News & Bulletins
The Law Commission's Proposal For
Reforming Insurance
Law: A Real Step Forward or More of the
Same
On the 17th July 2007 the law commission issued a consultation
paper to tackle the problems in insurance law in the area of
misrepresentation, non-disclosure and breach of warranty by the
Insured.
The current law on the areas above is unsatisfactory, as many
commentators would point out, and the law commission is aiming to
put that right with its new proposals for reform. The criticism,
generally, is that these principles of law were developed by the
courts over time and were codified in the Marine Insurance Act
1906. The 1906 Act has been treated as codifying the law applicable
to all insurance contracts (not just marine). It is written in
clear forthright terms, and the courts have found it difficult to
adapt its principles to changing social and economic
circumstances.
The specific criticism that is directed towards the insurance
law on non-disclosure and misrepresentation law is based on the
fact that the law imposes heavy duties on those applying for
insurance. Potential policyholders are required to volunteer
information to the insurer about anything that would influence a
prudent underwriter's assessment of the risk. If the policyholder
fails in this duty, and the insurer can show that, if it had been
given the information it would not have agreed to the policy on the
same terms (or at all), the insurer may "avoid the policy". This
means that the insurer can treat the policy as if it never existed.
Similarly, the insurer may avoid the policy if the policyholder
makes an incorrect statement of fact that is material. It does not
matter that the policyholder had no reason to know that the
statement was untrue, or that it was material to the insurer.
In relation to insurance law on warranties, it takes a strong
approach to enforcing these terms of the insurance contract. A
warranty may refer to the future - that is “a promise that a
particular thing shall be done or shall not be done, or that some
condition shall be fulfilled". Alternatively, it may apply to the
past or present - where the policyholder "affirms or negatives the
existence of a particular state of facts". Warranties "must be
exactly complied with, whether material to the risk or not". The
insurer is not required to pay any claims that arise after the date
of the breach, even if the breach is later remedied or had nothing
to do with the loss in question.
It is fairly well appreciated that the law should strike a fair
balance between the interests of insurers and policyholders. It
should give potential policyholders confidence in insurance by
ensuring that it meets their reasonable expectations while
protecting the legitimate interests of insurers and not imposing
undue costs or unnecessary restrictions. It should also be
coherent, clear and readily understandable and it is clear that
this is not the case in relation to the issues raised above. The
law commission is proposing to deal with these problems through
developing a separate set of rules for consumers and businesses in
the following manner:
(1) For consumer insurance, the law commission is
provisionally proposing a mandatory regime based largely on
existing Financial Ombudsman Service (FOS) guidelines. This would
apply to individuals who take out insurance for purposes wholly or
mainly unrelated to their businesses.
(2) For business insurance, the law commission is
provisionally proposing a new default regime based on accepted good
practice. It would apply in the absence of an agreement to the
contrary.
The law commission’s main proposals focus on the following:
1. Abolishing consumers' duty to volunteer information.
2. Distinguishing between three types of misrepresentation
being:
a. "deliberate or reckless" misrepresentations, where the policy is
avoided;
b. reasonable misrepresentations (which the FOS terms where the
policyholder is protected; and
c. negligent misrepresentations (which the FOS terms
"inadvertent"), where the insurer is granted a compensatory
remedy.
3. In relation to renewal of insurance policies, it is
proposed that they are treated in the same way as new applications
i.e. consumers would not be required to volunteer information but
would be required to answer questions honestly and carefully.
4. Abolishing “fact warranties” and “basis of the contract”
clauses. This would mean that if a policyholder signed an incorrect
statement on an
application form, the insurer would not have an automatic right to
avoid the policy. Instead, the insurer's remedy would depend on
whether the incorrect statement was made recklessly, negligently or
innocently.
5. For business insurance, the law commission is proposing
that the duty to disclose should be retained. It is part of the way
the UK market works; it may be needed for unusual risks- and where
the insured is represented by an experienced broker the system
generally works well.
6. However, the disclosure duty, in relation to business
insurance, is currently too wide. At present, the insured is
required to disclose anything that it knows, or should know in the
ordinary course of business, if it "would influence the judgment of
a prudent insurer in fixing the premium, or determining whether he
will take the risk". The Law Commission does not think that the law
should penalise those who act honestly and reasonably, simply
because they do not understand what would influence a prudent
underwriter Under their new proposals, in order to
found a claim for non-disclosure, the insurer would have to show
either:
(a) that a reasonable insured in the circumstances would
have appreciated
that the fact in question was one that the insurer would want to
know
about; or
(b) that the proposer actually knew the fact was one that the
insurer would
want to know about.
7. For misrepresentations, in relation to business
insurance, the law commission is proposing new default rules
similar to the scheme they have outlined for consumers. The insurer
would need to show that:
(a) the business made a misrepresentation,
(b) which induced the insurer to enter the contract, and
(c) which a reasonable person in the circumstances would not
have made.
The first two requirements exist in current law. The proposed
change is that an insured who has acted honestly and reasonably
should not lose cover unless that is specifically agreed in the
contract.
On a separate note, the Law Commission is also proposing to
advise on the issue of costs to the market in relation to these new
proposals. In the consumer market, the Law Commission’s proposals
largely reflect existing FSA Rules and FOS practice. For law firms
that already follow the FSA and FOS, the impact will be minimal
(though they should find it easier to understand what is required
of them). The main impact will be on firms who currently disregard
FSA Rules and FOS practice, but who would find it more difficult to
disregard clear law.
For consumers, the main change over FOS practice would be the
possible
adoption of a five-year cut-off period for negligent
misrepresentations in life
insurance. The Law Commission says that this would need to be
costed separately.
Finally, the Law Commissions’s proposals are a step in the right
direction which, if implemented, should restore consumer confidence
in the insurance market and should increase certainty from the
lawyers’ point of view. As we all know, there is a history in the
UK for Law Commission proposals to be consigned to the history
books largely due to overarching political considerations at the
time, but I, as a consumer and a lawyer, hope that this is not
repeated because insurance law is in desperate need of reform.
Walid Salib
Solicitor
Corporate Department
Date:
October 2007
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