Insurance law reform: Law Commission review

The road to 2010: how the next 'Big Bang' may play
Those following the current joint review by the English and Scottish Law commissions into insurance contract law will be aware that the commissions intend to publish a consultation paper shortly with a view to soliciting responses by November, 2007.

The intention remains to propose a reform of particular principles of insurance law that the commissions believe should follow further to the current consultative process. To achieve this, the current aim is to issue a final report and also to present a final Bill to Parliament to approve in 2010.

An idea of where the commissions may be heading may be gleaned from the contents of the “issue papers” that they have jointly published in the last nine months.

Ripe for reform
These signpost the fact that ripe for reform in the commissions’ eyes are many long-established principles relating to issues of misrepresentation and non-disclosure, warranties, pre-contractual information and also in respect of intermediaries, ie, brokers.

A major focus of this review has been on the consumer or small business policyholder. In most other systems of law where a similar review of insurance principles has been undertaken, there has been no distinction drawn between the type and status of policyholder concerned, but that is not the path chosen by the commissions.

Many proposals presently being canvassed are quite radical in terms of the changes that they will make to the existing legal principles applicable to insurance. For example, changes floated that would affect a consumer or small business policyholder include:

• A redefinition of the test of materiality for actionable non-disclosure/misrepresentation: an insurer would only be able to avoid a policy issued to a consumer or small business policyholder if the insurer could demonstrate, in addition to proving actual inducement, either that the insured appreciated that the relevant fact in question would be relevant to the insurer or, if not, that the fact was a matter that a reasonable insured in the relevant circumstances would have appreciated.
• While an insurer should have an unfettered right to avoid a policy issued to a consumer or small business policyholder, if an insured had acted fraudulently then those rights would be abrogated: if a non-disclosure/misrepresentation was negligent then both parties ought to be put into the position they would have been had the insurer known the true facts. On the other hand, if the non-disclosure/misrepresentation was innocent, the insured should not be penalised at all.
• All statements of existing facts should be treated as representations rather than warranties; insurers should only be entitled to refuse a claim by a consumer or small business policyholder for breach of warranty if that warranty was set out in writing, sufficient steps had been taken to bring it to the policyholder’s attention, and the breach had caused or contributed to the loss.

It would be wrong for those dealing with other, larger-scale businesses - and specifically the wholesale broking community - to believe that this review has no relevance to them. Many proposals are specifically contemplated to be of general application.

For example, the idea of abolishing the prudent insurer test as the test of materiality in an avoidance scenario, replacing it with the prudent assured test is suggested for all policies. In other respects there may be modified application.

It will be readily apparent that in many instances changes of the nature canvassed will completely transform the current matrix of legal relationships within the general market place, particularly between brokers and underwriters.

One particular proposal of general application is the commissions’ suggestion that a breach by a placing broker of his independent duty of disclosure to insurers in the placing process - a duty arising pursuant to Section 19 of the Marine Insurance Act 1906 - should not result in an insurer having a right to avoid the policy in question: instead, the insurer should honour the claim (and the policy) but have a right to sue the broker concerned for the insurer’s loss.

This is pretty radical stuff: the insurer claims that would hitherto amount to a right to avoid because of some (alleged) default in the placing process by the broker, the insurer pays the assured and the insurers and the brokers are left to fight out if the broker should recompense the insurers.

At present if such issues are raised and the insurer can avoid if he prevails, then perhaps after further litigation it will be the broker’s PI insurers who will compensate the assured - and in the interim the assured remains out of pocket.

Reasonable expectations
The commissions clearly view this current potential state of affairs as an inequity and state it to be contrary to an assured’s reasonable expectations of what should happen if the broker was at fault.

Although the commissions rejected the suggestion that every agent should be treated as the agent of insurers, a proposal that a broker could be liable for damages to the insurer for a breach of broker’s Section 19 duty arguably imposes an agency relationship between those parties without corresponding legal foundation.

Such a reworking of how such issues might in the future be resolved may also result in a subtle impact on how those disputes left over between broker and insurer are played out.

At a practical level, such a changed legal regime may well raise some interesting commercial issues.

While the assured affected might benefit from receiving a payment of its claim, if the broker and insurer were left to litigate over the issue of whether the broker had breached its independent duty, would commercial leverage as opposed to considerations of pure legal merit then come into play to resolve that dispute left over?

One can imagine that some parties - and it could be brokers as much as insurers - might wish to point to the state of current trading relationships between them when discussing the proposed resolution of issues.

The current difference
True, that might happen, but the difference is that when a broker and insurer are discussing whether an insured’s claim should be paid in circumstances where an insurer has a complaint about an open market placement, this is not usually against a backdrop of the insurer having a direct cause of action against the broker for damages.

From the insurer’s perspective, he will also have to accept a statutory trade off the right to avoid with the credit risk of the broker being able to make good any loss in the future caused by that broker’s default. Broker selection in dealing will become potentially more important.

It remains to be seen whether the commissions’ review ultimately makes it to the statute book or indeed comes to naught, a fate suffered by many earlier reviews. If it does translate into a statute, be prepared for a whole new ball game in the process of the market’s ability to contest claims and the allocate financial responsibility between market members.

This article first appeared in Insurance Day magazine on 5/7/07