Know the form

The Law Commission is considering the abolition of the duty of disclosure - at least for consumers - in its first issues paper on misrepresentation and non-disclosure. Richard Evans takes a close look at these proposals and their implications for the insurance industry

On 22 September, the Law Commission released its first issues paper on misrepresentation and non-disclosure as part of its remit to overhaul existing insurance contract law (Post, 28 September, p3). So what proposals does it contain and what do they mean for insurers?

The Law Commission's approach is to look at consumers and businesses in a different way - there will be an option to contract out in the commercial world but not otherwise.

The general theme is that consumers should not lose their rights if they have acted reasonably. It is, therefore, proposed that insurers should ask specific questions in their proposal forms and that the residual duty of disclosure should be abolished. Should there then be a misrepresentation, the test for materiality would require the insurer to not only show it was induced by the facts to enter into the contract on the relevant terms but also that the consumer appreciated that the facts in question would hold that significance or that a reasonable insured in the circumstances would have so appreciated.

Distinctive remedies

Remedies would broadly follow the distinctions drawn by the Financial Ombudsman Service as to whether the misrepresentation was fraudulent, negligent or innocent. Where fraudulent, insurers would be allowed to avoid the policy; where innocent, the insurer would have no remedy; and for the middle ground of negligent misrepresentation, the court would look at what the insurer would have done had it known the true facts. For example, if it would have declined the risk or added an exclusion that would have applied, the claim could be refused. If a higher premium would have been charged, the claim would be reduced proportionately.

It is also proposed that 'basis of the contract' clauses should be ineffective. For businesses, the duty of disclosure would be retained but the same test of materiality would apply. A similar approach would also be taken in relation to remedies, except that the application of proportionality in a business context has been left open.

Under the new proposals, failing to ask a specific question could leave insurers without a remedy. This could result in significantly longer, more tightly worded proposal forms. For example, if an insurer is asking about criminal convictions but criminal prosecutions are also material, specific reference will need to be made to them.

So how would such a lengthy document fit with the trend of offering quotes over the telephone or even by text messaging?

The insurance industry may need to review its advertisements where it is suggested cover can be achieved in a couple of minutes before dinner or over the phone on providing the barest information.

There will also be a greater burden on insurers to investigate. It is suggested that an insurer should be treated as knowing information contained in its own files, provided the information is reasonably identifiable - no distinction is drawn between paper and computer files. Information kept in a paper file in one part of the business - for example, the claims department - may be deemed sufficient knowledge for underwriting purposes under these proposals. Even within computer systems, there are likely to be practical issues about the ease of trawling systems for information, especially where systems are not fully integrated.

Renewal misrepresentation

Access to documents also rears its head with the suggestion that, on renewal, insurers can only rely on misrepresentation if they let the consumer know how they answered questions at the proposal stage. This would again seem to ignore current sales channels and may well throw up logistical problems for insurers.

The draconian measure of avoidance has been reduced so that it only applies where there is fraud. Moreover, the test for fraud has been made even harder, requiring not only that the insured knew that the statement was untrue (or realised that it might be and did not care) but also that the insured knew that the statement was material to the insurer (or realised it might be).

This will require false statements to be analysed further. For example, if a consumer states that they do not have a second car, when they do, that may indicate fraud. However, what if the insured then says they did not realise the statement might be material to insurers as they thought the question was only asked for marketing purposes and wanted to avoid being sent junk mail? In such circumstances, the misrepresentation could be classified as negligent or even innocent.

In interpreting answers, the Law Commission has also mooted a further test of whether particular characteristics of the insured, known to the insurer, should be taken into account. Therefore, if insurers know that English is not an insured's first language, it would appear that the responses should be considered in such light.

There should also be consideration of how the proposals will affect the Fraud Bill. This Bill makes it a criminal offence not to disclose information if there is a legal duty to disclose it; but if the duty of disclosure is abolished, then the criminal offence is also rendered ineffective.

Where next?

The second issues paper, on breach of warranty, is expected in November, with a first consultation paper on these topics following next summer. Other issues papers indicated for 2007 include the post-contractual duty of good faith and intermediaries, with a second consultation paper anticipated in 2008. The industry should be considering the proposals now, in order to avoid any surprises at the content of a draft Bill in 2010.

- Richard Evans is a partner and head of the policy coverage unit at national commercial law firm Beachcroft.

CONTRACT LAW EVENT

Beachcroft will be hosting an event in December to discuss the next issues paper on breach of warranty, having hosted an event at Lloyd's at which this first issues paper was released. If you would like to attend, please contact Charlotte Shakespeare at [email protected].

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