On 12 August 2016, the most fundamental reforms of UK insurance contract law for over 100 years will come into force. The reforms are being introduced to redress the imbalance between insurers and policyholders – insurers being perceived as having too much leverage in coverage disputes because the existing law was overly protective of the insurers' position.
For buyers of insurance, the changes are undoubtedly a very positive development. They do, however, significantly change the way UK insurance business will be conducted. Policyholders who want to take advantage of the benefits of the reforms need to understand the changes and adapt their practices accordingly. This article provides a summary of the areas policy holders need to address.
Why is insurance important?
The UK insurance market (which is the third largest in the world and the largest in Europe), plays a significant role in underpinning global trade by insuring trade related risks.
Physical assets are almost always covered for loss or damage. In trade finance transactions banks may want to be co-assured on the policies that cover the goods, to take an assignment of the proceeds or at the very least be named as loss payees. They may also require cover to be taken out for the premises where goods are produced.
The obligor’s non-payment risk can be insured, as can the borrower's credit risk on financed deals, and the country or political risks that may adversely affect the borrower's ability to service the loan. Over the last ten years these types of credit policies have become increasingly popular, particularly so where the financer can obtain risk capital relief for the insurance. To qualify for the relief, the robustness of risk transfer needs to very clear and confirmation of eligibility supported by legal opinions.
What has changed?
The Insurance Act 2015 (the ''Act''):
- radically changes the pre-contractual disclosure process and policyholders' duty;
- introduces a wider range of remedies, which are designed to be more proportionate, in the event of policyholder breach;
- reforms the law relating to insurance warranties;
- codifies the rules that apply if a policyholder makes a fraudulent claim; and
- provides for damages in the event of late payment of claims.
When the Act comes into force on 12 August 2016, it will apply to all contracts of insurance and reinsurance, and to any variations to existing contracts made on or after that date.
This article focuses on the aspects of those changes that require a change of practice by policyholders.
New duty to make fair presentation
Policyholders will be under a duty to disclose material information known to senior management and any individuals responsible for arranging the insurance. Those responsible for the insurance are responsible not only to the internal insurance or risk management team, but also the external insurance broker.
As under the current law, any information is material if it would influence the judgement of a prudent insurer in determining whether or not to take the risk or fix the terms in so doing. Materiality will therefore depend upon the field of activity (e.g. shipping, banking, commodity trading); the nature of the risk; and the relevant class of insurance (e.g. property insurance, credit risk, marine cargo).
Policyholders will also be under a duty to conduct a reasonable search for information that "ought to be known". This includes not only information within the organisation, or its possession and control, but also relevant information held by third parties outside the organisation.
Presentation needs to be clear and accessible
There is a new standalone duty to present information to insurers in a manner that is ''reasonably clear and accessible". The Law Commissions (which had spent many years working on the reform proposals that culminated in the Act) were critical of the practice of proposed insurers providing large quantities of un-signposted documentation without any indication as its potential relevance. As a result, the last minute "data dumping" of unstructured information will no longer be permitted.
Practical Impact of Fair Presentation Duty
Policyholders need to start considering their renewal process and opening the dialogue with placing brokers about what needs to be achieved much earlier. The presentation is now supposed to be an interactive process with insurers asking questions regarding the information provided. The timetable needs to build in this flexibility.
Brokers should be able to provide guidance on what information should be considered ‘material’ for any particular type of risk. Part of the long lead-in time permitted between when the Act received Royal Ascent and came into force (18 months), was to enable insurers, brokers and policyholder bodies to work together to develop guidance and protocols setting out what a standard presentation of risk should include for different types of risks.
Organisations, in particular, need to take advice on what should be the ambit of their "reasonable search” and agree that with insurers. The Act provides for a default regime only. Accordingly, if the parties want to agree that the ambit of the relevant search will be narrower than the terms of the Act, they are free to do so.
Who has relevant ''knowledge''?
It will be essential to identify those within the organisation who fall within the definition of "senior management". The Act defines senior management as those individuals who play a significant role in making decisions about how the policyholders' activities are managed/organised. In a corporate context this is likely to extend beyond simply the main Board, and could be a substantial group of people depending on the structure and management arrangements of the organisation.
Policyholders should consider whether the knowledge of such a large group of individuals is really relevant for the purpose of any particular insurance policy. For example, if a commercial bank regularly takes out individual policies covering their clients’ credit risk, is it practical for every individual falling within the definition of senior management to be consulted about whether they have that relevant "knowledge"? It is much more likely that the transaction team, who have put the deal together, will have the pertinent information and therefore it would be sensible to amend the policy to reflect that fact.
Knowledge also extends to those individuals who are responsible for the policyholders’ insurance. This includes any corporate risk management function but also the placing broker. Policyholders therefore need to liaise closely with their broker and agree what knowledge is relevant and who is responsible for searching for - and in due course storing - the various categories of historical information that might be needed to fulfil the duty.
More onerous obligations
The duty to undertake a reasonable search for information substantially increases the policyholders' obligations. Remember, a reasonable search will now include relevant information in the hands of third parties – e.g. agents, subcontractors, consultants, professional advisers and those to whom relevant business functions have been outsourced. Policyholders need to make sure they have considered which individuals or organisations are likely to have relevant information and allow enough time to collate it.
Explaining the crucial importance of responding to the information requests in a rigorous manner will also be key.
Explain the risks
Any individual whose knowledge is considered relevant needs to understand the importance of the information gathering exercise, and the likely impact of getting it wrong. A bland enquiry "do you know anything about X" may not result in the appropriate degree of scrutiny, unless it is put in context.
Make it clear, for example, that the organisation is about to insure a physical asset of considerable worth and that the insurance may turn out to be a wasted expense, if relevant information is not disclosed.
Blind Eye Knowledge
When requesting information, whether from senior management or as part of the "reasonable search" obligations, individuals need to be reminded that knowledge under the terms of the Act is not limited to that which an individual actually knows. Knowledge extends to matters which an individual suspected, and of which he or she would have had knowledge, had they not deliberately refrained from confirming or enquiring about them. This is concept is often expressed by the shorthand term of "blind eye" knowledge. Once again, however, parties are free to agree that knowledge, for the purpose of any particular policy, should be limited to actual knowledge.
Keep records updated
Policyholders need to make and retain detailed records as to the searches they have undertaken and received. Do not assume that the list of individuals relevant for the purpose of the "reasonable search" enquiry will stay static. The commercial activities of an organisation can change radically during the course of a year and the question of what constitutes a reasonable search needs to be revisited at every renewal, and every time a request is made to insurers to amend the policy.
Reforms of the law on Warranties
Under the current law it is open to insurers to add a declaration to insurance proposal forms or policies stating that the policyholder is warranting the accuracy of all the answers given, or their answers form the "basis of the contract". This has the legal effect of warranting the truth of every piece of information given in the proposal. Any inaccuracy, however immaterial, can entitle insurers to treat themselves as discharged from liability automatically.
The Act abolishes clauses of this type and, if included, they will no longer be given effect to.
The Act also replaces the existing remedy for breach of any warranty and provides instead for more proportional remedies. The policy might provide, for example, that the insured warrants that a particular physical commodity will be stored in a secure warehouse protected with 24-hour security personnel. If the relevant storage warehouse is left unattended, the warranty will be breached. The Act provides that for any loss occurring during the period of the breach, insurers will have no liability. If, however, the breach is remedied, and the security arrangements become fully effective, again insurers will become liable for any loss arising after the breach has been remedied.
Going forward, any ‘basis of contract’ clauses in policies or proposal forms should be struck out. They will no longer be effective in any event, so why keep them?
Policyholders should continue to take insurance warranties extremely seriously. Even though the new remedies will now be proportionate, insurers will still be able to escape liability for any loss that happens during the period of breach.
Make a careful note of any warranties that have been given, consider how compliance is monitored and put in place reporting procedures to keep tracking compliance. Any inadvertent breach must be quickly remedied if remedy is possible. Evidence as to the date and times that breaches are remedied must be retained so that this can be provided to insurers in the event of a loss. If the breach cannot be remedied, get advice promptly on what options might be available e.g. getting insurers to waive breach.
Under the new Act, if the policyholder makes a fraudulent claim, the insurer is not liable to pay that claim, even it would seem (although this is not beyond doubt) those parts of the claim that are entirely honest. The insurer may also give notice to the policyholder to terminate the contract and may retain the premium.
The Act does not define what is fraud or what amounts to a fraudulent claim. That is left for the courts to interpret that as a matter of common law.
Everyone involved in an insurance claim needs to be clear that absolute and scrupulous honesty is required. Exaggerating any aspect of a claim, or providing insurers with any documents in support of a claim where there are suspicions as to their authenticity, can lead to serious problems.
The second practical step is to consider whether the fraud clause in your policy appears more onerous than the Act. If so, the justification for including it should be discussed.
Damages for Late Payment of Claim
A late amendment inserted into the Act by the Enterprise Act 2015 introduces an implied term into insurance contracts that the insurer will pay claims within a ‘reasonable period of time’. Breach of that implied term entitles the insured to a claim in damages. This new provision comes into force on 4 May 2017. Under the old rule, even if an insured had suffered significant losses as a result of insurers delaying a claim payment, the insured had no remedy.
Insurers will have a defence under the Act if they had reasonable grounds for disputing the validity or quantum of the claim. It remains to be seen how the Courts will interpret the test of reasonableness, but the introduction of an implied term will undoubtedly give policyholders more leverage if insurers are obviously dragging their feet without any apparent justification.
The time limit for bringing a claim for damages for late payment of claim is extremely tight. The insured will only have one year from the date insurers paid the claim and this deadline need to be carefully noted.
Changes introduced by the Act undoubtedly place policyholders in a significantly better position.
This is good news for trade finance parties where there has been some scepticism about the value of insurance owing to concerns that insurers would find reasons not to pay. Achieving more certainty about the effectiveness of insurance as a risk transfer or mitigation tool, in a trade finance context, will increase its attractiveness.
However, if policyholders want to take advantage of the benefits that the Act was designed to confer, they need to understand the changes and adapt their practices accordingly. The manner in which insurance risks need to be presented going forward has changed radically. Carrying on with "business as usual" could result in claims being denied or policy proceeds being significantly reduced.