Out-Law Guide | 21 Mar 2008 | 12:15 pm | 12 min. read
This guide is based on the law of England and Wales. It was last updated on 29th April 2009.
English insurance law is often accused of being too insurer-friendly. The duty of utmost good faith applies to both insured and insurer but the only available remedy for breach operates against the insured, even if it was the broker’s fault.
And if an insured breaches a warranty, however trivial, his cover will automatically terminate, even if there is no connection with the loss claimed under the policy.
For consumers, who may have little knowledge of insurance law, the rules have been softened over the years by voluntary industry codes, the regulatory regime and the Financial Ombudsman Service (FOS) which applies a “fair and reasonable” test to complaints brought by consumers and small businesses.
The Law Commissions of England and Scotland now want to bring insurance law more into line by introducing a mandatory consumer regime that in many respects formalises current FOS practice.
Businesses tend to be better informed and better advised than consumers. The risks they want to insure also cover a far wider range, both in value and complexity. For them, the proposals would introduce a default regime, leaving the parties free to agree different provisions.
This straightforward divide between consumer and business insureds, however, raised concerns that very small businesses ("micro-businesses") might be put at a disadvantage when buying cover. The Law Commissions' latest suggestion is to treat such businesses as consumers when they provide pre-contract information to insurers.
The first consultation paper on insurance law reform was published in July 2007. Summaries of responses received to the consumer proposals and to the business proposals were published separately in May and October 2008.
In general, the consumer proposals received widespread support. The proposals for business insurance, however, got a more mixed response.
Encouraged by the consumer feedback, the Law Commissions have given priority to the preparation of a final report and draft bill on pre-contract information in consumer insurance, due to be published this autumn.
In March 2009, they produced a policy statement setting out their revised thinking on the status of intermediaries in consumer insurance. This was followed on 16th April by an issues paper asking whether micro-businesses should be treated in the same way as consumers for the purposes of pre-contractual information.
As part of the Law Commissions' wider project to reform insurance contract law, an issues paper on insurable interest was published on 14th January 2008. Further papers on post-contractual duties of good faith and on whether insurers should pay damages for the late payment of claims are awaited.
Under English law, an insured is under a duty of utmost good faith. When he applies for insurance he must volunteer material information, whether or not the insurer asks about it. If he fails to disclose (or he misrepresents) a material fact that induces the insurer to enter into the contract on the agreed terms, the insurer is entitled to avoid the policy entirely, as if it never existed.
What is material is judged from the viewpoint of a prudent insurer, not the insured. No distinction is made between innocent, negligent or dishonest behaviour, and avoidance is the only remedy available.
Under the Law Commissions' proposed reforms, a consumer would no longer be obliged to volunteer information. Instead he would have a duty to respond honestly and with reasonable care to questions asked. The focus would move on to the quality of those questions.
Throughout the proposals runs the notion of the "reasonable insured". If an insurer asks a loosely-worded or open-ended question, would a reasonable consumer realise it was asking for the information the insurer now says should have been given? Did the consumer act reasonably when he assumed the insurer would obtain the information from elsewhere?
The test would take into account the type of policy, the way it was advertised and sold and the normal characteristics of consumers in the market. Consumers' subjective circumstances could be taken into account, but only if the insurer was aware of them.
For business insurance, the Law Commissions proposed retaining the insured's duty voluntarily to disclose and not misrepresent material information known to it or that it ought to have known. But a new test for materiality would replace the "prudent insurer" with a "reasonable insured".
Instead of asking whether the information was something that would influence the judgment of a prudent insurer, the question would be whether it was something a reasonable insured in the circumstances would have appreciated the insurer would want to know about.
In the business context, the reasonable insured test would take into account the type of market, the questions asked and whether the insured had professional advice. The Law Commissions considered this would be sufficiently flexible to deal with the wide range of business insureds, from sophisticated buyers acting with professional advice to smaller businesses buying their own cover.
In consumer insurance, the insurer's remedy of avoidance for an inaccurate or misleading statement would be replaced by a range of remedies depending on the degree of fault.
If a consumer insured acted honestly and reasonably, the insurer would have no remedy. But if he was dishonest or reckless (in that he knew the information was relevant to the insurer and that his answer was untrue, or did not care either way) the insurer would be able to avoid the contract.
A consumer would be presumed to know what someone in their position would normally be expected to know. And if an insurer asks a clear question about something, the insured would be presumed to know it was relevant.
If a consumer is negligent, the remedy would aim to put the insurer into the position it would have been in had it known the true facts. If the insurer would have charged more premium, the claim will be reduced proportionately. If it would have imposed a particular term, the claim will be treated as if the policy included that term. If it would have declined the risk altogether, the policy may be avoided, the premiums returned and the claim refused.
Even here, the Law Commissions had concerns that the law might sometimes operate unfairly. When a consumer has been negligent and the insurer would have declined the risk but the fault is minor, should the court have a residual discretion to prevent avoidance, imposing a reduction on the claim instead?
In the business context, as under the consumer regime, the insurer would have no remedy if the insured acted honestly and reasonably. As for other breaches, the paper asked whether the remedies should follow the same pattern: avoidance for dishonest or reckless breaches and proportionate remedies for negligence.
For business insureds, however, this would only be a default regime. The parties could agree more stringent terms if they wished.
A warranty is basically a promise to do or not to do something or that a state of affairs exists or will exist. The main concern with warranties is the draconian nature of the remedy for breach.
Under current English law, if the insured has made a warranty of past, present or future fact, it must be strictly complied with or the cover will automatically terminate, even if the warranty is about something relatively unimportant and even if there is no connection between the breach and the loss claimed under the policy.
The solution proposed for both consumer and business insurance is a requirement for a “causal connection”. For the insurer to be able to avoid paying all or part of the claim, the breach must have caused or contributed to all or part of the loss. The insured would be entitled to be paid in full if he could show there was no such connection.
For the most serious breaches, the insurer would have a separate right to terminate the policy for the future.
There would be some additional protections. Warranties in consumer insurance would be limited to warranties of future fact and these would always have to be set out in writing. Insurers would also have to show they took sufficient steps to draw them to the insured's attention. Statements of past or present fact could only ever be representations and so subject to the new proportionate remedies.
In the business context, insurers could require warranties of past, present and future fact as long as they are clearly set out in the policy. Since this would be a default regime, however, the parties could agree different terms, for instance removing the need for a causal connection.
For both business and consumer insurance, the consultation paper proposed to abolish all "basis of the contract" clauses - clauses that automatically transform statements made by the insured into warranties.
In order to provide smaller businesses with additional protection, the Law Commissions initially put forward an additional, mandatory rule that would affect standard form insurance policies.
They proposed that contracts concluded on the insurer's written standard terms would not be allowed to give the insurer greater rights to avoid claims than under the default regime, if this would defeat the insured's reasonable expectations of cover.
Although many of those who responded to the consultation agreed that small businesses needed extra safeguards, most thought this rule would introduce too much uncertainty over what are standard terms.
The Law Commissions agreed. Their latest issues paper suggests a different approach - removing the smallest businesses from the business regime altogether and treating them in the same way as consumers for the purposes of giving pre-contract information.
This would mean that, like consumers, micro-businesses would no longer be under a duty to volunteer information to insurers when applying for insurance. They would only be required to answer honestly and with reasonable care any questions asked.
And, instead of being entitled to avoid the contract altogether for an inaccurate or misleading statement (as under the current law), insurers would have a range of proportionate remedies.
The issues paper also suggests extending the Unfair Terms in Consumer Contracts Regulations 1999 to micro-businesses in relation to insurance contracts.
The change would allow the smallest enterprises to challenge policy terms for unfairness, provided the term has not been individually negotiated and is not a "core" term. Terms (including core terms) that are not expressed clearly in plain language would also fall foul of the regulations.
How would a micro-business be defined? The Law Commissions are as yet undecided between a straightforward test based on the number of employees (0-9), on annual turnover of less than a specified amount (possibly £1million), or on whether the business falls within the jurisdiction of the Financial Ombudsman Service.
The current FOS threshold is a turnover of less than £1 million, but there are plans to change this to a combined test of fewer than 10 employees and a turnover of less than €2 million.
Secondary tests would filter out sophisticated operations, such as special purpose vehicles, that might otherwise be defined as micro-businesses.
The turnover or number of employees in any associated or group company would be taken into account when calculating the figure for the basic test. In addition, businesses that spend more than a certain amount on their insurance premium (say £15,000) or that hold assets or have a turnover of more than £10 million would not qualify.
Insurers would need to ask the right questions at the pre-contract stage to determine whether or not the prospective insured is a micro-business. The paper asks for views on how best to deal with businesses that are wrongly classified, whether by mistake or because of a misrepresentation.
English law still generally assumes that a broker or intermediary acts as agent for the insured when passing pre-contract information to the insurer, which means that the insured usually bears the risk of the intermediary getting it wrong.
If the intermediary fails to pass on information (or passes on incorrect information) to the insurer, the insurer simply avoids the policy against the insured, even though the insured may be wholly innocent of the breach. Even when the intermediary is for all other purposes the tied agent of an insurer, the law treats him as the agent of the insured if he completes the proposal form on the insured's behalf.
Unaware of this, consumers tend to assume the intermediary is working for the insurer. The Law Commissions hoped to bring the law closer to consumers’ reasonable expectations by introducing a single test to determine for whom an intermediary acts.
They initially proposed that, in both consumer and business insurance, a broker would be treated as acting for the insurer for the purposes of receiving pre-contract information, unless he was clearly independent of the insurer and acting on the insured's behalf.
Independence would be judged on whether the intermediary undertook a fair analysis of the market. An intermediary regarded as the insurer’s agent would remain so throughout the pre-contract process, even if he helped the insured complete the proposal form.
The paper also proposed that, where the insured signed an incorrect form completed by the intermediary, the signature would be good (but no longer conclusive) evidence that the insured adopted the statements made in it. The court or ombudsman deciding on the appropriate remedy would have to consider whether, in signing the form, the insured acted reasonably, negligently or recklessly.
The proposals on intermediaries, however, found little favour with consultees. Two thirds of those responding strongly opposed the fair analysis of the market test. Many insurers were concerned that they would effectively become responsible for intermediaries over whom they exert little or no control.
It was also thought the relaxation of the common law on signatures would send out the wrong message to insureds.
In March 2009, the Commissions published a policy statement setting out their revised thinking on the intermediary question as regards consumer insurance.
Instead of a single test, they now propose a new statutory code that sets out a range of factors to be considered. The code is based largely on existing law, supplemented by FOS practice and industry understanding.
An intermediary with authority to bind the insurer to provide cover, or who is the appointed representative of the insurer, or who is expressly authorised by the insurer to collect pre-contract information on its behalf would always be treated as the insurer's agent.
But in other cases, the intermediary would be treated as acting for the insured, unless a close relationship between the intermediary and the insurer indicates the insurer has granted the intermediary authority to act on its behalf.
The policy statement sets out a non-exhaustive list of factors which would be taken into account when considering whether the insurer/intermediary relationship is sufficiently close.
One indicator is where the insurer exerts substantial control over the way the intermediary conducts its business. Branding and white labelling - where the insurer allows the intermediary to brand its services with the insurer's name, or conversely where the insurance product is branded with the intermediary's name - are factors that could indicate an agency relationship between insurer and intermediary.
Tied or multi-tied agents, who only place insurance with one insurer or a limited number of insurers, would also be more likely to be found to be agents of the insurer. The smaller the number of insurers, the closer the relationship with those insurers is likely to be.
An intermediary is more likely to be acting for the insured where he provides impartial advice, where the insured pays a fee, or where the intermediary fully discloses any commission he has received from the insurer.
The paper also confirms that different agency relationships can arise in respect of different tasks. The code would only apply to the passing on of pre-contract information in consumer insurance and not to other areas of agency, such as when an intermediary collects premiums on the insurer's behalf.
The principles will be included as a free standing code in the Law Commissions' draft bill on pre-contractual information in consumer insurance, due to be published in the autumn of 2009.
Further afield, moves towards creating a common frame of reference for insurance contract law are taking place in Europe.
In December 2007, the Restatement of European Insurance Contract Law project group produced a set of draft principles of European Insurance Contract Law (PEICL).
These go significantly further than the current Law Commissions' proposals, but are being put forward as a voluntary regime. Parties would be able to opt out of their national insurance contract law regime and opt in to PEICL for cross-border and domestic business.
At present, the Law Commissions see harmonisation of European insurance law as a distant prospect, but point out that there would be more chance of being able to influence the outcome if domestic law has already been reformed.
Contact: Colin Read ([email protected] / 020 7418 7305)