Insurance/Reinsurance- United Kingdom

The English and Scottish Law Commissions' plans to review insurance contract law were announced in January 2006. Before the recommendations are published later in 2007, a series of issues papers are being produced to promote debate at open seminars organized by the commissions. Papers on non-disclosure/misrepresentation (September 2006) and warranties (November 2006) have now been published.

Non-disclosure and Misrepresentation

Existing Law

All insurance contracts are based on the duty of utmost good faith. The applicability of the principle as regards disclosure of material circumstances and the making of material misrepresentations is set out in the Marine Insurance Act 1906. A circumstance is deemed to be 'material' if it is one that would affect the judgment of the (re)insurer in assessing the risk, even if it would not ultimately have a decisive effect on the (re)insurer’s acceptance of the risk or the amount of premium charged. The remedy for breach of duty is avoidance of the contract, irrespective of whether the breach was made innocently, negligently or fraudulently. However, before a (re)insurer can avoid, it must be shown that the non-disclosure/misrepresentation actually induced the underwriter to accept the contract on the relevant terms.

Proposed reform

Consumer contracts

The most significant proposal is that the test of materiality be redefined. In addition to proving actual inducement, the insurer would be required to demonstrate that: (i) the insured appreciated that the fact in question would be relevant to the insurer (in the sense that it would have an effect on the insurer’s mind in assessing the risk); or (ii) a reasonable insured in the circumstances would have appreciated that the fact would be relevant to the insurer.

The paper recommends that the applicable remedy should depend on the proposer’s state of mind, with the result that:

where the proposer has acted fraudulently, the insurer should be entitled to avoid;

where negligently, both parties should be put in the position in which they would have been had the insurer known the true facts; and

where innocently, the proposer should not be penalized.

Business contracts

The commissions suggest that the duty of disclosure should continue to apply to business insurance contracts, but that the reasonable insured test set out above should apply. They also propose that the remedies proposed in the consumer context should apply to business contracts in cases of fraudulent and innocent non-disclosure/misrepresentation. In cases of negligence, they query whether the insured should be required to demonstrate that it did not know what a person in its position would be expected to know, or that it would not know why an inaccurate response to a clear question was material.

The commissions’ proposals raise numerous questions: who is the reasonable insured? How can this be determined when insureds vary so dramatically in size, resources and familiarity with the product in question? How would the test work in the context of reinsurance? However, in their warranties issues paper, the commissions have revised the approach to business contracts, recommending that new rules on misrepresentation/non-disclosure should be compulsory for business as well as consumer contracts. The rationale for this change was that if (re)insurers were to be entitled to treat statements of fact as misrepresentations rather than warranties and stipulate in the policy the remedies available for misrepresentation, this would enable them to sidestep the commissions’ proposed new rules on warranties. Although this makes sense from a legal perspective, it increases the potential significance of the commissions’ proposals on misrepresentation/non-disclosure for the market.

Warranties

Existing law

There are two broad categories of warranty in (re)insurance contracts: warranties about past or present facts at the time when the contract is entered into and warranties about the insured’s future conduct during the contract period. It is a question of interpretation whether a particular term is a warranty. It is well established that a breach of warranty, however minor, automatically discharges the (re)insurer from further liability under the policy from the time of the breach, regardless of whether the (re)insured acted fraudulently, negligently or innocently, and regardless of whether the breach was subsequently remedied. The commissions believe that because of the strict consequences which flow from a breach of warranty, the current law has potential to cause considerable unfairness to policyholders, particularly in the consumer market, where policyholders are unlikely to understand the significance of warranties. Few policyholders would expect (re)insurers to be entitled to reject a claim because of a breach of warranty which has no causal connection with the claim. Their tentative proposals distinguish between warranties as to past or existing facts and warranties as to future conduct.

Proposed reform

Warranties as to past or existing facts

The commissions recommend that, for consumer contracts, all statements of existing fact be treated as representations rather than warranties and be subject to the proposed new rules on misrepresentation. In relation to business contracts, they propose either that the position be the same as for consumer contracts, or that (re)insurers be entitled to rely on a breach of warranty as a defence to a claim only if (i) the warranty has been set out clearly in a written statement provided to the (re)insured, and (ii) the claim is causally connected with the breach.

Warranties of future conduct

The commissions propose that (re)insurers be entitled to refuse a claim for breach of warranty only if: (i) the warranty is set out in writing and included or referred to in the policy and, for consumer contracts, if the insurer has taken sufficient steps to bring it to the policyholder’s attention; and (ii) the breach caused or contributed to the loss. The commissions ask whether (re)insurers should be entitled to contract out of the causal connection rule for business contracts, and whether the same rules should apply not only to warranties, but to any term which purports to exclude or limit a (re)insurer’s liability for matters which increase the risk of loss (eg, clauses which limit the scope of cover or exclude certain activities from cover). The commissions also recommend that, for both consumer and business contracts, a breach of warranty should no longer automatically discharge a (re)insurer from liability under the policy. Instead, they suggest that (re)insurers should be entitled to terminate cover for the future against pro rata refund of premium, but should remain on risk unless and until they have given notice of termination to the (re)insured.

‘Basis of the contract’ clauses

In a ‘basis of the contract’ clause the applicant warrants the accuracy of the answers given in the proposal form and usually agrees that the answers form the basis of the contract. Their effect is to elevate statements in proposal forms into contractual warranties. There has been widespread criticism of such clauses because of the potential severity of the consequence of giving an inaccurate answer in a proposal form. The commissions have renewed the call for these clauses to be abolished.

Comment

There will be an opportunity for the industry to voice its views on the proposals during the formal consultation process which begins next summer. Given the significance of reform for the market, this is an opportunity which the industry cannot afford to ignore.

International Law Office