The Law Commissions have dispensed with the idea of a "causal connection" between breach and loss in their latest paper on warranties in insurance. Instead, they propose treating warranties as suspensive conditions, absolving the insurer from liability to pay claims until the breach is remedied.
This note looks at proposed changes to the law on warranties in business and consumer insurance. The same paper also includes measures to clarify the pre-contract duty of disclosure in business insurance and reform the remedies for breach. These are considered separately in Reforming insurance law: business insurance.
A warranty is basically a promise to do or not to do something or that a state of affairs exists or will exist. In insurance law, the main concern with warranties is the draconian nature of the remedy for breach.
Under current English law, if the insured has made a warranty of past, present or future fact, it must be strictly complied with or the insurer is automatically discharged from liability as from the date of the breach, even if the warranty is about something relatively unimportant and even if there is no connection between the breach and the loss claimed under the policy. It makes no difference if the insured has remedied the breach before the loss is incurred.
Basis of the contract clauses
In most cases, warranties are expressly set out in the terms of the policy, even though the insured may not realise the full consequences of breach. But many insureds also fail to note that the declaration they make in the proposal form (that the information given is true and complete) is often stated to form the "basis of the contract".
This has the effect of incorporating the declaration into the insurance contract as a warranty. Any incorrect or inaccurate answer given in the proposal form, however trivial, will be a breach of warranty and entitle the insurer to treat the contract as repudiated.
For consumers, the rules have been softened somewhat by industry practice, the regulatory regime and the Financial Ombudsman Service (FOS) which applies a "fair and reasonable" test to complaints brought by consumers and small businesses. The Courts, however, are bound to apply the law - unless they are able to construe the warranty as a "suspensive condition", which suspends liability only for the duration of the breach.
In their 2007 consultation paper, the Law Commissions of England and Scotland proposed to abolish "basis of the contract" clauses in both consumer and business insurance.
Section 6 of the Consumer Insurance (Disclosure and Representations) 2012 implements this ban for consumer insurance, although the Act is not yet in force. Insurers will, however, still be able to include specific warranties in their policies.
The 2012 consultation paper reiterates the proposed abolition of basis of the contract clauses in business insurance. Any clause which purports to give warranty status to answers in a proposal form would be of no effect. As with consumers, insurers would still be able to use warranties of past or present fact, but these would have to be included specifically in the contract.
In order to limit the draconian effect of warranties in insurance, the Law Commissions originally suggested introducing a "causal connection" requirement. An insurer would only be able to avoid paying all or part of a claim on grounds of a breach of warranty if the breach caused or contributed to all or part of the loss. The insured would be entitled to be paid in full if he could show there was no such connection.
The proposal proved controversial. So much so that the Commissions have had a rethink. "It is clear that a causal connection test is not appropriate for all contract terms," they acknowledge in their 2012 consultation paper, "and we think it would generate too much uncertainty to attempt to apply such a test to some terms and not others".
Instead, they now propose that all warranties should be treated as "suspensive conditions". If breached, the insurer’s liability would be suspended for the duration of the breach. But if the breach had been remedied by the time a loss occurred, the insurer would have to pay the claim (assuming there was no other defence).
In consumer insurance, there would be a provision preventing any contracting out of the consequences of breach. In business insurance, the parties could agree to apply different remedies "provided they did so in clear, unambiguous terms and brought the term to the attention of the other party".
This would enable the parties to devise their own remedies where, for instance, the terms of a particular warranty did not easily convert into a suspensive condition or where remedying the breach is unfeasible.
The Law Commissions have, however, concluded there is no need for a specific provision requiring warranties to be in writing. "In business insurance, insurers already put warranties in writing, and this will continue," the paper states. "In consumer insurance, insurers already need to comply with Financial Services Authority rules on key facts documents. We do not see the need to distinguish between warranties and other terms, by requiring warranties to be in writing."
Reducing the risk
The Law Commissions’ third proposal is to introduce a special rule for terms designed to reduce the risk. This would not be confined to traditional warranties but would apply to any term designed to reduce the risk of a particular loss.
The paper gives examples of terms to install burglar alarms or sprinkler systems, which may or may not be described as warranties in the policy.
Under the proposed special rule, breach of a term intended to reduce the risk of a particular type of loss, or the risk of loss at a particular time or in a particular location, would only suspend liability in respect of that type of loss (or a loss at that time or in that place).
If, for instance, the insured breached a term to install a burglar alarm, the insurer’s liability to pay a claim for loss caused by an intruder would be suspended. But it would still be liable if the loss was from a flood or a fire, since the loss is of a different type. Similarly, failure to employ a night watchman in breach of a policy term would suspend the insurer’s liability for losses at night, but not for losses during the day.
In consumer insurance, the rule would be mandatory. In business insurance, the parties would be able to contract out of the provision (for instance, by specifying that breach of a particular term would absolve the insurer of all liability). "This, however, would need to be spelled out in clear, unambiguous terms and specifically brought to the attention of the other party," the consultation paper warns.
The Law Commissions hope this approach will receive industry support: "We do not think that this is a controversial proposal. Insurers value warranties as an effective means to manage risk, but it is clear from their responses that most do not wish to use warranties oppressively where faults have already been remedied."
"Furthermore, the proposal does not introduce untoward distinctions between types of term...Finally, we think that the reform would encourage compliance. Policyholders will be more inclined to remedy problems if they know that the effect will be to restore cover."
Nor do they believe the changes should concern reinsurers unduly: "We do not think that reinsurers have anything to fear from our proposals, especially as they may contract out of them if they wish," the paper states.
"We think that if a direct insurer is liable to pay a claim after the policyholder has remedied their breach of warranty, then the starting point should be that the reinsurer will reimburse the direct insurer under the terms of the contract. If the parties wish to come to another arrangement, they will be free to do so."
The consultation closes on 26th September 2012. The Law Commissions plan to publish their final report and a draft Bill by the end of 2013. This will cover pre-contract duties of disclosure in business insurance, warranties, damages for late payment, insurers’ remedies for fraudulent claims, insurable interest, and policies and premiums in marine insurance.