Insurance law should treat micro-businesses as consumers, say Law Commissions

According to Government figures for 2008, there are 4.5 million "micro-businesses" in the UK with fewer than 10 employees. Most of them are sole proprietorships and their average turnover is less than £500,000. But together they provide employment for one third of employees working in the private sector.

With little specialist insurance knowledge, however, these enterprises are often no more financially sophisticated than consumers when they buy insurance cover.

They are also the least likely type of business to use insurance brokers. In 2007, according to FSA research, about half of them bought insurance directly from insurers, often online. This proportion is likely to increase.

Against this background, the Law Commissions want to know whether micro-businesses should be given the same legal protections as consumers when they provide information to insurers before buying cover and when faced with unfair contract terms in their insurance policies.

Mandatory regime

In their 2007 consultation paper on insurance law reform, the Law Commissions put forward a mandatory scheme for consumers, but suggested businesses should be subject to a default regime that would allow insured and insurers to "contract out" if they wished to decide their own terms.

To provide smaller businesses with some additional protection, however, the paper suggested there should be a mandatory rule that would prevent insurers who used standard written terms from giving themselves greater rights to avoid claims than under the default regime, if this would defeat the insured's reasonable expectations of cover.

Although many of those who responded to the consultation agreed that small businesses needed extra safeguards, most thought the proposal introduced too much uncertainty over what would be deemed standard terms. After some further consideration, the Law Commissions agreed.

In a new issues paper published on 16th April, they now suggest removing micro-businesses from the business regime altogether, putting them in the same mandatory regime as consumers.

This would mean that, like consumers, micro-businesses would no longer be under a duty to volunteer information to insurers when applying for insurance. They would only be required to answer honestly and with reasonable care any questions asked.

And, instead of being entitled to avoid the contract altogether for an inaccurate or misleading statement (as under the current law), insurers would have a range of remedies depending on what they would have done had they known the information.

The new regime would also severely restrict the occasions when insurers could avoid liability by relying on breach of a warranty. Even in such cases, insurers would have to show the breach caused or contributed to the loss claimed under the policy.

Unfair contract terms

The Law Commissions' second suggestion is to extend the Unfair Terms in Consumer Contracts Regulations 1999 to micro-businesses in relation to insurance contracts.

The change would allow the smallest enterprises to challenge policy terms for unfairness, provided the term has not been individually negotiated and is not a "core" term. Terms (including core terms) that are not expressed clearly in plain language would also fall foul of the regulations.

What insurance terms would be considered unfair?

The FSA has already taken action under the regulations against unduly onerous notification clauses and premium variation clauses in consumer contracts.

The paper puts forward other examples, such as cover for "storm damage" which actually only applies to force 10 gales or above, or exclusions that at first sight appear limited but turn out to be unexpectedly wide, such as an exclusion for "riot" that includes robbery, terrorist attacks or hijacking.

The extension would only apply to micro-businesses and only to insurance contracts. "It would mean that whilst their protection in the field of insurance would be brought into line with that of consumers, in other fields, for example, banking, it would not," the paper confirms.

"We appreciate that the unique extension of the [regulations] to insurance contracts and the possibility that this may set a precedent may cause concern". 

Definitions

Crucial to the proposals is a workable definition of a micro-business. The Law Commissions are as yet undecided between a straightforward test based on the number of employees (0-9), on annual turnover of less than a specified amount (possibly £1million), or on whether the business falls within the jurisdiction of the Financial Ombudsman Service.

The current FOS threshold is a turnover of less than £1 million, but there are plans to change this to a combined test of fewer than 10 employees and a turnover of less than €2 million.

There would also need to be secondary tests to filter out sophisticated operations, such as special purpose vehicles, that might otherwise be defined as micro-businesses.

The Commissions propose that the turnover or number of employees in any associated or group company should be taken into account when calculating the figure for the basic test. In addition, businesses that spend more than a certain amount on their insurance premium (say £15,000) or that hold assets or have a turnover of more than £10 million would not qualify.

Insurers will need to make sure they ask the right questions at the pre-contract stage to determine whether the prospective insured is a micro-business or not. The paper asks for views on how best to deal with businesses that are wrongly classified, whether by mistake or because of a misrepresentation.

The Law Commissions promise, however, that the scope of the new definition will be strictly limited. "The definition of micro-business that we shall propose would be used purely for the purpose of pre-contractual information and unfair terms in insurance contracts and the ambit of the definition would be limited to the new bill on these matters," the paper states.

"It will not affect the FSA's definition for the purposes of the ICOBS rules or for any other legislation."

Responses to the issues paper are required by 17th July 2009. The Law Commissions' draft bill on pre contractual information in consumer insurance is due to be published this autumn.