Proposed law reforms: misrepresentation and non-disclosure in business insurance

The Law Commission and Scottish Law Commission have recommended sweeping reform of, amongst other things, the insured’s pre-contractual duty of good faith. They propose to change the law on both misrepresentation and non-disclosure.

The Commissions draw a firm distinction between consumer insurance on the one hand, and business insurance on the other. Yet whilst the most significant proposed changes to the law on good faith concern consumer insurance, these largely echo the current practice of the Financial Ombudsman. In practice therefore, and assuming they are implemented, it is the field of business insurance that the changes are most likely to be felt. They would apply across all classes of business, including reinsurance.

What is business insurance?

The Commissions have not put forward a definition of business insurance in their proposals, in contrast to consumer insurance. In the vast majority of cases, this should not cause a problem. But what of the entities which are neither businesses nor consumers? For example, it is not clear where charitable organisations and unincorporated associations would fit within the proposed regime.

Commissions’ proposals

The Commissions’ proposals include the following.

• Unlike the consumer insurance field, the Commissions propose to retain the business insured’s pre-contractual duty of disclosure, but with significant amendments to the law.
• The insured is currently obliged to disclose that which it (a) actually knows; or (b) ought in the ordinary course of business to know. The Commissions propose to replace this with the requirement that the insured must disclose that which it “ought to have known”.
• An insurer can currently rely on a wholly innocent misrepresentation to avoid a policy. Under the proposals, absent agreement otherwise by the parties, an insurer would only be able to rely on a negligent or fraudulent misrepresentation. The insurer would need to show that the insured did not honestly and reasonably believe the representations to be true.
• Under the current law, the insured must not misrepresent or fail to disclose any matter which would influence a prudent insurer when assessing the risk (the “prudent insurer” test). The Commissions would replace this with a “prudent insured” test. An insured would only be required to disclose a matter that either (a) it actually knows is relevant to the insurer; or (b) a reasonable insured would in the circumstances have appreciated was relevant to the insurer. The insurer would still need to show inducement for both misrepresentation and non-disclosure. The test for this would remain the same.
• The Commissions have invited views on whether or not the law should continue to provide a remedy of avoidance for negligent misrepresentation and negligent non-disclosure. Their alternative suggestion is that the insurer would be entitled to avoid only if it would not have written the policy had it known the true position. Where it would have written the policy with an exclusion or warranty, the policy would remain in force, but the court would assume that it contained that clause. Where the insurer would have charged a different premium, the insurer would be obliged to pay the same proportion of any claim as the premium actually charged bears to the premium that would have been charged had the true position been known to the insurer. So, if the insurer would have charged double the premium, the insured’s claim would be reduced by half.
• The parties would be free to contract on different terms, provided those terms were clear. For example, the parties could agree that the insurer has a right to avoid in the event of innocent non-disclosure or misrepresentation. However, the Commissions propose the following controls on insurers relying on their standard terms where they alter the default regime in the insurer’s favour. First, the terms must be clearly set out in writing. Secondly, the terms must have been specifically brought to the insured’s attention. If not, insurers would not be able to rely on them. The Commissions are not, however, currently proposing that the courts could adjudicate on the substance of the term: for example whether or not it is “fair” would be irrelevant.

For an overview of the Commissions’ proposals generally, please click here. For a summary of the Commissions’ proposals on warranties, please click here and on intermediaries, please click here. The Commissions have invited responses to their proposals by 16 November 2007.