Following a consultation period last year, the Treasury released draft legislation to extend the unfair contract terms regime to insurance contracts. In releasing the draft legislation, the government has reaffirmed its commitment to implementing all 76 recommendations from Commissioner Hayne’s Royal Commission Final Report.
The draft legislation comes during a time of significant regulatory change in the Australian insurance industry. Insurers are already grappling with implementation of product design and distribution obligations, changes to internal dispute resolution processes, and potential regulation of claims handling. Furthermore, the Australian Financial Complaints Authority (AFCA) has set the stage for what the Hon Helen Coonan (Chair of AFCA) called a ‘fairness revolution’.1 At the heart of this change is an intense focus on putting the customer at the centre of all decisions.
What is the unfair contract terms regime?
The unfair contract terms regime was introduced in 2010 to protect consumers from unfair contract terms in standard form contracts. Under section 12BF of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act), a term of a ‘consumer contract’ or ‘small business contract’ is void if three essential elements are met:
- the term is unfair;
- the contract is a standard form contract; and
- the contract is a financial product, or a contract for the supply, or possible supply, of services that are financial services.
When the regime was first introduced, it was decided insurance contracts would be exempt as they were governed by the Insurance Contracts Act 1984 (Cth) (ICA), which already has a number of protections for customers. By amending section 15 of the ICA as proposed in the draft legislation, insurance contracts that are also consumer contracts or small business contracts will be subject to the regime in the ASIC Act.
Provisions governing the insurance contract will therefore reside outside the ICA, upsetting the longstanding position that the ICA operates as a single code governing the insurance contract.
It will be interesting to understand when an insurance contract will not be a standard form contract. For example, the small business insurance market is heavily intermediated. Brokers frequently negotiate with insurers on policy wordings, seeking specific endorsements. The Explanatory Memorandum to the draft legislation suggests that in some circumstances, negotiated insurance policies will not be standard form contracts.
What is the meaning of ‘unfair’?
Under section 12BG of the ASIC Act, a term of contract is unfair if it:
- would cause a significant imbalance in the party’s rights and obligations arising under the contract;
- is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
- would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.
A court must take into account all relevant matters, including the extent to which the term is transparent, and the contract as a whole. In the draft Explanatory Memorandum, the Treasury suggests the following terms could be unfair in the insurance context:
- a term that allows the insurer to settle a claim with a cash payment according to the cost of the repair to the insurer, rather than how much it would cost the customer to make the repair; and
- a term that allows the insurer to require the insured to pay an excess before the insurer pays the claim.
What terms are protected?
However, not all terms of a contract are captured by the regime. Under section 12BI of the ASIC Act, the regime does not apply to terms of a contract that:
- define the main subject matter of the contract;
- set the upfront price payable under the contract; or
- is a term required, or expressly permitted, by a law of the Commonwealth or a State or Territory.
For insurance contracts there has been significant debate about what is the main subject matter, as the concept is currently undefined for financial products. Commissioner Hayne’s view is the main subject matter of an insurance contract is the description of what is being insured and nothing else. This narrow interpretation has been expressly adopted in the draft legislation despite opposition from the Insurance Council of Australia and other stakeholders. If the draft legislation is adopted, it will mean the regime will apply to all policy exclusions and conditions.
Policy exclusions will in almost all cases cause detriment if applied. There is a legitimate concern that insurers may be forced to justify every exclusion, with regulators acting as quasi underwriters.
What should insurers do?
Following the Royal Commission there has been intense focus on ensuring products are suitable for the customers to which they are sold. Product design and distribution obligations are already law and will take effect from April 2021. These obligations will require insurers and other financial institutions to ensure each product has a defined target market and the product is suitable for those in the type of market.
Insurers should take a holistic view when implementing regulatory change. This will not only reduce duplication of effort, but ensure that processes are in place across the business. By putting the customer first, insurers are more likely to land on the right answer when navigating the new laws. Although unfair contract terms have been in place in the financial services industry for some time, insurance contracts operate differently and will continue to be subject to the ICA. A specific insurance-focused lens is therefore required when implementing these laws. We will be keeping a close eye on the consultation process and final legislation.