Better late than never

Much to the surprise of many who had been following the progress of insurance contract law reform in the UK, the Consumer Insurance (Disclosure and Representations) Bill had its first reading in the House of Lords on 16 May. This first stage is a formality which signals the start of the Bill's journey through the House of Lords. The second reading opens the general debate on all aspects of the Bill, which will begin its passage through Parliament in the Lords before reaching the House of Commons.The date for the second reading is yet to be scheduled. Many had thought it unlikely that the Bill would get parliamentary time and another opportunity to reform insurance law for consumers would be lost.

The Law Commissions of England and Wales and of Scotland began their review of insurance contract law in 2006. Calls for reform of the law on misrepresentation and non-disclosure in insurance contracts are not new. A law reform committee first recommended reform in 1957, followed by further calls in a 1980 report. Indeed, the 1980 English Law Commission report described reform to the law of insurance contracts as “too long delayed”.

There has been widespread support for reform in the area of consumer contracts as the existing law can have harsh consequences on a public largely oblivious of their legal obligations. Insurers, brokers, consumer groups, lawyers and the Financial Ombudsman Service (FOS) have all recommended legislative reform to clarify these obligations. For many years industry practice guidelines and the FOS’s approach to resolving complaints have been out of sync with the strict letter of the law; resulting in two alternative approaches in law and in regulatory and market practice.

The current law, set out in the Marine Insurance Act 1906 (MIA) requires prospective insureds to volunteer information about the risk they are seeking insurance for. Section 18 of MIA requires insureds to disclose those “material circumstances which would influence the judgement of a prudent insurer in fixing the premium, or determining whether he will take the risk”. Failure to do so can allow the insurer to avoid the contract. At present there is no obligation in law for the insurer to ask questions in relation to those facts he wishes to know. Thus a consumer must ask themselves what information a professional underwriter would wish to know. Very few consumers are even aware of this duty; and, if they are, do not have the means to know what information they are required to volunteer to the insurer. The current law does not take into account what a reasonable consumer might think relevant to disclose.

The 1906 law was drafted in an age when insurance contracts were almost invariably conducted through brokers who had capacity to advise their customer of their obligations towards the insurer. This is no longer the case. Consumers currently buy a significant proportion of insurance policies through aggregator websites or directly though the insurer - a fundamental shift in the nature of pre-contractual negotiations.

MIA further imposes a duty upon insureds not to misrepresent the information which they do tell the insurer (section 20 of MIA). Any misrepresentation will allow the insurer to avoid the contract. The law will recognise a distinction between a misrepresentation of a fact and an honestly held expectation or belief which then proves to be untrue. Nevertheless, the resulting consequences of an inadvertent misrepresentation (as with a non-disclosure) can be severe where an apparently minor mistake invalidates an insured’s claim.

The Bill proposes to change the nature of the parties’ pre-contractual negotiations so that insurers are obliged to ask those questions about the risk they want to know. In response, consumers will be under a new duty to take reasonable care to answer the questions asked by the insurer fully and accurately.

Where a consumer has made a mistake in answering the insurer’s questions, the Bill makes a distinction between “careless” and “deliberate or reckless” misrepresentations. The remedy which an insurer will have in the event of a misrepresentation will depend upon the category of mistake. This new classification of misrepresentations will give legislative effect to the approach currently taken by the FOS. The remedies for the various types of misrepresentations are as follows:

• Where the misrepresentation was deliberate or reckless, the insurer may refuse the claim. A statement will be deliberate or reckless if the consumer knew that it was untrue or misleading or did not care that it was so and knew that the matter was relevant to the insurer. Following a deliberate or reckless misrepresentation the policy will be treated as if it had never existed and all claims by the insured can be refused. This approach is like that taken under the current law, although the insurer will now be able to retain any premium unless there are compelling reasons for this to be returned (for example in certain life policies containing an investment element). The retention of premium and avoidance of the policy retains the penal element currently included to dissuade consumers against deliberately or recklessly misleading insurers.
• Where the misrepresentation is merely careless, the Bill provides for a proportionate remedy which will reflect the position that the insurer would have been in had the true facts had been known. It is for the insurer to show that a misrepresentation was deliberate or reckless, otherwise it will be deemed merely careless. Under the current law, insurers are able to avoid the entire policy for an innocent misrepresentation with potentially severe consequences for the insured. The Bill provides the insurer with a compensatory remedy. Therefore, where the insurer would have excluded a particular type of claim, the insurer should not have to pay claims falling within this exclusion. Where a warranty or excess would have been imposed, the resulting claim should reflect the policy had such a warranty been included. Where the insurer, on knowing the true facts, would have charged a higher premium, a proportionate settlement should be given to the insured. Finally, where the insurer would have declined the risk altogether, the policy may be avoided and the premium returned. 

The proposed new law retains the requirement that the insurer must have been induced by the misrepresentation (as set out in Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd [1995] 1 AC 501). Therefore, under the proposed Bill, the insurer will still have to demonstrate that without the misrepresentation, it would not have entered into the contract at all - or at least on the same terms. However, the new law no longer requires the insurer to prove that the misrepresentation would have influenced the judgement of other underwriters in the market. It will be enough for the insurer to show that they were so induced and that a reasonable consumer would not have made such a mistake.

The Bill requires that insureds take reasonable care not to make a misrepresentation. The standard of care will be that of “a reasonable consumer” but an additional element is added which demands that the insurer should take into account the actual circumstances of the individual consumer where they are aware of them. It further includes an additional specification to clarify that a dishonest misrepresentation (even if reasonable to the average consumer) will always be unreasonable. This prevents the more knowledgeable person relying upon the excuse that a less well informed consumer would not have known the significance of a particular fact.

As mentioned above, consumers are required to take reasonable care not to make any misrepresentations. However, the Bill will take into account certain circumstances which will affect the degree of care that should be taken. The following must be taken into account:  

• the type of consumer policy and its target market;
• any relevant explanatory material or publicity produced or authorised by the insurer;
• how clear and specific the insurer’s questions were; and
• whether or not an agent was acting on the insured’s behalf.

The Bill has largely followed the approach taken by the Financial Services Authority (FSA) and various EU directives in their definition of a consumer insurance contract which covers contracts taken out for purposes “wholly or mainly unrelated to the individual’s trade, business or profession”.  However, one key distinction is that the definition will extend the application of consumer law to certain mixed contracts.

The Bill introduces a statutory determination of when the intermediary will be considered to be acting for the insurer rather than the insured. This matters in those circumstances where it is the intermediary who has acted carelessly or recklessly in transmitting the insured’s information to the insurer.

If the intermediary acts for the consumer, any mistake in the information presented via the intermediary to the insurer will be the responsibility of the consumer. However, where a mistake is made by an intermediary acting for the insurer, any claim must be paid in full. 

In its 2007 Consultation Paper on reforming consumer insurance law, the Commissions proposed a single bright line test to determine whether an intermediary acted for the consumer or the insurer. The Commissions’ initial view was that, unless an intermediary clearly acted for the consumer, they should be taken to act for the insurer. In response to considerable criticism of this approach, Schedule 2 of the Bill now states that an intermediary will be acting for the insurer in the following circumstances:

• where the intermediary is the appointed representative of the insurer;
• the insurer has given the intermediary express authority to collect the information as its agent; or
• the insurer has given the intermediary express authority to enter into the contract on the insurer’s behalf.

In other cases the intermediary is presumed to act for the consumer unless, in light of relevant circumstances, it appears that they act for the insurer. The Schedule sets out factors which will tend to show whether the agent is acting for either the insurer or the insured.

The Bill abolishes “basis of the contract” clauses by stating that any representation made by a consumer is not capable of being converted into a warranty by means of a provision of the contract. Basis clauses have been criticised for many years and their use was prevented under the Association of British Insurer’s 1986 Statement of General Insurance Practice (withdrawn in 2005). The FSA rules do not directly outlaw basis clauses, even though their application to consumers would fall foul of the FSA’s Principle 6 (which requires firms pay due regard to the interests of its customers and treat them fairly). In their research, the Law Commissions found numerous examples of the continued use of basis clauses in consumer contracts; the Bill would unequivocally remove these onerous terms from consumer policies.

Special provisions are included in the Bill for group insurance schemes. Under section 7 of the Bill, where a misrepresentation is made by a group member of a scheme there will only be consequences for that individual, rather than for the group as a whole. Group policies such as those made by businesses on behalf of their employees do not usually fall within the consumer regime. The proposals ensure that any dispute about a misrepresentation made by a person entitled under the group policy will be treated in accordance with the consumer rules.  

In addition to the proposals for group policies, the Bill establishes that where a consumer takes out insurance on the life of another person, and information is provided by the person insured (but not the policyholder) to the insurer, any misrepresentations will be treated as though they were supplied by a party to the contract. Under the current law, should the person insured make a misrepresentation (for example about their state of health) the insurer is not entitled to any remedy as only the policyholder is under a duty not to misrepresent information. In the absence of basis of the contract clauses, the insurer is offered no protection in such circumstances. The Bill addresses this potential problem by placing both the policyholder and the insured under the duty to take reasonable care not to misrepresent information.

It is believed that pressure from Europe to harmonise consumer insurance contracts has prompted the Bill’s introduction into the Parliamentary timetable. We will continue to inform you about the Bill’s progress through Parliament - implementation is anticipated in 2013.