Proposed insurance law reforms: warranties

The Law Commission and Scottish Law Commission have made proposals for the reform of insurance contract law. For an overview of the Commissions’ joint consultation paper published on 17th July 2007 click here.

If adopted, the proposals will see sweeping changes to the law on warranties in insurance contracts.

In November 2006, the Commissions concluded that the law in relation to warranties was unfair, did not reflect the expectations of insureds, and the consequences for breach draconian (Law Commissions’ Issue Paper 2: November 2006 - for more detail on the Commissions’ Issues Paper on warranties click here). Last week, the Commissions published a joint consultation paper setting out its provisional proposals for the reform of insurance contract law. In relation to warranties, the Commissions have stated that:

• some of the principles embodied in the Marine Insurance Act 1906 (the “1906 Act”) are no longer appropriate to a modern insurance market and do not meet policyholders’ reasonable expectations;
• self-regulation, the FSA and Ombudsman practice provides insufficient, incoherent and unclear protection for consumers and businesses alike; and
• the law reform should strike a fair balance between the interests of insurers and policyholders.

The Commissions therefore propose that:

Warranties as to past/current facts

• “basis of contract” clauses (which allow insurers to treat all answers contained in proposal forms as warranties) be abolished for consumer insurance.
• “fact warranties” be abolished for consumer insurance - any statement of past or current fact made by a consumer before entering into an insurance contract would be treated as a representation rather than a warranty. Insurers’ remedy for an incorrect statement would not (as under the present law) be automatic avoidance of the contract, but would depend on whether the incorrect statement was made innocently, negligently or recklessly.
• For business insurance, warranties of past or present fact would be permitted if specifically agreed by the parties. For example, an insurer may wish for a fact warranty in relation to specific information such as previous convictions for company directors. There would, however, be controls on their use in standard term contracts.
• If the fact warranted is not true, the insurer may refuse to pay the claim provided that:

(i) the information to which the breach relates is material; and

(ii) it had some connection to the loss.

• The parties would be free to agree other consequences for breach of warranty, but these would need to be clearly set out in the contract.
• The insurance contract would need to specify which facts were to be given warranty status.

Warranties as to future

The 1906 Act sets out harsh consequences for any breach of a warranty as to the future: if the warranty is not strictly complied with, insurers are automatically discharged from liability and may refuse to pay any claim that arises after the breach whether or not connected with the breach and whether or not the loss occurs after the breach has been remedied.

The Commissions’ view is that the rules have the potential to be applied arbitrarily so as to defeat the insured’s reasonable expectation of cover. The Commissions therefore propose that a warranty should be set out in writing and that an insured should be entitled to be paid a claim if it can be proved on the balance of probabilities that the event or circumstance constituting the breach did not contribute to the loss. This would, however, be a default rule and, in the case of business insurance, the parties could agree other consequences if they wished. A breach of warranty would not automatically discharge the insurer from liability, but would instead give the insurer the right to terminate cover for the future.

The Commissions have invited responses to the proposals by no later than 16 November 2007 in anticipation of publishing a Bill to be laid before Parliament in 2010. Click here for a copy of the summary of the Commissions’ proposals.

A Law-Now on the proposals regarding non-disclosure and implications for brokers will follow this article shortly.