774, the principal aims of which were twofold: to distinguish between insurance and wagering contracts and to protect against moral hazard (the incentive to destroy the subject matter of the insurance). Pursuant to the 1774 Act, life insurance contracts made without an insurable interest or as wagers are void. Subsequent case law has gone further and the current position is that such contracts are illegal. The 1774 Act does not, however, state that this interest must be continuing at the time of loss. Nor does it indicate what type of insurable interest is required.

The essence of the doctrine is that the individual taking out the cover should either gain a benefit from the preservation of the insured subject matter or suffer a disadvantage were it to be lost. Legal developments since 1774 have left us with four categories of insurable interest that will satisfy the requirement in the context of life business:

(1) interest arising out of natural affection;

(2) interest arising out of a potential financial loss that is recognised by law and can be shown at the time of the contract;

(3) interest arising out of statutory provisions; and

(4) interest recognised by the courts that does not fit into any of the above.

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