Claiming rights

With its crude, all-or-nothing approach, insurance law has come under the scrutiny of the Law Commission. Francis Mackie and James Heyhoe report

Insurance law is often criticised as being too ‘insurer friendly’. As part of its general review of insurance contract law, the Law Commission has recently published an ‘issues paper’ dealing with the law of misrepresentation and non-disclosure. Its aim is to promote discussion before a formal paper is published in summer 2007. The thrust of its tentative proposals is to restrict the circumstances in which insurers may avoid their policies.

The current positionIn ordinary commercial contracts, the governing principle is caveat emptor – let the buyer beware. A party may not misrepresent facts, but it does not have to disclose facts about which it is not asked.

Parties to an insurance contract, however, owe each other a duty to act with the ‘utmost good faith’. They have to make full disclosure of all material facts even if no question is asked (failure to do so is non-disclosure) and avoid making material mis-statements (misrepresentation).

The test for materiality is whether a fact would have an effect on the mind of a prudent underwriter. An insured party therefore has to decide what to disclose by reference to what a prudent insurer would want to know. This can be a difficult judgment call to make, especially for an insured with little or no experience of the market.

The consequences of a misrepresentation or non-disclosure are potentially severe: the insurer can choose to avoid the policy. This means that the contract is treated as though it never existed, with premium and claims monies being returned – clearly, an attractive remedy for an insurer faced with large losses. It does not matter if the misrepresentation or non-disclosure is fraudulent, negligent or innocent. Nor does it matter if the misrepresentation or non-disclosure bears no relation to the loss suffered. The insurer is entitled to avoid the policy even though the insured has acted reasonably and honestly.

Consumer policiesThe draconian nature of the current law has already resulted in various measures being introduced to protect the position of the consumer, including Statements of Practice issued by the Association of British Insurers (ABI), regulation by the Financial Services Authority (FSA), and the dispute resolution service of the Financial Ombudsman Service.

The Law Commission reviewed the existing measures, but concluded that they are inaccessible and obscure. It has therefore come up with some proposals for change. Under these, consumers no longer have a residual duty of disclosure and the remedy of avoidance is limited to fraudulent conduct.

Under the commission’s ‘tentative’ proposals for consumer insurance, insurers should only be entitled to a remedy for an insured’s non-disclosure or misrepresentation in so far as this is material. To establish materiality, the actual insurer must first show inducement. It must also show that the proposer either appreciated that the fact in question would have that significance or, if not, that a reasonable insured in the circumstances would have appreciated its significance.

The remedy available should differ according to the state of mind or conduct of the insured. Insurers should be allowed to avoid policies where the insured has acted fraudulently. Where the proposer has made a negligent misrepresentation, the court should apply a proportionate remedy by asking what the insurer would have done had it known the true facts. If an insurer would have charged more premium, for example, the claim should be reduced proportionately to the continued #+ continued under-payment of premium. If the insured had reasonable grounds for believing the truth of what they said, or was not negligent in other ways (such as failing to answer a question), the insurer should have no remedy for misrepresentation or non-disclosure.

Insurers should also ask consumers clear questions about any matter that is material to them. If they do not ask questions on a particular point, the insurer should be regarded as having waived its right to such information.

Business policiesBusinesses do not currently enjoy the extra protection from the law afforded to consumers, since they are generally assumed to be more sophisticated customers who often use the services of a professional broker. It is in this area, therefore, that the Law Commission’s proposals break most ground.

The commission’s ‘tentative’ proposals for business insurance are:#the law affecting business insurance should be changed to give the insured certain additional rights, but the rules in general should not be mandatory;#the duty of disclosure should continue to apply, but in a modified way;#a reasonable insured test of materiality should apply to all business insurance: ‘What would a reasonable insured in the circumstances understand to be material to the underwriter in question?’;#the insurer can avoid the policy where a business insured has behaved fraudulently;#a negligent misrepresentation or nondisclosure should be a ground on which the insurer may cancel the policy after reasonable notice, without prejudice to claims that have arisen or arise within the notice period;#where a business insured has acted without negligence in making an incorrect statement or in other ways, the insurer should have no right to avoid the policy or refuse to pay a claim under it on that ground.

Businesses still have a duty of disclosure. However, the test for materiality is no longer whether a fact would have an effect on the mind of a prudent underwriter, but whether a reasonable insured would understand the fact to be material to the underwriter in question.

This would mean a sea change in the evidence required to prove a case: expert evidence would no longer be concerned with the views of the ‘prudent underwriter’, but with the views of a ‘reasonable insured’ (if one can be found).

As with consumers, the remedy of avoidance is retained only for fraudulent conduct and there is no remedy for innocent misrepresentation or non-disclosure. The Law Commission has queried whether the remedy for negligent misrepresentation should be proportionate, in that it should aim to put the insurer into the position it would have been in had it known the true circumstances.

It has also queried whether there is any reason not to apply the proposals for business insurance to reinsurance (although it has stated that its starting point is that the same rules should apply unless a good case is made out otherwise).

The case for reform in this area would appear to be less strong: insurers dealing with insurers can be expected to appreciate what their fellow professionals would wish to know.

If adopted, the Law Commission’s proposals would sound the death knell for the avoidance of insurance contracts (save in cases of fraud, which would be difficult to prove). It should publish its final report before 2010. nFrancis Mackie is a partner and James Heyhoe an associate at LeBoeuf Lamb Greene & MacRae