The commercial insurance market, which is set for its biggest overhaul since 1906, saw the introduction of the Marine Insurance Act, which gradually formed the basis for commercial policies in both marine and non-marine contexts.
Whilst that Act will remain, the new Insurance Act 2015 - which comes into force on 12 August 2016 - will carve up the rules governing commercial insurance contracts with a view to providing transparency and eliminating the perceived bias in favour of the insurer.
Below is a summary of the key changes to be implemented by the Insurance Act 2015:
Commercial policyholders are currently subject to the duty of “Uberrima Fides” (utmost good faith), which provides that the insured must:
- disclose all material facts and information about the business (known or ought to be known);
- not misrepresent the business; and
- not provide misleading information.
Failure in this respect, whether fraudulent, reckless, careless or merely innocent, entitles the insurer to repudiate the contract “ab initio” (from the beginning), regardless of whether the insured’s breach bore any relevance to the loss suffered. Where the insurer takes this action, the contract of insurance is treated as though it never existed.
Unlike the parallel provisions for consumer policies (governed now in this regard by the Consumer Insurance (Disclosure and Representations) Act 2012), the duty to volunteer information will remain beyond August, albeit in a reduced capacity.
The Insurance Act 2015 will usher in the replacement duty on the applicant to make a “fair presentation of the risk” - a disclosure of every material circumstance which is known or ought to be known; or at the very least, the provision of information sufficient to put the insurer on notice of the potential need for further enquiries.
Knowledge in this respect shall be taken to mean what is known, or ought to be known, by the insured’s senior management (including the board of directors) and those involved in arranging the insurance. Whilst the test is objective and assessed on the basis of the size, nature and complexity of the insured’s business, the insured will be deemed to know what “should reasonably have been revealed by a reasonable search.”
Knowledge held by third parties (unless confidential and obtained during the course of business through someone other than the insured and unconnected to the insurance) may therefore be imputed to the policyholder, provided it can be shown, within reason, that a reasonable search would have unearthed such information.
The insurer will only be entitled to repudiate the contract if the insured’s breach of duty was deliberate or reckless. Otherwise, the burden of proof will shift to the insurer to prove that the policy would have been established on different terms had the insured given a fair presentation of the risk. It will then be for the court to assess the merit of the claim on those new terms.
Where the insurer would have charged a higher premium but for a careless or innocent misrepresentation or omission, the claim will be scaled down proportionately. For instance, if the insurer can establish that the premium on the policy would have been double if the insured had made a full and fair presentation of the risk, the claim value will be reduced by fifty percent.
In the absence of guidance, it is difficult to predict how the courts will apply the 2015 Act’s provisions. It seems likely that a deluge of case law will be required before legal teams can confidently advise underwriters as to liability in the event of a careless or innocent misrepresentation of risk.
Whilst the onus has somewhat shifted to the insurer to be proactive, to qualify as a “fair presentation of the risk” the insured’s disclosure must be “in a manner which would be reasonably clear and accessible to a prudent underwriter.” It is envisaged that this requirement will discourage ‘data dumping’ and place the onus back on the policyholder to make a clear, ‘signposted’ representation of their business.
The state of the existing law has been widely criticised for its potentially draconian effects for breach of a warranty. The criticism is in part due to ‘basis of contract’ clauses, which take effect to elevate the status of pre-contractual statements to warranties which, if breached, discharges the insurer from all liability under the contract. This is regardless of how trivial it is and whether or not the warranty said to be breached had any bearing on the loss that occurred.
This now all changes under the new Act. Basis of contract clauses are prohibited - following the position with consumer insurance contracts, meaning all warranties must clearly be expressed as such.
Breach of a warranty will also be treated differently under the Insurance Act 2015, with warranties becoming “suspensive conditions.” This means that the insurer’s risk is suspended whilst the insured is in breach, but the insurer will come back on risk if the policyholder remedies the breach. For example, if the insured were to warrant that the burglar alarm would be tested each month, and ten months later the insured was the victim of a burglary, the only operative question on the warranty would be to ask if the alarm was tested in the month in which the crime occurred; it would matter not that the insured failed to test the alarm in the month previous to the burglary.
In most cases where a breached warranty remained un-remedied at the point of loss, it will be for the insured to demonstrate that the breach had no bearing on the loss, or the potential for that loss. If they are able to establish this on the balance of probabilities, the insurer will not be able to avoid the contract.
However, where non-compliance with a warranty might have increased the chances of the loss that occurred, the insurer will be entitled to avoid the policy. The extent of this is yet to be defined - to use the example above, if the burglary would have occurred irrespective of the existence of a tested, operational burglar alarm, it is uncertain whether the insurer may rely on the fact that the policyholder had failed in that month to test it.
Clear thought will need to be given to the policy wording on warranties. It is advisable that insurers clearly set out the scope of risk that a warranty, or a policy requirement, is intended to cover and to address the consequences of a failure to comply. However, as with most new laws, the grey is unlikely to turn black and white before it is brought before the courts.
Insurers currently have no liability to pay a fraudulent claim; they may avoid the insurance and recover sums already spent in respect of it. The treatment of genuine losses between a fraudulent act and the discovery of the same, or the termination of the policy, has seemed largely irreconcilable for decades. The 2015 Act aims to clarify this.
Under the new law, insurers will have the option to terminate the policy from the date of the fraud as opposed to the date of discovery of the fraud. Whilst the insurer will remain liable for genuine losses that occurred prior to the date of the fraud, they will avoid liability for any claim brought after the date of the fraud without the return of any premiums to the policyholder.
The extent of the fraud appears to be irrelevant with no attempt being made to define what constitutes a fraudulent claim. Until the small print is decided by the courts, it seems that the insurer will be entitled to terminate the contract from the date of the fraud, regardless of the extent of the act or omission, and irrespective of whether only part of the claim is fraudulent.
It is also envisaged that the Insurance Act 2015 will facilitate flexibility and protect innocent parties in group policies: new provisions will be introduced allowing the insurer to separate fraudulent members and terminate their share of the policy only, on the same basis that the insurer could under single policyholders.
The consultation leading to the inception of the 2015 Act identified the need to mitigate against unnecessary interference with the market’s operation. As such, the legislative changes are intended as a “default regime” only; insurers will be afforded the option to contract out, but they should be wary of doing so.
It must be noted that insurers will be unable to opt to disapply the 2015 Act’s prohibition on ‘basis of contract’ clauses, although insurers will be free to agree specific warranties for particular facets of the policy if so required.
For everything else, the Insurance Act will include transparency requirements for use in opting out of the default regime. It must be highlighted to the policyholder the disadvantages of contracting out of each particular term and this must be in a manner that is clear and unambiguous. It will not be sufficient to purport to contract out of all ‘optional’ changes by way of a single clause or tick-box.
The level of transparency required will depend on the characteristics of the insured and how sophisticated the insured’s business is. A distinction will be drawn between those arranging insurance cover through Lloyd’s, for instance, and small businesses arranging cover online. The absence of a broker will also drive the desire for heightened transparency, or rather a heightened explanation of the disadvantages of opting out.
It is undeniable that contracting out introduces a degree of flexibility into non-consumer insurance contracts, but it follows that this will introduce more variety to businesses seeking cover, which in turn will mean insurers will need to be wary of contracting out of greater protection for policyholders simply because they have that option. Insurers should focus on what matters to them, but it is envisaged that contracting out will become common in sophisticated markets such as marine insurance.
Damages for Late Payment
The Enterprise Bill 2015 will amend the Insurance Act 2015 to include provision for damages for late payment of insurance claims. The Government had omitted to present the Insurance Act Bill to Parliament with the inclusion of this notion on the basis that it would encounter too much market pressure for an expedient Parliamentary process. The proposition has, however, found its way into the Insurance Act and will take effect from August 2016.
An implied term will be inserted into every non-consumer policy (consumer policies also, but under slightly different rules) that sums due in respect of a claim under a policy will be paid by the insurer within a reasonable time. What constitutes a reasonable period of time will depend on the size and complexity of the claim, and will be inclusive of the (reasonable) periods of time the insurer may need to investigate and assess the claim. However, the insurer’s conduct throughout the investigation and assessment will factor into the equation.
Those opposed to the proposition of damages for late payment had voiced concerns that additional damages may exceed policy limits and wind up wholly disproportionate to the loss actually suffered by the insured. It seems that these concerns fell on deaf ears, with the Enterprise Bill making clear that damages for late payment are to be treated as entirely distinct from sums due under the policy and any interest on such sums, however arising.
Damages will, however, be applied on the ordinary common law test of foreseeability; damages will be awarded to indemnify the insured against any loss naturally arising from the insurer’s late payment and against any loss that might be proven to be within the reasonable contemplation of the parties at the time the contract was entered into.
To further understand how the changes to commercial insurance might affect your business please speak to Andrew Tilley, Head of Commercial Litigation at Dutton Gregory on 01962 844333 or email him at firstname.lastname@example.org