Proposals for reform: pre-contract information and
warranties
This guide is based on the law of England and Wales. It was
last updated on 25th February 2008.
The case for reform
English insurance law is often accused of being too
insurer-friendly. The duty of utmost good faith applies to both
insured and insurer but the only available remedy for breach
operates against the insured, even if it was the broker’s
fault.
And if an insured breaches a warranty, however trivial, his
cover will automatically terminate, even if there is no connection
with the loss claimed under the policy.
For consumers, who may have little knowledge of insurance law,
the rules have been softened over the years by voluntary industry
codes, the regulatory regime and the Financial Ombudsman Service
which applies a “fair and reasonable” test to complaints brought by
consumers and small businesses.
The Law Commissions of England and Scotland now want to bring
insurance law more into line by introducing a mandatory consumer
regime that in many respects formalises current FOS
practice.
Businesses tend to be better informed and better advised than
consumers. The risks they want to insure also cover a far wider
range both in value and complexity.
For them, the proposals would introduce a default regime,
leaving the parties free to agree different provisions, subject to
some additional controls on the use of insurers' written standard
terms.
The Law Commissions' first consultation paper on insurance
law reform was published in July 2007. A summary of responses is
due to be published in April 2008. In preparation for a second
consultation, an issues paper on insurable interest was published
on 14th January 2008. A final report and a draft Bill are planned
for 2010.
Non-disclosure and misrepresentation
Under English law, an insured is under a duty of utmost good
faith. When he applies for insurance he must volunteer material
information, whether or not the insurer asks about it. If he fails
to disclose (or he misrepresents) a material fact that induces the
insurer to enter into the contract on the agreed terms, the insurer
is entitled to avoid the policy entirely, as if it never
existed.
What is material is judged from the viewpoint of a prudent
insurer, not the insured. No distinction is made between innocent,
negligent or dishonest behaviour, and avoidance is the only remedy
available.
Consumers
Under the proposed reforms, a consumer would no longer be
obliged to volunteer information. Instead he would have a duty to
respond honestly and with reasonable care to questions asked. The
focus would move on to the quality of those questions.
Throughout the proposals runs the notion of the
"reasonable insured". If an insurer asks a loosely-worded or
open-ended question, would a reasonable consumer realise it was
asking for the information the insurer now says should have been
given? Did the consumer act reasonably when he assumed the insurer
would obtain the information from elsewhere?
The test would take into account the type of policy, the way it
was advertised and sold and the normal characteristics of consumers
in the market. Consumers' subjective circumstances could be taken
into account, but only if the insurer was aware of them.
Businesses
Business insureds would have a duty voluntarily to disclose and
not misrepresent material information known to them or that they
ought to have known. But a new test for materiality would replace
the "prudent insurer" with a "reasonable insured".
Instead of asking whether the information was something that
would influence the judgment of a prudent insurer, the question
would be whether it was something a reasonable insured in the
circumstances would have appreciated the insurer would want to know
about.
In the business context, the reasonable insured test would take
into account the type of market, the questions asked and whether
the insured had professional advice. The Law Commissions believe
this will be sufficiently flexible to deal with the wide range of
business insureds, from sophisticated buyers acting with
professional advice to small businesses buying off-the-shelf
cover.
Remedies for breach
In consumer insurance, the remedy of avoidance for an inaccurate
or misleading statement would be replaced by a range of remedies
depending on the degree of fault.
If a consumer insured acted honestly and reasonably, the insurer
would have no remedy. But if he was dishonest or reckless (in that
he knew the information was relevant to the insurer and that his
answer was untrue, or did not care either way) the insurer would be
able to avoid the contract.
A consumer would be presumed to know what someone in their
position would normally be expected to know. And if an insurer asks
a clear question about something, the insured would be presumed to
know it was relevant.
If a consumer is negligent, the remedy would aim to put the
insurer into the position it would have been in had it known the
true facts. 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.
Even here, the Law Commissions have concerns that the law might
sometimes operate unfairly. When a consumer has been negligent and
the insurer would have declined the risk but the fault is minor,
should the court have a residual discretion to prevent
avoidance, imposing a reduction on the claim instead?
For life insurance, a special five-year cut-off rule is
proposed. An insured who negligently made an inaccurate or
misleading representation when applying for life insurance would be
entitled to be paid in full after that period.
In the business context, as under the consumer regime, the
insurer would have no remedy if the insured acted honestly and
reasonably. As for other breaches, the paper asks whether the
remedies should follow the same pattern: avoidance for dishonest or
reckless breaches and proportionate remedies for negligence.
For business insureds, however, this would only be a default
regime. The parties could agree more stringent terms if they
wished.
Warranties
A warranty is basically a promise to do or not to do something
or that a state of affairs exists or will exist. 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 cover will automatically terminate, 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.
The proposed solution for both consumer and business insurance
is a requirement for a “causal connection”. For the insurer to be
able to avoid paying all or part of the claim, the breach must have
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.
For the most serious breaches, the insurer would have a separate
right to terminate the policy for the future.
There would be some additional protections. Warranties in
consumer insurance would be limited to warranties of future fact
and these would always have to be set out in writing. Insurers
would also have to show they took sufficient steps to draw them to
the insured's attention. Statements of past or present fact could
only ever be representations and so subject to the new
proportionate remedies.
In the business context, insurers could require warranties of
past, present and future fact as long as they are clearly set out
in the policy. The parties could, of course, agree different terms
(for instance, removing the need for a causal connection), subject
to the additional controls on standard terms.
For both business and consumer insurance, the Law Commissions
also propose to abolish "basis of the contract" clauses - clauses
that automatically transform statements made by the insured into
warranties.
Written standard terms
A default regime might leave small businesses vulnerable if
insurers could take advantage of the new rules by imposing
draconian warranties, exclusions or definitions on relatively
unsophisticated insureds.
To deal with this, the Commissions propose an additional,
mandatory rule. Contracts concluded on the insurer's written
standard terms would not be allowed to give the insurer greater
rights to avoid claims than under the default regime, if this would
defeat the insured's reasonable expectations of cover. This would
not interfere with the freedom to negotiate contracts on an
individual basis.
Brokers and intermediaries
English law still generally assumes that a broker acts as agent
for the insured. This means that the insured usually bears the
risk of the broker getting it wrong. If the broker fails to pass on
information (or passes on incorrect information) to the insurer,
the insurer simply avoids the policy against the insured, even
though the insured may be wholly innocent of the breach.
Even when the broker is for all other purposes the tied agent of
an insurer, the law treats him as the agent of the insured if he
completes the proposal form on the insured's behalf.
Unaware of this, consumers tend to assume the broker is working
for the insurer. The Law Commissions want to bring the law closer
to consumers’ reasonable expectations.
In both consumer and business insurance, a broker would be
treated as acting for the insurer for the purposes of receiving
pre-contract information, unless he is clearly independent of the
insurer and acting on the insured's behalf.
Where the broker is the insurer’s agent and makes an error, an
insured who acted honestly and reasonably would not be prejudiced.
The insurer would have to pay any insurance claim in full. If
the insured acted negligently, the proportionate remedies would
apply. Only if the insured had been dishonest or reckless would the
insurer be entitled to avoid.
In addition, a broker regarded as the insurer’s agent would
remain so throughout the pre-contract process, even if he helps
complete the proposal form.
Where the insured signs an incorrect form completed by the
broker, his signature would be good (but no longer conclusive)
evidence that he adopts the statements made in it. The court or
ombudsman deciding on the appropriate remedy would have to consider
whether, in signing the form, the insured acted reasonably,
negligently or recklessly.
The Law Commissions anticipate these proposals will have less
impact on the business sector as businesses are more likely to
instruct independent brokers to search the market for them.
Such brokers would continue to be treated as agents of the
insured.
Harmonisation in Europe
Further afield, moves towards creating a common frame of
reference for insurance contract law are taking place in
Europe.
In December 2007, the Restatement of European Insurance Contract
Law project group produced a set of draft principles of European
Insurance Contract Law (PEICL).
These go significantly further than the current Law Commissions'
proposals, but are being put forward as a voluntary regime. Parties
would be able to opt out of their national insurance contract law
regime and opt in to PEICL for cross-border and domestic
business.
At present, the Law Commissions see harmonisation of European
insurance law as a distant prospect, but point out that there would
be more chance of being able to influence the outcome
if domestic law has already been reformed.
Contact: Colin Read (colin.read@pinsentmasons.com
/ 020 7418 7305)
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