Insurance Act 2015: a fairer deal for businesses
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What is the Insurance Act 2015 and what impact will it have on commercial insurance?
You need only peer out of your window to see how insurance underpins the foundations of society and commercial life. The cars travelling down the road must be insured by law. The buildings on either side of the street may be insured against flood, fire, terrorism and all manner of other risks. The businesses occupying those buildings will maintain a range of policies to protect against a variety of risks, for example: public liability; employer's liability; professional negligence; and they will most likely maintain a policy to protect the personal liability of their directors and officers too. At home, those directors will have their pets insured, their mobile phone insured, their lives insured…
The Insurance Act 2015 comes into force on 12 August 2016. It will radically affect how these policies are drafted and negotiated between businesses and their insurers, and how those businesses and insurers respond when a loss occurs.
Policyholders mentioned above will be relieved to hear that the act goes some way to make the law more favourable to business insureds.
The reform process: a brief history
Insurance as a method of protecting against risk rose to prominence in the 17th Century. Property insurance became popular in the aftermath of the Great Fire of London. The first insurance market was also established during this period – at Edward Lloyd's coffee house on Lombard Street, London. There members of the shipping industry would meet to insure their ships before setting sail to exotic locations around the globe.
The collection and codification of the principles of English insurance law has not been a swift process. Edward Lloyd's coffee house had been established for over two centuries before the first unifying statute governing the principles of English insurance law, the Marine Insurance Act 1906, made it onto the statute book. The 1906 act still largely governs commercial insurance in the United Kingdom. This is despite the Law Reform Committee noting as long ago as 1957 that the area was in need of reform.
This current round of reform began with a Law Commission scoping process in 2006 and has been through a policy statement, three consultation papers, nine issues papers and two reports before culminating in the new Insurance Act, which was finally enacted in February 2015.
This article is an introduction to some of the elements of the reform which will be of interest to policyholder clients.
Pre-contract disclosure and avoidance for breach of the duty of good faith
One change introduced by the 2015 act is that insurers will no longer have the automatic right to avoid a policy (ie, treat it as if it had never come into existence) if there has been a breach of the duty of utmost good faith by the policyholder when it was negotiated. To provide an example of how policyholders suffered due to the inherent unfairness of the current law, insurers could avoid a policy for the breach of this duty for the policyholder's non-disclosure of a material fact, even if this non-disclosure was entirely innocent, for example, the policyholder was unaware that the fact in question would be of interest to insurers.
The imposition of this duty on policyholders has long been seen as unfair because the remedy is "all or nothing", meaning that an insurer could avoid a policy completely for what might seem to be a minor non-disclosure or misrepresentation, if it can prove that the non-disclosure did in fact affect the terms on which it agreed to write the insurance. Further, whether a fact is 'material' (and so would need to be passed on to the insurer) is determined by reference to the judgment of the 'prudent insurer' - and an insurer's understanding of what is relevant could be very different from that of a policyholder. Even after 109 years on the statute book it is still (understandably) difficult for policyholders to predict what a 'prudent insurer' would deem to be 'material'.
The 2015 act makes a number of changes that will rebalance the law to make it fairer to policyholders. The insurer's automatic right to avoid will be restricted to circumstances where the policyholder's non-disclosure represents a deliberate or reckless breach of the duty that the new act imposes on policyholders to make a "fair presentation". The burden is on the insurer to prove fraud or recklessness, and they may find this difficult. In other cases, the new law in the 2015 act will impose a "proportionate remedy" – reflecting what the insurer would have done if a fair presentation had been made. The insurer might still be able to avoid the policy if it can show that it would not have accepted the risk on any terms, but if all it did was charge a lower premium than it would have done, the remedy would just be to reduce the claim payment proportionately.
‘Warranties’ in insurance policies are terms which are considered to be essential to the risk insured, and breach of which by an insured (under the current law) will entitle an insurer to treat itself as discharged from liability under the policy. Where a term is classified as a warranty, breach by an insured will therefore give the insurer a complete defence to a claim even if the breach did not in fact increase the risk of an insured loss, or was irrelevant to a loss which has actually occurred. The 2015 act will also significantly change the law in this area, mitigating its harshness for insureds.
‘Basis clauses’, under which an insurer required a policyholder to warrant that all matters disclosed in pre-contract negotiations were true, will also be abolished.
Warranties will now become 'suspensory' conditions under the 2015 act. Previously it was the case that a breached warranty entitled an insurer to treat itself as discharged from liability even if that breach was remedied before the incident which gave rise to the claim. This seems unfair. Say, for example, a policyholder warranted that it would keep its property protected by a working fire alarm and that this alarm was broken for a two-week period in March, before being replaced. If the policyholder then suffered a fire in November, the insurer could refuse to indemnify the policyholder for their losses because of the breach of the warranty in March, even though this had been remedied long before the fire occurred. Under the 2015 act the insurer cannot escape liability in this way. The insurer could now only avoid their obligations if the fire took place while the warranty was in breach, namely while the fire alarm was out of action.
Breach of a warranty aimed at reducing the risk of one sort of loss will not entitle an insurer to avoid liability for other types of losses – so in the example above, if a flood occurred while the insured was in breach of his or her obligation to maintain a working fire alarm, that would not allow the insurer to avoid liability for the flood.
The new law will therefore go a long way to temper the effects of warranties for policyholders.
Business customers and their insurers will be able to contract out of most provisions of the act, so the current law continues to apply. However, commercially it may be difficult for insurers to persuade business customers to agree that rules which are considered to unfairly favour insurers continue to apply.
Damages for late payment by insurers
The Enterprise Bill 2015 seeks to correct a long-standing perceived injustice in the law of England and Wales by inserting a new Section 13A into the Insurance Act, incentivising insurers to pay claims within a reasonable time and to provide policyholders with a right to general damages where a loss is incurred owing to an unreasonable delay in payment. The bill has successfully negotiated its path through the House of Lords and, at the time of writing, is awaiting the date of its second reading in the House of Commons. The introduction of this provision will address what has long been seen as an unfair rule of English insurance law - the so-called rule in Sprung v Royal Insurance (UK) (1996). Sprung's case came before the Court of Appeal in 1996 after his factory was severely damaged when it was broken into by vandals in April 1986. Sprung's insurers refused to indemnify him at the time and he did not have the financial resources to carry out the repairs required himself. As a result, Sprung was forced out of business six months later. Ultimately, Sprung's insurers did indemnify him for the cost of repairs, but they took three years to do so. Sprung sought to recover the amount he had been caused to lose as a result of his business failing because the insurers paid late, but this claim failed – the Court of Appeal reluctantly held that the only further remedy Sprung had was a right to interest on the insurance monies that had been paid late. The unfairness of this is clear, given that the insurers had accepted that they were under a responsibility to pay out to Sprung in response to the vandalism he suffered. Had they done so at the time of the incident, he would have had the financial backing to undertake the repairs and resurrect his business. In future, insureds in Sprung's position will be protected if this provision comes into force.
The changes that will be effected by the act are complex and radical, and will no doubt give rise to some uncertainty and a fair share of litigation while the act beds in. Policyholders can be comforted, though, that the future looks a lot more balanced than in the past.
Joe Cater is a trainee solicitor at DLA Piper UK LLP.