Proposed new law would make it harder for insurers to avoid contracts

A joint consultation (253-page / 640 KB PDF) by the Law Commission and Scottish Law Commission suggests replacing the current 'all or nothing' remedy of avoidance – which has the same effect as if the contract never existed - with proportional remedies based on what the insurer would have done had it known the true facts.

The proposed changes to the law on disclosure will, the Law Commissions hope, create a "more neutral" law that would "place reciprocal burdens" on both companies and insurers.

The existing law, which is set out in a 1906 Act, places an "onerous" duty on a policyholder to disclose "every material circumstance" which it knows, or ought to have known "in the ordinary course of business" before concluding a contract, the consultation paper said. If it does not the insurer may avoid the policy and refuse to meet any claims under it.

While it would be up to the policyholder to "volunteer essential information", including any unusual or special circumstances that could affect the level of risk, the Commissions said, insurers must equally "ask further questions" if this information suggested potential problems. Insurers and businesses should "work together to provide further guidance" on how these principles should work in practice, it added.

Insurers will still be able to avoid the contract completely where a policyholder deliberately conceals information, the Commissions said. In other cases, the remedy would be proportionate and reflect what the insurer would have done had it had the correct information. So, 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.

The Law Commissions have also proposed amending the law relating to warranties, which are conditions that policyholders must fulfil in order for the contract to be valid. Under current law, insurance cover automatically terminates if the policyholder does not comply exactly with one of these terms - for example, to install a working fire alarm - regardless of whether not doing so is relevant to the type of claim or if the policyholder fixes the situation before the loss occurs.

Under the proposals, a breach of warranty would "suspend", rather than invalidate, a policy until the breach is remedied. In addition, insurers' liability will be suspended "only in relation to" a particular type of risk if the term is designed "to reduce a particular type of risk". As an example, the Commissions said that where a business failed to check its sprinkler systems as provided under the contract, liability would be suspended for fire damage but not for flooding, until the sprinklers were checked.

The changes to warranties would be mandatory for consumer contracts, they said. However businesses would be able to contract out of the provisions "provided they did so in clear, unambiguous terms and the term was brought to the attention of the other party".

Insurance law expert Toby Thompson of Pinsent Masons, the law firm behind Out-Law.com, said that the changes were similar to those introduced for the consumer insurance sector following an earlier consultation process. The Consumer Insurance (Disclosure and Representations) Act received Royal Assent in March, however its provisions have not yet been brought into force.

"If implemented, these reforms should increase the global competitiveness of the UK insurance market," Thompson said. "It is important that insurers engage with the proposed reforms to ensure they understand how the risk profile of their commercial insurance business will change."

Professor Hector MacQueen of the Scottish Law Commission said that the existing law was weighted against businesses and needed to change.

"Large, complex, international corporations struggle to cope with its requirements as much as their smaller counterparts because the present rules and remedies are weighted against them all," he said. "We are offering the industry and its business policyholders and opportunity to come together to develop definitions, principles and protocols that make for a clearer, fairer law."

"Many of the definitions and principles we are proposing are already found in the current case law," David Hertzell, leading on the project for England and Wales, added. "Embedding them in the statute would make the law clearer and fairer for insurers and their clients."

The courts have already begun to restrict the application of the duty to disclose "every material circumstance" by instead stressing that policyholders should make "a fair presentation of the risk" when taking out an insurance contract, the consultation paper said.

"Although the case law may not have completely clarified what the duty of disclosure means in practical terms for a risk manager with the job of placing insurance on behalf of a business, we believe that it is possible to distil general principles of what amounts to good practice," the consultation paper said. "We think, therefore, that there is much to be said for incorporating those judicial developments into the statute itself."