In The Insurance Act 2015: A Banking Case Study, published in the previous edition of the Banking and finance disputes review, we commented on the absence of a provision in the Insurance Act 2015 entitling a bank insured to contractual remedies (including damages) in the event of late payment or an unreasonable refusal by insurers to pay insurance claims. While the government had omitted such a clause from the Act given the opposing views of a number of stakeholders, it promised to introduce such a clause in legislation once a solution had been agreed.
It has now done so. Part 5 of the Enterprise Bill (the Bill), introduced in the House of Lords on 16 September 2015, provides for the insertion into the Act of clause 13A which largely mirrors the wording proposed by the Law Commissions of England and Wales and of Scotland (the Commissions). If this amendment to the Act is successful, it will come into force a year later – that will be some time after August 2016 (when the Act as originally passed comes into force).
As discussed in our previous article, claims by banks may involve complex issues of compliance, knowledge and disclosure, that lead to lengthy investigations by insurers. These are exactly the circumstances where this amendment should rebalance the position between insurers and bank insureds.
In this article, we first 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 of insurance law, before providing a summary of clause 13A, addressing the likely areas of dispute that may arise out its current drafting.
The current position and reasons for reform
The normal position 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 insurance contracts fall outside this rule. In English law, an 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 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)  AC 395).
The operation of the “hold harmless” principle is clearly illustrated in Sprung v Royal Insurance (UK) Limited  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.
The Commissions’ report on insurance law reform in July 2014 set out a number of reasons for changing the unfairness illustrated by Sprung, including the following:
- The notion that an insurer’s primary obligation under a contract of indemnity is to prevent the insured loss from occurring does not reflect commercial reality. Insureds expect to have a contractual right to a payment in the event of a loss;
- The current position unfairly favours the interests of 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 insureds. 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 insurers to pay claims promptly and allow for damages to be paid to policyholders who have suffered loss as a result of late payment. However, the introduction of the Commissions’ proposal in the Bill has come as a surprise to the insurance industry which opposed the introduction of such a remedy as drafted in clause 13A. The industry was against the inclusion of such a requirement on the basis that it would impair insurers’ ability to investigate claims thoroughly before taking a decision on liability and make it almost impossible to calculate future liabilities.
Clause 13A makes it an implied term of every contract of insurance that, following a claim, the insurer must pay sums due under an insurance policy “within a reasonable time”. Failure by the insurer to do so will entitle the insured to pursue the remedies available under contract law, including damages, and those remedies shall be separate to the insured’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 an insurer can show that there were reasonable grounds for disputing a claim or its quantum. The 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 an insurer in handling the claim when deciding whether a breach has nonetheless occurred.
While contracting out of the remedies available for breach of the implied term is prohibited for consumer insurance contracts, it will be possible to contract out for non-consumer contracts, although any attempt to do so will be invalid if the 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 Act (see further below).
Likely areas of dispute
What is a “reasonable time”?
This was one of the key areas of concern for stakeholders during the consultation process, 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.
The explanatory notes to the Bill explain that some types of insurance, such as business interruption, are likely to take longer to assess than simple claims for property damage. Factors beyond the 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 insurer.
It is inevitable that the scope of this wording, if incorporated into the Act in its current form, will be the subject of dispute. Its interpretation will also be of fundamental importance for determining when the breach of contract occurs, for the purposes of limitation of actions. The courts, aided by expert evidence, are likely to expand on the above factors and add additional ones, and for a market as diverse as the insurance industry, a range of standards is likely to emerge.
The insurer’s defence
Establishing coverage under an 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 an insurer should be afforded an appropriate amount of time to be able properly to 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.
Again, the courts will have to determine what should constitute reasonable grounds for disputing a claim, as well as the types of conduct by the insurer and any other factors which could negate the defence.
Has an insurer successfully contracted out?
Another area of uncertainty, and therefore one which is likely to end up being the subject of dispute, is whether the parties to an insurance contract have effectively contracted out of the remedies available under clause 13A. Pursuant to clause 16A (also introduced by the Bill) and clause 17 of the Act, an insurer attempting to include a term in a policy which puts an insured 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 insured’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 insured involved, and the circumstances of the transaction in determining whether these requirements have been met. For example, in the case of a small business purchasing insurance, the insurer might be expected to be more proactive and take more steps to bring the term in question to the insured’s attention than it would have to if the insured is a large business and a sophisticated buyer of insurance.
The drafting of any term in an 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 insurer to contract out, if that insurer deliberately or recklessly breaches clause 13A then its attempt to contract out will be ineffective.
Financial institutions will welcome the reform allowing damages for late payment of insurance claims. Complex insurance claims under a bank’s D&O liability, for instance, are susceptible to delay in payment while the insurer investigates and difficult arguments of construction of the policy are resolved. The old rule was becoming increasingly anomalous as the Financial Ombudsman Service will frequently compensate consumers for distress and inconvenience caused by late payment and Financial Conduct Authority rules (Insurance Conduct of Business Sourcebook (ICOBS) 8.1.1.R) require insurers to handle claims promptly and fairly.
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 insurers to pay sums due under insurance policies within a reasonable time (within the context of the wider reforms introduced by the Act) is no different. These issues and uncertainties will have to be addressed over time by the courts, legal practitioners and the market, and while the precise mechanism of the obligation may yet change during its passage through the legislature, financial institutions should obviously monitor any consequential changes to the wordings of policies they purchase.