UK: Insurance Contract Law Reform And The Perils Of Inertia

Originally published in the Insurance Law Quarterly - Spring 2006 - Issue 62

The Law Commission has confirmed that its latest review of insurance contract law will review the law relating to nondisclosure and breach of warranty. Comment is now sought on the merits of 17 further topics, ranging from the need for a definition of insurance, insurable interest and unjustifiable delay in claims settlement through to post-contractual good faith and the treatment of fraud.

On 18 January 2006, the Law Commission issued a scoping paper inviting views upon the areas of insurance contract law which should be reviewed with a view to possible reform. Non-disclosure and breach of warranty will be reviewed, and views are sought on which other further topics should be included in the process.

Most of the topics suggested for review involve perceived unfairness to the policyholder, although some reforms might benefit insurers or reinsurers.

The last statutory codification of insurance law was the Marine Insurance Act 1906. Reports over many years have recommended reform, including those of the Law Reform Committee (1957); the Law Commission (1980); the National Consumer Council (1997); and BILA (2002).

The Law Commission’s last call for reform did not produce any. Instead the Government favoured self-regulation by the insurance market, which saw the introduction of the ABI’s Statement of General Insurance Practice and the creation of the Insurance Ombudsman Scheme, latterly the Financial Ombudsman Service. More recently, further measures have been introduced such as the Insurance Conduct of Business rules.

As such schemes have evolved, those policyholders who fall outside their ambit are obliged to comply with legislation seen as outdated, however much refined by case law. The Law Commission itself asks the question: how can it be acceptable that an insurer exercising its legal rights may still face orders to pay compensation and even fines?

Methods adopted for the placement of covers are undergoing constant change. Cover may be ever more specialised and sometimes novel in form. It is important not to disturb those areas where legal idiosyncrasies have been satisfactorily overcome and due allowance has been made for the respective knowledge and resources of the parties involved. The views of all corners of the market therefore need to be taken into account, including the reinsurance market.

The Law Commission specifically questions whether its review should apply to reinsurance.

If reinsurance is excluded, is there a concern that risks faced by an insurer would not match those of their reinsurers? Reinsurers are affected both by changes to their own and their reinsureds’ assumed contractual responsibilities. Many of the concerns prompting calls for reform apply far less obviously, however, to the making of reinsurance contracts.

Six areas of concern have prompted the review of non-disclosure: (i) a failure to reflect the changed relative knowledge of a risk between insurer and applicant; (ii) the difficulty of a consumer applicantunderstanding the requirements of a prudent underwriter; (iii) the lack of any obligation upon an underwriter to ask questions; (iv) the "all-or-nothing" remedy in the form of avoidance; (v) the lack of significant distinction in the consequences of innocent, negligent and fraudulent non-disclosure; and (vi) the absence of the need for any causal link between any non-disclosure and a loss which occurs.

Consumer and small business purchasers of insurance products have had reason to take issue with the potential harshness of the law in this area. Given that the purchaser of reinsurance is itself an insurance carrier, often employing a professional broker, there is less obvious need for statutory protection where parties are capable of negotiating what duties of disclosure are to be observed and what warranties are agreed in full knowledge of upon what, potentially different, terms any underlying risks have been accepted.

There are many challenges presented by supposedly more readily accessible information being available to all parties at placement, but the case for a cedant to be excused shortcomings in its own presentation or that of its agent is certainly less compelling than with a purchaser who has no familiarity with insurance.

In turn, the question raised of whether a reinsurer (or insurer) should be obliged to pay compensatory damages for any unjustifiable delay in settling a claim may be complicated, for example if there has been a dispute over access to records.

In reviewing warranties, the Law Commission is reflecting concern that there is presently no need for a causal connection between any breach and loss; and the impact of "basis of the contract clauses" (designed to make warranties of all answers given upon a proposal form regardless of their intrinsic importance).

In the case of most reinsurance contracts, the parties are fully aware (and encouraged to record clearly in their wordings), what they seek to have warranted and to leave no doubt about the consequences of any breach. Many of the cases involving breaches of warranty which have most exercised the courts have involved relatively blameless insureds.

A legitimate requirement for reinsurers (as for many insurers) when agreeing a contract of reinsurance is that there should be an adequate deterrent against cedants deriving benefit from reinsurance provided on a false premise. This may perhaps have allowed cover at too low a premium, which is capable only of retrospective correction in the event of later discovery. Any denial of future liability would then only be permitted if the breach in question was connected to the actual loss.

The path to insurance contract law reform remains long and uncertain. In the case of reinsurance, many identified areas of concern appear less compelling. It would be unwise, however, for those involved in the market simply to do nothing in the hope that they may continue to benefit where the law is perceived as operating to the unfair detriment of a policyholder. The prospect of European harmonisation of insurance contract laws looms and any benefits presently enjoyed by carriers may yet be denied. Where the case for resisting or shaping reform is cogent, the longer-term perils of inertia may prove most unwelcome.

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