Tipping the balance too far?

The review of insurance law carried out last month by the Law Commission was prompted by the perception that insurance law operates unfairly on insureds, particularly individuals and small businesses, who lack the specialist knowledge and access to external advice which would give them equal bargaining power with insurers.

Insurance law is seen as out of step with ABI statements of practice, the FSA Insurance Conduct of Business rules, and the rules applied by the Financial Ombudsman Service (FOS), all of which restrict or qualify insurers' strict legal rights in the consumer context.

In our view, however, some of the proposals discussed would, if adopted, tip the balance of rights between insurers and insureds too far in the direction of insureds.

Reforms such as the dilution of avoidance rights, bad faith damages and liability for broker default would ultimately be likely to result in premium increases for all.

Bad faith damages
In a few isolated cases, individuals and small businesses have been driven into bankruptcy by unjustified delays on the part of insurers in settling claims.

In response, the commission has suggested that the equivalent of bad faith damages could be made available to an insured when an insurer "unreasonably delays the settlement of a claim". Currently, insureds cannot claim damages (except in the consumer context) for late payment, but can claim interest.

This issue is under consideration despite the Court of Appeal decision in the Mandrake v Countrywide case late last year not to allow an appeal to the House of Lords to review this area of the law. In this case the court upheld the ruling that insurers were liable only to the extent of their contractural limits, and were not liable for consequential loss.

Granting a general right to consequential damages would have a significant impact on an insurer's cost base and would inevitably lead to increased premiums.

Claimants would routinely allege that insurers had delayed unreasonably in paying claims, giving rise to numerous disputes and claims for consequential losses.

Courts and arbitration tribunals would be left with the near-impossible task of determining in each particular case whether the time taken by an insurer to complete an investigation into the extent of cover was reasonable.

It would also be impossible for insurers accurately to assess their exposures, with significant solvency test and regulatory implications.

The commission is concerned that currently insurers are entitled to avoid a policy on the basis of an entirely innocent non-disclosure by the insured, which is unrelated to any loss. One option they suggest is to restrict the insured's duty of disclosure, or even abolish it altogether.

In place of the current requirement to disclose anything which might influence the underwriter's mind when assessing the risk, an insured might have to disclose only facts which a reasonable insured should realise are material.

The onus would be on insurers to ask specific questions about areas of concern. Conversely, insurers could be obliged to disclose their complaints records and details of previous regulatory interventions - failing which the insured would be entitled to damages.

Under the "proportionality" principle (as currently applied by the FOS), if a non-disclosure led to an insured paying only 50% of the correct premium, insurers would be liable to pay 50% of the claim rather than being entitled to avoid the policy.

The courts could also be given discretion to award damages for misrepresentation, as an alternative to avoidance.

Causal connection
Similarly, insurers could no longer be entitled to rely upon a breach of warranty, unless there is a direct causal connection between the breach and the loss.

Basis clauses, which have the effect of converting proposal responses into warranties, are also under attack.

Concern has been expressed by the commission about the dual role played by brokers, acting both as agents of the insured and of the insurer. This can cause confusion, at least in the consumer sphere. For example, an insured discloses a material fact to his broker, who then fails to pass this on to the insurer - entitling it to avoid.

Potential conflicts of interest in this area are the subject of a current FSA initiative, and discussions are also underway concerning the management of "legacy" claims.

There are also concerns relating to premium being paid to brokers in the first instance (and occasionally not paid on to insurers) and the involvement of brokers in the claims process. There is also concern at the possibility of fraud by brokers.

Broker defaults
One option suggested by the commission is for insurers to be made liable for the defaults of brokers (as under FOS rules). Alternatively, the law could be reformed to make brokers solely the agent of the insured, subject to overcoming the practical difficulties which would arise.

Perhaps more palatable from the perspective of insurers is the proposed formulation of a statutory definition of fraud in the insurance context and a statement of its consequences. For example, should insurers have a right to damages and/or a right of repudiation in serious cases, and should they be liable for claims made subsequent to any fraud?

If reform is required, is it necessary or appropriate to extend recent rule changes in the consumer context to commercial (re)insurance generally, where the perceived imbalance of power between insurer and insured does not exist?

In our view, a new consumer insurance code would address the concerns more quickly and directly than full blown legislative reform in the form of a new Insurance Contracts Act.

Responses to the scoping paper are required by 19 April 2006 - at this stage short comments on the list of proposed areas for review. As many members of the market as possible should make their voices heard by submitting responses. IT

' Edward Mann is a partner and Marcus Knight is a solicitor with Reynolds Porter Chamberlain