INSURANCE CONTRACT LAW REFORM Manchester Claims Association – 5 th July Christina Sparks

1. INSURANCE CONTRACT LAW REFORM Manchester Claims Association – 5th July Christina Sparks

2. Introduction and Consumer Insurance (Disclosure and Representations) Act 2012

3. Project timeline • 2006 – Scoping study led to decision for a phased programme. • July 2007 – First Consultation Paper on pre-contract disclosure and misrepresentation. • December 2009 – Report on Consumer Insurance Law: Pre-contract disclosure and misrepresentation. • December 2011 – Second Consultation Paper on post contract duties and other issues. • March 2012 – the Consumer Insurance (Disclosure and Representations) Act 2012 received Royal Assent. • June 2012 – Third Consultation Paper on business insurance and warranties – responses by 26 September 2012. • End 2013 – Publish final draft Bill.

4. Project breakdown • Divide Project into 3 – • Consumer pre-contract, • Post–contract matters and other topics, and • Business pre–contract and warranties • Consumer/business divide unusual for insurance law but normal elsewhere. • Reflects market, FSA, FOS practice. • Economic and social policy reasons for split.

5. Consumer Insurance (Disclosure and Representations) Act 2012 • Active market participation has produced workable solution to 50 year old problem. • Like 1906 Act codifies existing rules. • Royal Assent March 2012. • Implementation scheduled March 2013.

6. Definition of consumer and consumer insurance contract Section 1 An individual – so a natural person who enters into the contract wholly or mainly for purposes unrelated to trade, business or profession. contract between the individual and a person who carries on the business of insurance. No contracting out.

7. No Duty to Disclose without Questions Section 2(4) substitutes any duty relating to disclosure (Marine Insurance Act 1906, section 18) with a new statutory duty. Section 2(2) - the consumer must take reasonable care not to make a misrepresentation. Otherwise “Qualifying Misrepresentation”. Section 3 sets out test for reasonable care. Objective but determined in the light of all relevant circumstances. [NB relevance of insurers’ questions] Section 3(4) – particular circumstances or characteristics of which insurer aware (or ought to have been) taken into account. If consumer takes reasonable care – no breach. Claim paid.

8. Qualifying Misrepresentations Qualifying misrepresentation (section 4) is one made in breach of duty to take reasonable care. Deliberate/reckless:- insured knew (or did not care) statement untrue or misleading and knew the matter (or did not care) relevant to insurer. [“must have known”] Careless if not deliberate or reckless. [“ought to have known”] Dishonest misrepresentation always lacks reasonable care. The misrepresentation must induce the insurer to enter into the contract at all or on the particular terms it did. Only remedies available are those provided by Act (schedule 1)

9. Insurer’s Remedies Remedies – schedule 1 Deliberate/reckless - insurer may avoid and refuse all claims. Need not return premium (unless unfair e.g. investment not risk transfer). Careless – proportionate remedy based on what the insurer would have done had the consumer complied with the duty. If insurer would not have entered contract – avoid. If entered on different terms (not premium) contract treated as if on those terms e.g. excess, exclusions or warranties. If charged higher premium – reduce claim proportionally. Statutory formula to calculate reduction.

10. Other bits and bobs Section 6 bans “basis of the contract” clauses from consumer contracts. These convert all answers in a proposal form into contractual warranties. Section 7 Group Insurance:- where a member of a group scheme makes a misrepresentation this will not avoid the whole policy but will only have effect on cover for that individual. Section 8 Life insurance on the life of another – person being insured is now under a duty not to make a misrepresentation. Section 9 preserves normal agency law – presumption agent of consumer for these purposes unless authorised representative or cover holder. Schedule 2 provides guidance in other circumstances. Future proofing important – principles not list.

11. Third Consultation: The Business Insured's Duty of Disclosure and the Law of Warranties Business proposals: misrepresentation and disclosure

12. Introduction • S 17 Marine Insurance Act 1906 – utmost good faith. • S 18 MIA– duty of disclosure. • S 19 MIA – Brokers’ duty of disclosure. • S 20 MIA – Representations. • Ss 33 – 49 MIA – Warranties and Voyage Conditions. • Inducement post Pan Atlantic • Associated case law.

13. Current law - MIA 1906 • Contracts of utmost good faith. • Proposer must disclose every “material circumstance” a prudent underwriter wants to know. • If questions - “material representations” must be true. • Failure to disclose or a misrepresentation – insurer can avoid policy. Only statutory remedy. • Warranties – must be strictly complied with whether material to the risk or not. Breach cannot be remedied. • Breach of warranty - insurer is “discharged from liability” from date of breach.

14. Disclosure - what happens elsewhere? • Australia – retains duty disclosure but “materiality” as considered by “reasonable insured” + proportionate remedies. • New York – duty of disclosure only for marine and reinsurance – for other types remedy if misrepresentation or “wilful concealment”. • Eire – retains duty but balanced by a duty on insurers to carry out reasonable investigations. • France, Germany, PEICL – insurer must ask questions.

15. Consultation proposals- business • Two policy areas to consider: 1) pre-contract. What is relevant? Who should know what? How (or who) decide(s) materiality? Who does what? (reasonable insured vs prudent underwriter) 2) “remedies” or post contract – what happens if…? • 2007 Consultation - - 50:50 for changes to materiality tests and even split insurers and insureds. - 60:40 for remedies but mixed views. - The 40% concerned about remedies often proposed alternatives i.e. “no but….”

16. Disclosure and materiality • Inclined to follow thrust of consultation response. Insufficient support for pre contract change + difference reasonable insured advised by reasonably competent broker vs prudent underwriter likely to be minimal. Therefore evolutionary approach: • Retain duty of disclosure. Familiar, may reduce cost. • Retain current law on materiality (prudent underwriter survives). Reasonable insured uncertain test. • Codify inducement (as per consumer bill). Insurer must show information relevant to its decision. • Update s 18 to clarify responsibilities.

17. Update s18 MIA? S 18 (1) ….the assured must disclose to the insurer,….every material circumstance which is known to the assured and the assured is deemed to know every circumstance which, in the ordinary course of business, ought to be known by him. S 18(2) Material circumstance = something which would influence judgment of prudent insurer in fixing premium, or determining whether he will take the risk. S18 (3) In the absence of enquiry the following circumstances need not be disclosed, namely:- (a) Any circumstance which diminishes the risk; (b) Any circumstance which is known or presumed to be known to the insurer. The insurer is presumed to know matters of common notoriety or knowledge, and matters which an insurer in the ordinary course of his business, as such, ought to know; (c) Any circumstance as to which information is waived by the insurer; (d) Any circumstance which it is superfluous to disclose by reason of any express or implied warranty. Update to cover recent case law and phrase in C21st language? In particular s18 (1) and (3) (b) and (c).

18. Nothing new? • Insuranceis a contract upon speculation. …the underwriter trusts to his (the proposer’s) reputation, and proceeds upon confidence that he does not keep back any circumstance in his knowledge, to mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risque, as if it did not exist. • If he (the underwriter) thought that omission was an objection at the time, he ought not to have signed the policy with a secret reserve in his own mind to make it void; if he dispensed with the information, and did not think this silence an objection then he cannot make it up now after the event. Lord Mansfield 1766 (Carter v Boehm) • Fair presentation on the one hand and no “claims underwriting” on the other.

19. Policyholder’s obligations • Policyholder must disclose all information needed to give fair presentation of risk – query who and what? • Who? - “Knowledge” for company = known to Board and insurance purchasers – e.g. risk manager. • Policyholder also has duty to disclose information that would have been discovered by reasonable proportionate enquiries (i.e. need good system). • What? - Actual knowledge + “blind eye knowledge”. • Broker should disclose information obtained as agent for insured (s19 MIA 1906). • Align representations (s 20 MIA 1906 ) – facts “ought to know” – must be true. Otherwise statement must be made “in good faith”.

20. Insurer’s obligations “...the proper line that an underwriter should take...is absolutely to abstain from asking any questions and leave the assured…to make full disclosure of all material facts without being asked. Per LJ Scrutton 1926 Appropriate C21st? Professional competence? Why employ underwriters at all? Insurer should expect fair presentation but proposer can expect competent and knowledgeable underwriter.

21. Insurer’s obligations • When insurer receives information which would prompt reasonable underwriter to make further enquiries cannot rely on failure to disclose what those enquires would have revealed – (waiver). Professional competence. • Policyholder need not disclose matters of: 1) common knowledge; 2) matters which insurer writing relevant class should know; 3) information already known to insurer (board or underwriters or agent). IT systems?

22. Remedies • S17 MIA “…if the utmost good faith be not observed by either party, the contract may be avoided by the other party”. • Brutal but simple. • Arguably imposes disclosure discipline but… • Must over or under compensate insurer. • Much criticised by judges and commentators. • Quite limited support in 2007 consultation. • Often not followed. • Not very mutual in practice.

23. “Proportional” solution? • Follows inducement – “OK. What would you have done?” • Seek to restore parties to position should have been in e.g. - • Claim will not be paid if insurer would not have accepted risk or imposed exclusion. • Claim may be paid in part if insurer would have imposed different limits or charged higher premium. • Claim paid if insurer would have accepted on same terms (less likely given P.U. and inducement).

24. Fault/Issues • If non-disclosure or misrepresentation is deliberate or reckless – avoid. • Otherwise apply proportional remedy – reason for error not relevant. Different to consumer bill. • Default regime as now. Freedom of contract applies. • Good faith continues as interpretative principle. • Uncertainty? Yes – more apparent than real. Courts very familiar with “what if?” elsewhere. • Subscription market. Will require guidance – follows inducement.

25. Micro-businesses

26. Single Business Regime? Micro-businesses. • Should micro-businesses be treated as consumers? • Opinion divided. Concerns over definitions, preventing abuse and creation of “third sector”. • We have discussed inter alia with ABI, FOS, FoSB, BIBA, BIS. Surveys of BIBA and ABI members. • Problems revealed relate to process rather than law. • Insufficient evidence of systemic problem or support for change to justify law reform and increased costs. • Therefore proposal for single, comprehensive business regime.

27. Summary Any definition would be arbitrary, complex and difficult to apply at the u/w stage. There is insufficient evidence of need to justify the potential costs of a special regime. The Financial Ombudsman Service is able to prevent injustice in hard cases. Reforms are proposed to the existing law (such as proportional remedies) which should apply to all businesses, large and small. See Appendix A in Consultation Paper 3 for more detail. Question? Do you agree that one business regime should apply to all businesses? If not, please provide evidence of need.

28. Warranties

29. Warranties: current law What is a warranty? LJ Rix “It is a question of construction, ...” Can be express or implied. May or may not use word “warranty”. Is not the same as normal contract warranty and is not a consumer guarantee. Section 33 MIA 1906 – partial definition which includes: a statement about past or present facts; a promise to do or not do something; a statement that some condition will be fulfilled. “Basis of contract clauses” – convert statements into warranties.

30. Warranties: current law Section 33(3) MIA 1906 – exact compliance (i.e. no link breach and loss) or… Insurer automatically discharged from liability from date of breach. Breach cannot be remedied. Section 34 (1) MIA 1906 - breach may be excused if warranty “ceases to be applicable” or when compliance becomes unlawful. Section 34(3) MIA 1906 – breach can be waived.

31. What does this mean? Warranties that- Ship has at least 50 hands on departure. Had 46 but picked up 6 more shortly afterwards. Claim not paid. Lorry parked at address. Parked in safer location. Claim not paid Item value £285. Actual price £271. Claim not paid. Vessel “fully crewed at all times”. Not crewed when berthed – claim not paid. In practice rare for insurers to rely on strict rights. FOS do not permit in consumer insurance.

32. Main defects in the current law “Basis of the contract” clauses – avoids s 20 MIA 1906. Catch policyholders out (although some protection for consumers now). Increasingly indiscriminate use of warranties – applied to terms dealing with minor matters. Effect of breach automatic, complete (all risks discharged) and severe. Policyholder may be without cover and not realise it. Later remedy irrelevant – even for most minor of breaches. Waiver – on what basis? “The contract is dead but the insurer can still waive it back to life”. The court’s use of construction to moderate harshness of the law – increased uncertainty. (Kler Knitwear)

33. Proposals for reform 1) Abolish “basis of the contract” clauses. 2) All warranties – breach suspends insurer’s liability for duration of breach. Breaches can be remedied and cover restored. 3) Terms designed to reduce the risk of a particular type of loss – breach suspends insurer’s liability for that type of loss for duration of breach. Insurer remains liable for other types. Avoid causal connection test (underwriting perspective – not claims). See Vesta v Butcher, Bamcell II, Printpak v AGF

34. How will it work? Yacht policy has 3 warranties:- Premium payment warranty. Premium due on 1 June but not paid until 15 June. Lock warranty on hatch. Specific lock required. Pleasure use only warranty. Owners breach all three. On 1 July yacht is total loss as a result of storm damage whilst on paid for whale watching trip. What is the effect of these warranties?

35. Specific points Consumer insurance - new regime is mandatory. Business insurance - can contract out but only effective if in clear, unambiguous writing and if brought to attention of policyholder. MAT – regime applies to express and MIA 1906 implied warranties but can contract out. Implied voyage conditions retained and not brought within the regime. Reinsurance – regime applies but can contract out.

36. Damages for late payment

37. Post contract - Damages for Late Payment • If an insurer delays payment causing the policyholder loss what compensation can the policyholder claim? • Can the policyholder claim for all losses caused by any delay? If so on what basis? Or • Only some losses caused by some delays? Or • Is the policyholder confined to interest on the original loss? • English law follows the third option – sometimes! • (Sprung v Royal Insurance) – insurer breachescontract when loss occurs + no damages on damages – therefore only interest. • Unique – not Scotland/FOS/life/re-instatement/rest of world etc.

38. Our current proposals: outline A statutory duty to pay valid claims within a “reasonable time”. Breach may lead to damages on normal contract principles. Definition of “reasonable time” - Insurers cannot make decision until receive “clean claim”. Factual. Insurers may contract out of liability in business insurance (but not in consumer insurance). But insurers may only rely on an exclusion clause if they have acted in good faith? When does time start to run (limitation period)? Damages for distress and inconvenience (consumer only).

39. Consultation responses Consulted in Issues Paper 6 and CP 2. Over 80% agree reform required. Over 80% agree insurers should pay damages for foreseeable losses. 80% agree consumers should be awarded damages for distress and inconvenience but query whether statutory reform required. Concerns relate to definition/calculation of reasonable time for payment, abuse by policyholders, ability/basis to exclude liability and calculation of limitation period.

40. Insurers’ remedies for fraud

41. Insurer’s remedies for fraud – the problem Serious and expensive problem and a major cost to insurance industry – and customers. ABI reports that in 2010 insurers uncovered 133,000 fraudulent claims. Claims totalled £919 million or 5% of the value of all claims made of ABI members that year. Insurance fraud costs UK economy £2 billion every year (ABI News Release 31/11, July 2011). Social attitudes to dishonesty are complex. Fraud in practice is hard to define. Fraudsters should face sanctions – to have a deterrent effect sanction should be clear.

42. Current law Marine Insurance Act S17 quite clear: “A contract of marine insurance is a contract based upon utmost good faith, and, if good faith be not observed by either party the contract may be avoided by the other party” Is section17 in this context a codification of the common law? - probably not. Does this apply post contract? – courts have said yes and no Do the courts apply S17? – no, not recently. Law incoherent. “The duty not to make a fraudulent claim has been characterised in several irreconcilable ways by the courts…Alternative positions have thus been created as to the remedies available to insurers in respect of fraudulent claims, but none long-established”. [ABI] Uncertainty about the effect of fraud on other claims (previous or subsequent). Insurer cannot sue an insured for damages following a fraudulent claim.

43. Our current proposals: outline New statutory remedies: s 17 of the 1906 Act would no longer apply. Forfeiture: Forfeiture of whole claim. Forfeiture of all claims after the date of the fraud. Fraud does not affect previous valid claims. Insurer can claim damages for costs reasonably and actually incurred. Subject to express terms in business insurance. but not in consumer insurance. Group members to be treated in the same way as if insured. Joint policies – should innocent party have statutory protection? What is not covered: definition of fraud - we concluded the issue was best left to the courts. Fact specific and question of morality. criminal fraud. third party claims.

44. Consultation responses Consulted in Issues Paper 7 and CP2. Over 90% of consultees agree that a policyholder who commits a fraud should forfeit the whole claim to which the fraud relates. This proposal was welcomed by many as an effective deterrent. Over 70% agree that they should also forfeit any claim where the loss arises after the date of the fraud. Over 90% agree that they should be entitled to be paid for any previous valid claim which arose before the fraud took place. Some issues raised relate to definition of fraud, fraudulent devices/exaggerated claims, “minimal fraud” to allow recovery in some cases, automatic forfeiture-notice to terminate instead.

45. Joint/group policies - consultation response 80% agreed that a fraudulent act by one or more group members should be treated as if the group member concerned was a party to the contract. Joint insureds - little evidence or examples provided of a problem in practice. Nearly 70% agreed that there is no need to legislate on the effect of fraud by one joint insured on the other joint insured’s claim.

46. Further information If you would like any further information please see the Law Commission’s website – insurance project page: http://lawcommission.justice.gov.uk/areas/insurance-contract-law.htm