Out of the grey
Written by Helen Yates
Should insurers be able to avoid contracts in cases where the insured has not provided a completely accurate picture of the risk underwritten? This is a point for debate in the latest round of insurance law reform proposals
In a 2010 survey Airmic surveyed its members on the duty of disclosure. It found that 75 per cent spend between two and six months preparing the information they submit to insurers. Despite this diligent approach, approximately a third said insurers had raised non-disclosure issues against them in the last five years. Of these, only half said the claim had been resolved satisfactorily.
The Law Commission’s latest consultation paper on insurance law reform covers the business insured’s duty of disclosure. At present, a policy can be avoided entirely if it transpires that an insured has failed to disclose a material fact. This treatment of non-disclosure under the Marine Insurance Act of 1906 is out-of-date, according to the Commission.
“The Marine Insurance Act is a fantastic piece of legislation – it is still as relevant as it ever was, however times have changed in the last 100 years,” says Richard Pedley, marine client manager at Aon Risk Solutions. “We had no FSA when it was written and the concept of treating customers fairly was not even thought of.
“We get down to the fundamentals of utmost good faith,” he continues. “You enter into a contract, you are asked questions and you disclose everything that you think is material to the risk. However, the Marine Insurance Act also says that if you don’t disclose something that is material to the risk, insurers can still walk away from the contract and we can cancel from the ground-up. It puts the onus on the insured and not on the insurer. The proposed changes seek to redress the balance, particularly for consumers.”
The case for proportionate remedies
In cases of innocent non-disclosure the Law Commission and bodies representing insurance buyers believe a more proportionate remedy would be more suitable. “Our view has been for some time that disclosure requirements and the remedies available are disproportionate and weighted in favour of insurers,” says Paul Hopkin, technical director at Airmic.
“What we are in favour of is a more balanced sharing of obligations and set of remedies available to insurers if there are circumstances of alleged non-disclosure, misrepresentation of the risk, alleged failure to comply with warranties. All those circumstances that can perhaps arise from time-to-time when you are providing the information related to large, complex organisations with complex activities, supply chains and so on.”
“We believe those sorts of remedies and more even-handed claims handling procedures are more appropriate than the sledgehammer that insurance companies can sometimes have in their hands, which is the ability to avoid the policy completely,” he continues. “We believe that remedy should only be available if there has been fraudulent and reckless non-disclosure.”
Reservation of rights
Under the current law, based on the Marine Insurance Act, the remedy for non-disclosure – whether made innocently or deliberately – is that the insurer may avoid the contract, even if the piece of information in question was never requested by the underwriter in the first place. If the non-disclosure was fraudulent, the insurer may be entitled to retain the premium.
The Law Commission’s consultation suggests the law is not in line with the reasonable expectations of the market as it “places an obligation on the insured to disclose all material facts, even if no questions have been asked of them”. It points out that UK insurance law appears to be particularly favourable to the insurer by international standards and that in civil law countries the onus is on the insurer to ask questions. Avoidance of the policy in these countries is restricted to intentional or fraudulent misrepresentations.
It suggests proportionate remedies should apply to all non-disclosures or misrepresentations which were not dishonest. Proportionate remedies focus on the contract that the insurer would have entered into with the policyholder if the insurer had been aware of all the information at the time. For instance, in cases where the underwriter would have charged a higher premium, the amount of the claim would be reduced proportionately.
Under the proposed reforms, the disclosure process becomes more of a partnership, thinks Hopkin. For its part, Airmic has sent its members a guide to developing and implementing suitable and sufficient disclosure. It has also issued its own clause on non-disclosure with the aim of suggesting appropriate remedies for innocent non-disclosure and reducing the frequency with which insurers issue Reservation of Rights following the notification of a claim.
“We’re supportive of this even-handed approach that says to Airmic members, ‘have good disclosure processes’ but also says to underwriters, ‘look at the information you’ve been given and don’t ignore it until a claim arises,” says Hopkin. “And if there is a large claim that the insurer is initially uncertain about there is a cooling off period before Reservation of Rights is issued.”
The Law Commission’s consultation follows the passing of the Consumer Insurance (Disclosure and Representations) Act 2012, due to come into force in a year’s time. This piece of consumer legislation is much simpler in its treatment of non-disclosure, thinks Hopkin, but should be a good template on which to base the law for business insurance.
“We’re in the throes of writing our Airmic submission to the Law Commission, who we’re fully supportive of,” he says. “What they’ve done with consumer legislation we believe a similar model should be in place for business insurance contracts. It can’t be quite the same because Airmic members should know what they’re doing.”
More cost and red tape?
“Underwriters are specialists in different areas of the market and they tend to know many of their clients and the brokers who they deal with well, as businesses,” insists Kees van der Klugt, head of legal and compliance at the Lloyd’s Market Association. “We do question some of the reasons the Law Commission gives for the need for law reform in the commercial (as opposed to consumer) arena where, for example, an expert broker is acting for the insured, which has an expert risk manager.”
Aon Risk Service’s Pedley is concerned the reforms – however well intentioned – could slow down the business and add an additional layer of cost at a time when resources are already stretched. “A lot of recent reforms in insurance were going to speed things up and if anything they’ve just added an extra layer of bureaucracy and expense.”Consumers would be the main beneficiary of the proportionate approach to non-disclosure, but Pedley suggests another beneficiary would also be the legal community. Insureds, brokers and underwriters will all be required to put in more
work to ensure a thorough disclosure process has been adhered to. The risk is this could delay the underwriting process and ultimately result in higher premiums.
Van der Klugt questions the need to reform a piece of legislation that has moved with the times. “The Marine Insurance Act is old but actually it’s survived incredibly well and of course the Common Law, which is built on to the Act, is developing – it’s not static. So I wouldn’t say just because it’s an old Act it needs to be reformed. However, the LMA is potentially in favour of a new Act if this is to codify the law as it has developed.”
The LMA is in the process of preparing its submission to the Law Commission and will be making its concerns known as part of that process. van der Klugt is keen to stress that the international nature of the London market needs to be taken into account. He is concerned that adding complexity to how non-disclosure is treated, including provisions on remedies which may raise many questions in the event of dispute, could change the way the market works and decrease the attractiveness of London as a centre for underwriting.
“What we’re concerned about is weakening the onus on the insured and its broker to make a fair presentation of material facts,” he says. “It’s got to come from the insured because they know about their business. We are worried that introducing new statutes and new tests, as opposed to a neutral re-codification, could have unexpected consequences.”
However the Law Commission decide to precede one thing is certain, reforms to the Marine Insurance Act covering the business insured’s duty of disclosure will not happen overnight. Hopkin is hopeful reforms can be made before the next election, but thinks it will take at least two to three years. “We’re not looking to disadvantage underwriters and insurance companies,” he says. “We simply don’t like the remedy of avoidance being available in circumstances we feel it’s inappropriate.”