Practical Guide to the Insurance Act 2015

David Kendall and Harry Wright

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CHAPTER 1 Background to the Insurance Act

Overview

1.1 This is a book about the Insurance Act 2015 and its impact on English law. The Insurance Act is the first comprehensive statutory reform of non-consumer insurance law since the Marine Insurance Act 1906, which essentially codified the existing common law. It is the product of extensive efforts by the Law Commissions of England and Wales, and Scotland, to reform UK insurance law,1 a process begun more than 50 years ago.2 1.2 The Insurance Act makes very significant changes to insurance law in the United Kingdom, and (it is expected) to the business of buying, underwriting and broking insurance contracts governed by the laws of the United Kingdom. It has been variously described as a ‘thorough overhaul’ of UK insurance law;3 ‘the most significant reform of the nation’s insurance law’ for 250 years;4 and (less promisingly) as in some respects ‘uncertain and obscure’;5 and a ‘risky sacrifice of the … prized certainty of business insurance law’.6 1.3 The Act is intended to level the playing field between the parties to a contract of insurance, which was previously seen as unduly favourable to the insurer.7 It therefore makes a number of changes which ought to favour the insured, most obviously the abolition of avoidance as the sole remedy for breach of the duty of utmost good faith, and its replacement with proportionate remedies for breach of a (new) duty of fair presentation. In addition, the Act transforms insurance warranties so that breach will no longer discharge the insurer’s liability automatically and permanently. It also

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heralds the potential availability of damages where an insurer fails to pay a claim within a reasonable time. These are fundamental changes. 1.4 The Insurance Act has gone substantially further than addressing merely those areas of insurance law most obviously in need of attention. It has also brought about a comprehensive reform of the law governing the knowledge of the insured and the insurer for the purposes of the duty of fair presentation. This is important, since an insured is required to disclose only material matters which it knows or is taken to know, and is not required to disclose matters known to the insurer. The law on knowledge therefore underpins the new duty of fair presentation. Whereas the aim of the Act was to advance the interests of insureds, reforms to the law on knowledge appear to add to the insured’s burden, or at least to uncertainty over what the insured must disclose. The Act also introduces a new restriction whereby an insurer will be unable to rely upon breach of any risk mitigation term in order to limit or discharge its liability, if the breach was irrelevant to the actual loss which has occurred (for example, there may be no reliance on breach of a burglar alarm warranty where the loss was caused by a flood). This provision will apply not only to warranties, but to a potentially wide range of terms which, if complied with, would tend to reduce the risk of loss. These too are fundamental changes. 1.5 This book is intended to assist those participating in the business of insurance (whether as buyers, insurers or brokers), or practising in the field of insurance law, to navigate and understand the meaning and practical effect of the changes brought about by the Insurance Act. It is written in something of a vacuum of authority since, at the time of writing, not a single decision based upon the Insurance Act has been handed down.8 It might, therefore, be considered premature, but the need for those carrying on the business of insurance appeared to the authors to warrant a tentative attempt to explain the new law, particularly those aspects which are obscure and likely to cause problems.

Recent history of insurance law reform in the UK

1.6 Since it was first considered by the Law Reform Committee in 1954, it has taken more than 50 years for statutory reform of non-consumer insurance law in the United Kingdom to be realised. From 1978, this process has been driven by the Law Commissions, though the movement for reform pre-dates their existence, which did not come about until 1965.9 The recent process of reform can be traced to 1954, when Viscount Kilmuir (then Lord Chancellor) invited the Law Commissions’ predecessor, the Law Reform Committee, to consider certain aspects of insurance law. In 1957, the Committee published its Fifth Report, recommending a softening of the duty of utmost good faith through amendment of the test for materiality, so that no fact should be deemed material unless it would have been considered material by a

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reasonable insured. Additionally, it was proposed that no misrepresentation should be actionable if the insured could prove that the statement in question was true to the best of his knowledge and belief. These reforms were never enacted. 1.7 There followed a period of inactivity until 1978, when the Law Commission of England and Wales was asked to consider insurance law reform by Lord Elwyn-Jones, the Lord Chancellor. The Law Commission reported in 1980,10 having considered matters including non-disclosure and misrepresentation, warranties and basis clauses. The 1980 Report proposed statutory reform through a draft ‘Insurance Law Reform Bill’, which included the following reforms of note:

(i) The insured would be required to disclose material matters which it knows or is assumed to know. The insured would be assumed to know a material matter if it would have been ascertainable by reasonable enquiry and if a reasonable person applying for the insurance in question would have ascertained it. The insured would be required to disclose a matter only if it is one which a reasonable person in the position of the insured would disclose to his insurers, having regard to the nature and extent of the insurance cover sought, and the circumstance in which it was sought.11
(ii) In a proposal form, the insured would be required to answer questions to the best of his knowledge and belief, having made such enquiries as were reasonable in the circumstances.12
(iii) A term would be capable of being a warranty only if it were material to the risk. There would be a rebuttable presumption that any term possessing the attributes of a warranty was material to the risk.13 The warranty would also need to be provided to the insured, in writing, within a reasonable time of it being given by the insured, failing which the insurer would be precluded from relying on breach of the warranty.14
(iv) An insured would be entitled to recover if it could show that, notwithstanding a breach of warranty, the warranty was intended to safeguard against the risk of a particular type of loss, and the actual loss was of a different type; or, even if the loss was of a type which the warranty was intended to safeguard against, the insured’s breach could not have increased the risk that the loss would occur in the way in which it did in fact occur. In either case, the insurer would be entitled to repudiate the contract for the future, on account of the breach of warranty.15 In addition, basis clauses would have been rendered ineffective.16

1.8 A major limitation of the 1980 recommendations was that none of them would have applied to Marine, Aviation or Transport insurance.17 As will be seen, many of the reforms proposed in the Law Commission’s 1980 Report and the Insurance Law Reform Bill bear striking similarities to provisions in the Insurance Act. In spite of

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the numerous and detailed recommendations, no reform was enacted. There followed a long period of relative silence on the subject of insurance law reform by the Law Commission, which appears to have been brought to an end by a 2002 report by a sub-committee of the British Insurance Law Association, which concluded that there was a need for reform.18 The BILA sub-committee recommended (in summary) that the Law Commission’s 1980 recommendations should be implemented,19 with certain moderations and additions (such as the introduction of proportionate remedies for breach of the duty of utmost good faith,20 and treating sums payable under an insurance contract as a debt, with an implied term requiring insurers to pay the debt within a reasonable time).21 The report, contributed to by senior judges, counsel, and academics, was described by the Law Commissions as a ‘major factor’ in their decision to return to the area of insurance law in 2005,22 when insurance law reform was again considered with a new intensity.

Consideration of reform in the new millennium

1.9 The Law Commissions returned to the subject of insurance law reform in March 2005, indicating that they would perform a review of insurance law.23 In January 2006, the Law Commissions published a Scoping Paper seeking views from interested parties about the areas of insurance law which were in need of attention. Over the following six years, the Law Commissions undertook a herculean review of UK Insurance Law, publishing a series of Issues Papers, Consultation Papers and a Final Report covering a multitude of topics:

Issues Paper 1: Misrepresentation and Non-Disclosure (September 2006).
Issues Paper 2: Warranties (November 2006).
Issues Paper 3: Intermediaries and Pre-contract Information (March 2007).
Consultation Paper No 182: Misrepresentation, Non-Disclosure and Breach of Warranty by the Insured (June 2007).24
Issues Paper 4: Insurable Interest (January 2008).
Issues Paper 5: Micro-Businesses (April 2009).
Consumer Insurance Law: Pre-Contract Disclosure and Misrepresentation (December 2009).25
Issues Paper 6: Damages for Late Payment and the Insurer’s Duty of Good Faith (March 2010).
Issues Paper 7: The Insured’s Post-Contract Duty of Good Faith (July 2010).
Issues Paper 8: The Broker’s Liability for Premiums: Should Section 53 be Reformed? (July 2010).
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Issues Paper 9: The Requirement for a Formal Marine Policy: Should Section 22 be Repealed? (October 2010).
Consultation Paper No 201: Insurance Contract Law: Post Contract Duties and Other Issues (December 2011).26
Consultation Paper No 204: The Business Insured’s Duty of Disclosure and the Law of Warranties (June 2012).27

1.10 Even a heavily abridged summary of the Law Commissions’ papers on insurance law reform would fill many pages, and could not do justice to the depth of research and consideration undertaken. The accumulated learning from the papers referred to above was condensed into the Law Commissions’ final (420-page) report of July 2014: ‘Insurance Contract Law: Business Disclosure; Warranties; Insurers’ Remedies for Fraudulent Claimant; and Late Payment’,28 which accompanied the draft Insurance Bill and Explanatory Notes. Extensive reference is made to the July 2014 Report in this book, as well as the other papers referred to above.29 The paragraphs below attempt to summarise the problems which the Law Commissions identified in the final July 2014 Report, which the Insurance Act is intended to remedy.

The problems of the old law

1.11 The Law Commissions considered (with some justification, it is submitted) that the old law was unduly favourable to insurers, and opposed to the interests of insureds. The principal source of this problem was the Marine Insurance Act 1906, which the Law Commissions considered to have two fundamental shortcomings. The first was one of policy, in that the 1906 Act deliberately placed the insurer in the dominant position in a number of respects, chiefly the effect of breaching a warranty, and the pre-contractual duty of utmost good faith.30 The second was one of drafting, namely the fact that the 1906 Act was written in such ‘clear and forthright terms’, which was thought to ‘hamper the ability of judges to develop the law’.31 It has been noted that the same criticism cannot be levelled at certain parts of the Insurance Act.32 In all, therefore, the Law Commissions considered that whilst there was much in the 1906 Act worth preserving, certain aspects had become outdated, and increased the likelihood that insurance may fail to respond as expected, or at all.33 This was seen as increasing the risk of insurance disputes, which caused delay, expense and uncertainty. There was also concern that unless the law was reformed, international trust in UK insurance in the international marketplace would be undermined.34

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Duty of utmost good faith and avoidance

1.12 The Law Commissions’ leading criticism of the old law was the nature of the duty of utmost good faith and (above all) the sole remedy of avoidance for its breach. The Law Commissions identified two problems about the nature of the duty: it was not properly understood and was too onerous; and two undesirable consequences of the duty: the phenomena of data-dumping and underwriting at the claims stage. Under the old law, the duty of utmost good faith required the insured to disclose every material circumstance which it knew or ought to know before entering into a contract of insurance. The Law Commissions considered this to be a duty ‘so wide and undefined that the policyholder can rarely be certain that they have complied with it’.35 In medium-sized and large companies, in which material information could be very diffuse, there was said to be a lack of understanding of what a company knows or ought to know;36 whose knowledge was relevant;37 and what was a material matter for disclosure. This was thought to be causing widespread failure to disclose material information.38 The duty of disclosure under the old law was also characterised as being too onerous, especially for medium-sized and large businesses, because every material circumstance may be of a significant or even ‘insurmountable’ volume.39 This was caused in part by the volume of information now available to insureds and insurers, which has grown exponentially since the 1906 Act, meaning the old law was seen as increasingly anachronistic.40 1.13 A combination of the uncertainty about what was a material circumstance and what knowledge was relevant for the purposes of the duty of disclosure was said to cause ‘data-dumping’, which is the disclosure by an insured of vast quantities of unstructured information in an attempt to safeguard against the prospect of non-disclosure.41 This phenomenon was blamed in part on the failure of the 1906 Act to make any provision on the way in which the insured must give disclosure to the insurer.42 Aside from the obvious practical difficulties of data-dumping for the insurer, the Law Commissions were concerned that the practice could be used to ‘bury’ important information in a mountain of unprocessed and irrelevant material.43 As well as data-dumping, the old law was said in certain cases to cause ‘underwriting at the claims stage’. This was when an insurer would accept a poor-quality risk presentation without asking questions unless and until a claim arose,44 whereupon the disclosure would be reviewed in detail in attempt to find a way to avoid the policy and therefore the claim for non-disclosure or misrepresentation.45 1.14 In spite of these misgivings about the nature of the insured’s pre-contractual duty of utmost good faith and the problems to which it gave rise, the Law Commissions’ central concern (shared by many) was the sole remedy of avoidance. It was described

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variously as ‘draconian’,46 ‘all or nothing’47, and a remedy that ‘over protects’ the insurer.48 Avoidance did not discriminate based upon severity of the breach, but instead applied regardless of whether the misrepresentation or non-disclosure was fraudulent or innocent.49 It also gave no room for consideration of what the insurer would actually have done differently, had the insured fulfilled its duty (such as charging a higher premium, or imposing different terms).50 Finally, given the ‘all or nothing’ nature of avoidance, it created an inequality of arms which enabled insurers to use the threat of avoidance as a negotiating tool to reduce the cost of settlement.51 These problems with avoidance could not be remedied by the common law, since the strictures of the 1906 Act provided that avoidance was the only remedy for breach of the duty of utmost good faith.52 The Law Commissions therefore concluded that statutory reform relating to the duty of utmost good faith was essential.

Warranties and basis clauses

1.15 Shortly behind avoidance was the problem caused by the old law on breach of warranty. The Law Commissions criticised the fact that an insurer could rely upon a breach of warranty as discharging its liability even when the breach had been remedied by the time of loss, or if the breach of warranty did not cause or contribute to the actual loss.53 For example, breach of a burglar alarm warranty would discharge the insurer from liability for loss caused by a flood or fire, even though the breach of warranty had nothing to do with the loss.54 As with avoidance, this problem was created by the Marine Insurance Act 1906, which formerly provided in clear terms that breach of warranty led to automatic discharge of the insurer’s liability, and the insured could not rely upon the defence that it had remedied its breach of warranty. Although the Law Commissions recognised that cases in which a technical breach of warranty was relied upon were ‘very rare’, it was thought that arguments based upon a breach of warranty may be used as a bargaining tool in order to drive down the cost of settlement of a claim.55 1.16 The Law Commissions considered that a specific instance of the injustice of warranties was seen in basis clauses, which typically took the form of a declaration by the insured that the statements contained in the insurance proposal formed the ‘basis of the contract’. Under the old law, this amounted to a warranty that all of the matters stated in the proposal were true. It followed that if any of the matters was incorrect, the insured was in breach of warranty and the insurer’s liability was permanently discharged. Such clauses have long been criticised by the Law Commissions,56 chiefly

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because they enabled an insurer to evade liability for any error in the proposal, no matter how immaterial.57 They were also thought to be little understood by insureds.58 The Law Commissions therefore proposed their abolition.

Fraudulent claims

1.17 The Law Commissions have acknowledged that insurance fraud is a serious and expensive problem, and that the civil law must play a crucial role as a deterrent.59 It was therefore considered necessary to have a clear statement of the consequences of insurance fraud as a matter of civil law, in order to act as a deterrent to wrongdoers.60 However, the Law Commissions considered the law in this area to be somewhat confused,61 as a result of tension between the common law rule that a fraudster forfeits (only) the fraudulent claim62 (including any part of it that is genuine63), and the 1906 Act, which permitted the insurer to avoid the entire contract ab initio for breach of the duty of utmost good faith (suggesting that previous and future claims would also be affected).64 In practice, the confusion was more theoretical than real, and the courts did not generally permit insurers to avoid in the context of fraudulent claims,65 although there was some residual uncertainty over the point.66 There was in addition uncertainty about the effect of a fraudulent claim on subsequent claims which were made in good faith. It was generally acknowledged that the making of a fraudulent claim amounted to a repudiatory breach of contract which gave the insurer a right to terminate, but the policy continued until such right was exercised, and any claim arising before the right was exercised had to be paid.67 The contrary view was that the making of a fraudulent claim brought the contract to an end automatically, meaning any claim post-dating the fraud did not need to be paid. The Law Commissions saw fit to clarify the law on fraudulent claims, and have done so in the Insurance Act 2015.

Damages for late payment of an insurance claim

1.18 The Law Commissions criticised the fact that formerly, under English Law at least,68 an indemnity insurer could not be liable for foreseeable loss caused by its

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failure to pay a valid claim within a reasonable time.69 For example, a factory owner whose premises were put out of action by vandals and whose insurance claim was disputed for a long time was forced to sell his business at a loss, yet he could not recover that loss when the insurers eventually accepted that the claim was valid.70 Generally speaking, this was likely to be of greatest disadvantage to smaller insureds which were incapable of reinstating damage unless timely payment of an insurance claim was made (as in Sprung).71 1.19 The problem brought about by the old law was a product of the legal fiction whereby an indemnity insurer’s duty is characterised as being to hold the insured harmless against the insured peril. In other words, the insurer is treated as having promised that the insured ship will not sink, or that the insured building will not burn down. If the insured peril causes loss, the insurer is liable in damages for breach of its duty to hold the insured harmless,72 and English Law does not permit a party to claim damages for a failure to pay damages.73 Whilst commenting that the legal fiction does not accord with the parties’ understanding of the nature of their duties under a contract of insurance,74 the Law Commissions have not sought to do away with the hold harmless fiction.75 This reflects a recognition that the fiction serves a useful purpose, not least in providing certainty as to when the limitation period starts to run, and for the calculation of interest. Nonetheless, the Law Commissions criticised the bar on damages for late payment as unfair, as well as being out of line with the law in Scotland, other jurisdictions, and ordinary principles of contract.76 They concluded that an insured should have a remedy where an insurer has acted unreasonably in delaying or refusing payment of a claim.77

Parliamentary passage of the Insurance Bill

1.20 The Insurance Act, like the Consumer Insurance (Disclosure and Representations) Act 2012, was enacted following the special procedure for uncontroversial Law Commission bills. This permits a bill to be introduced into the House of Lords and considered by a Special Public Bills Committee, thereby spending less time on the floor of the House of Lords and the Commons, and standing a substantially better prospect of being enacted. The Special Public Bills Committee procedure hands the conduct of the committee stage to a select committee, which can take written and oral evidence, before going through the bill clause by clause and considering amendments. Whilst any bill can be scrutinised in this way, the procedure is usually reserved for technical measures which are not controversial in party-political terms, such as

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uncontroversial Law Commission bills. However, the concept of an ‘uncontroversial’ bill is not defined for these purposes,78 and appears to have been applied in the context of the Insurance Act with some fluidity, as will be seen. When it was introduced into the House of Lords, the Insurance Bill79 was identified as being suitable for the special procedure described above. The original Bill attached to the July 2014 Report contained two provisions which proved difficult, however: clause 11 (on ‘terms relevant to particular descriptions of loss’),80 and clause 14 (on damages for late payment of an insurance claim).81 1.21 In essence, clause 11 provided that where a term would tend to reduce the risk of loss of a particular kind (if complied with), the insurer could not rely upon breach of such a term if the actual loss was of a different kind. After the Law Commissions published the July 2014 Report and draft Bill, there was significant opposition to clause 11 on the basis that it was uncertain82 and too broad in scope.83 The Treasury therefore asked the Law Commissions to redraft the provision. The Law Commissions produced a new draft clause 11 on 7 November 2014,84 but the Government Minister (Lord Newby) appears to have considered even that revised clause as too controversial, when it was considered in the Special Public Bills Committee on 2 December 2014:

The Chairman [Lord Woolf]: Do the Government intend to pursue the Law Commission’s November 2014 revision of the clause governing terms not relevant to the loss?

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