Though commercial insurance buyers are set to benefit from imminent legal changes, they will also have greater responsibilities around the information they disclose to their insurers.
The UK commercial insurance market is entering a new era. The incoming Insurance Act – described by the UK government as the “biggest reform in more than a century” – will change obligations for insurance buyers and insurers when it becomes effective in August 2016.
The Act levels the playing field between insurers and policy holders, especially in the event of a claim.
Insurers currently have sweeping powers to void policies for breaches of contract terms (usually warranties), often discovered only after a claim is made. Insurers can avoid liability even if the breach was in no way relevant to the loss suffered.
For example, a policyholder who, in breach of a warranty under the policy, fails to install window locks in a property that is subsequently flooded might find that the insurer avoids the policy. Insurers can even avoid policies for breaches of warranty put right before the loss occurred.
Worse still, ‘basis of contract clauses’ in many contracts turn any of the buyer’s pre-contractual statements to the insurer, such as those made in proposal forms or questionnaires, into warranties.
From August 2016, insurers will only be entitled to avoid cover if the breach of warranty exists at the time of the loss. So the insured’s breach of warranty suspends, but does not extinguish, the insurer’s liability under the contract.
Furthermore, in the event of a breach of a contractual term, the insurer has a remedy only if the breach was relevant to the actual loss. The Act also renders ‘basis of contract clauses’ ineffective, meaning that pre-contractual statements can no longer be converted into warranties.
The Act also introduces more proportionate remedies for failures by buyers to disclose material information to insurers.
For example, if a buyer fails to disclose a fact that would have caused an insurer to charge a higher premium, the indemnity can simply be reduced by a proportionate amount.
The insurer will be entitled to avoid the policy only in specified circumstances, explains Graham Terrell, Casualty Technical Specialist at JLT Specialty.
“The insurer will only be able to void the policy if the non-disclosure is deliberate or reckless or they can prove they wouldn’t have taken the risk in the first place,” says Terrell, who, as deputy chair of the British Insurance Brokers Association’s casualty and accident committee, worked closely with the Law Commission during the drafting of the bill before it became law.
Buyers can start benefitting from these changes now, Terrell adds, by pushing insurers, directly or through their brokers, to remove basis clauses and clarify in policies that innocent nondisclosure will not automatically void cover.
“Don't wait for August 2016. If you don't make changes to your policy you will have to wait all the way until your next renewal to gain any benefit at all.”
The changes are not all about making life harder for insurers, however, Terrell notes.
First, some insurers argue they rarely actually enforce the powers they have. This is broadly true, says John Hurrell, Chief Executive of Airmic, not least because it would do their reputation no good and because the current law is so unreasonable that judges and juries “bend over backwards to find in favour of the policyholders”, he says.
It has therefore often been in insurers’ interests to avoid the courts. But this is less likely to be the case in future, says Hurrell.
“Policy holders can no longer rely on insurers not taking action. I think insurers will interpret the new law strictly and, in fact, in cases where there are grey areas there will almost be an incentive for them to take things to trial to test the law.”
Insureds – and their brokers – also need to be wary of insurers attempting to reintroduce their powers to void policies through the back door, says Alan Percival, Chief Operating Officer for JLT Specialty’s Regional Risk Practice.
“The Act won’t stop some insurers from refusing to pay claims and it may just enable them to find a way to do it.
“That said, at the same time we have actually seen certain insurers using the new Act in a positive way to pay claims that might otherwise not have been covered, by applying premium to remedy a breach of fair presentation and enabling the policy to indemnify,” Percival says.
The Act allows contracting parties to explicitly opt out of provisions, for example, and some insurers may also try to replace warranties with ‘conditions precedent’ – essential conditions that must be satisfied before the insurer becomes liable.
The Act attempts to address this – again to prevent insurers relying on conditions irrelevant to a claim to turn it down. Nevertheless, it is an area where the Law Commission has said it expects to see litigation.
More fundamentally, the removal of insurers’ powers to void policies is accompanied by increased obligations for buyers to ensure their insurers have the information necessary to assess risks correctly at the outset: known as the ‘Duty of Fair Presentation’.
In one sense the duty simply codifies the existing law and obligations on buyers, says Christopher Galyer, Group Legal Head of Global Insurance at JLT Group. “It’s what buyers should be doing already.”
But the Act is much more prescriptive and explicit about how this should be done. Rather than simply obliging insurance buyers to answer questions in good faith, the Act makes clear that they are required to disclose everything they know (or ought to know) that the insurer needs in order to decide whether and how to insure the risk.
The individuals whose knowledge counts for these purposes include the buyer’s senior management and those responsible for the company’s insurance, both inside and outside the organisation, including subsidiaries and brokers, for instance.
Failing that, they must provide sufficient information of relevant facts to put the insurer ‘on notice’ that it needs to make further enquiries. This might, for example, mean mentioning the business is looking to move premises in the coming year.
If buyers meet these obligations, insurers will have fewer opportunities to avoid paying. However, the requirements placed on buyers are significant, says Paul Lewis, Partner at law firm Herbert Smith Freehills.
“There will be much more emphasis on the format of the presentation of information and on who a policyholder needs to obtain information from.”
First, buyers will have to disclose the relevant information available to them, which is deemed to include everything that “should reasonably have been revealed by a reasonable search”. This includes information held by the buyer and its broker.
Second, buyers can no longer side-step their disclosure obligations through ‘data dumping’. Businesses will still be able to use ‘data rooms’ to house the information insurers need, but it will need to be reasonably organised so insurers can find the information relevant to the risk they are insuring.
Percival says: “Companies will no longer be able to just have an area or a file and dump anything with the word insurance there. Businesses will have to be a lot more careful how they organise and label data.”
Insurance buyers will have to fulfil the ‘Duty of Fair Presentation’ as far as possible – and be careful to document their efforts to do so.
This is likely to prove the best defence against possible legal disputes as the new law beds in and it becomes clear what a ‘reasonable search’ means in practice, or who is included as being senior management or responsible for the insurance contract.
Lewis says: “If an insurance buyer can demonstrate they’ve done everything prescribed in the Act, the courts ought to have a degree of sympathy with any omission that slips through the net.”
Ensuring they can demonstrate this will require significant work for some, though, and all firms – big and small – need to make a start, Terrell says.
“Insurance buyers need to take the time to understand exactly what a fair presentation entails, identify who the senior management and responsible people are, make a reasonable search of their data, and ensure the material information is sent to underwriters in a clear and easily accessible way.”
Insurance Act: the key changes
- The vague duty on the insurance buyer to disclose material information to the insurer in ‘utmost good faith’ is clarified with a new duty to make a ‘fair presentation of the risk’.
- Basis of contract clauses are banned.
- Warranties are to be ‘suspensive conditions’ so breaches no longer permanently discharge the insurer’s liability if the breach is remedied prior to the loss
- The automatic right of insurers to void the contract for failures in disclosure is removed, with a range of proportionate remedies introduced.
- Both parties can opt out of the terms of the Act, provided that this is done transparently.
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For more information, please contact Alan Percival, Regional Risk Practice, Chief Operating Officer on +44 (0)121 626 7811 or firstname.lastname@example.org