Insurance Focus - Part II

Better late than never – insurance contract law reform in the UK

To the surprise of many the Consumer Insurance (Disclosure and Representations) Bill had its first reading in the House of Lords on 16 May. This first stage is a formality whilst the second reading opens the general debate on all aspects of the Bill, which will begin its passage through Parliament in the Lords before reaching the House of Commons. Many had thought it unlikely that the Bill would get parliamentary time and the second opportunity to reform insurance law for consumers would be lost. Michael Mendelowitz and Laura Hodgson consider the main provisions of the Bill.

The Law Commissions of England and Wales and of Scotland began their review of insurance contract law in 2006. Calls for reform of the law on misrepresentation and non-disclosure in insurance contracts are not new. A law reform committee first recommended reform in 1957, followed by further calls in a 1980 report. Indeed, the 1980 English Law Commission report described reform to the law of insurance contracts as "too long delayed".

There has been widespread support for reform in the area of consumer contracts as the existing law can have harsh consequences on a public largely oblivious to their legal obligations. For many years industry practice guidelines and the Financial Ombudsman Service's (FOS) approach to resolving complaints have been out of sync with the strict letter of the law.

The current law, set out in the Marine Insurance Act 1906 (MIA) requires prospective insureds to volunteer information about the risk they are seeking insurance for. Section 18 of MIA requires insureds to disclose those "material circumstances which would influence the judgement of a prudent insurer in fixing the premium, or determining whether he will take the risk". Failure to do so can allow the insurer to avoid the contract. At present there is no obligation in law for the insurer to ask questions and a consumer should consider what information a professional underwriter would wish to know. Very few consumers are even aware of this duty; and, if they are, do not have the means to know what information they are required to volunteer to the insurer. The current law does not take into account what a reasonable consumer might think relevant to disclose.

The 1906 law was drafted in an age when insurance contracts were invariably conducted through brokers who had capacity to advise their customer of their obligations towards the insurer. This is no longer the case. Consumers currently buy a significant proportion of insurance policies through aggregator websites or directly though the insurer – a fundamental shift in the nature of pre-contractual negotiations.

Section 20 of MIA further imposes a duty upon insureds not to misrepresent the information which they do tell the insurer. Any misrepresentation will allow the insurer to avoid the contract. The law will recognise a distinction between a misrepresentation of a fact and an honestly held expectation or belief which then proves to be untrue. Nevertheless, the resulting consequences of an inadvertent misrepresentation (as with a non-disclosure) can be severe where an apparently minor mistake invalidates an insured's claim.

The proposed new regime: the insured's duty to take reasonable care The Bill proposes to change the nature of the parties' pre-contractual negotiations so that insurers are obliged to ask those questions about the risk they want to know. In response, consumers will be under a new duty to take reasonable care to answer the questions asked by the insurer fully and accurately.

Where a consumer has made a mistake in answering the insurer's questions, the Bill makes a distinction between "careless" and "deliberate or reckless" misrepresentations. The remedy which an insurer will have in the event of a misrepresentation will depend upon the category of mistake. This new classification of misrepresentations will give legislative effect to the approach currently taken by the FOS. The remedies for the various types of misrepresentations are as follows:

Where the misrepresentation was deliberate or reckless, the insurer may refuse the claim. A statement will be deliberate or reckless if the consumer knew that it was untrue or misleading or did not care that it was so and knew that the matter was relevant to the insurer. Following a deliberate or reckless misrepresentation the policy will be treated as if it had never existed and all claims by the insured can be refused. This approach is similar to that taken under the current law, although the insurer will now be able to retain any premium unless there are compelling reasons for this to be returned (for example in certain life policies containing an investment element). The retention of premium and avoidance of the policy retains the penal element currently included to dissuade consumers from deliberately or recklessly misleading insurers. Where the misrepresentation is merely careless, the Bill provides for a proportionate remedy which will reflect the position that the insurer would have been in had the true facts been known. It is for the insurer to show that a misrepresentation was deliberate or reckless, otherwise it will be deemed merely careless. Under the current law, insurers are able to avoid the entire policy for an innocent misrepresentation with potentially severe consequences for the insured. The Bill provides the insurer with a compensatory remedy. Therefore, where the insurer would have excluded a particular type of claim, the insurer should not have to pay claims falling within this exclusion. Where a warranty or excess would have been imposed, the resulting claim should reflect the policy had such a warranty been included. Where the insurer, on knowing the true facts, would have charged a higher premium, a proportionate settlement should be given to the insured. Finally, where the insurer would have declined the risk altogether, the policy may be avoided and the premium returned. The proposed new law retains the requirement that the insurer must have been induced by the misrepresentation (as set out in Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd [1995] 1 AC 501). Consequently, under the proposed Bill, the insurer will still have to demonstrate that, without the misrepresentation, it would not have entered into the contract at all – or at least on the same terms. However, the new law no longer requires the insurer to prove that the misrepresentation would have influenced the judgement of other underwriters in the market. It will be enough for the insurer to show that they were so induced and that a reasonable consumer would not have made such a mistake.

The Bill requires that insureds take reasonable care not to make a misrepresentation. The standard of care will be that of "a reasonable consumer" but an additional element is added which demands that the insurer should take into account the actual circumstances of the individual consumer where they are aware of them. It further includes an additional specification to clarify that a dishonest misrepresentation (even if reasonable to the average consumer) will always be unreasonable. This prevents the more knowledgeable person relying upon the excuse that a less well informed consumer would not have known the significance of a particular fact.

As mentioned above, consumers are required...