The Insurance Act 2015 (Act) has been described as the most significant revision of insurance law in a century. One of the key areas addressed by the Act in non-consumer contracts of insurance was the issue of non-disclosure of pertinent information to an insurer.
Prior to the Act, policyholders owed an insurer the duty of “utmost good faith”, which was routinely underlined by the inclusion of “basis of contract” clauses in policy wordings. The result was that in the event of a non-disclosure, the insurer could void the policy of insurance from inception, thus releasing themselves from any and all liability.
The non-disclosure often came to light in the investigations surrounding a claim, but the non-disclosure did not have to be relevant to the claim for the insurer to be released from liability. Over the years, this power was questionably exploited by insurers in some instances, with results that many felt were inequitable.
These concerns led to a set of revisions in the Act which prohibited “basis of contact” clauses altogether, and stipulated the circumstances in which an insurer has the power to void policies from inception for non-disclosure – principally where the non-disclosure was dishonest and reckless.
However the Act introduced a new situation, which in some ways is more concerning.
If there is a non-disclosure of pertinent information, and the insurer can show it would not have written the policy on the same terms, the insurer may amend the terms of the policy. At an extreme, the insurer can still come off cover by showing that if they had known the information they would not have quoted at all, but the insurer does have to return the premium to the policyholder.
However there is a check and balance to this, in that insurance brokers are involved in many transactions with the same insurer, and may well be able to point to a similar case where in fact the insurer did write a policy in the same circumstances, or on similar terms. As such the insurer no longer has a pure legal right to void a policy, and instead an insurer’s assertions must be consistent with their commercial practice (i.e. there is an underlying factual matrix which can be considered).
But the concern doesn’t end there. If an insurer asserts that they would have charged a higher premium, then the Act stipulates that under-insurance exists (section 8 and Schedule 1 of the Act), and allows the insurer to reduce any claims by the percentage of under-insurance.
In practice, the percentages involved can make significant differences. If an insurer asserts that if it had known the undisclosed information it would have charged a premium 15% higher, this may be very true, and in any case, it may be very difficult to prove a clear and consistent pricing strategy to the contrary. As a result of such an assertion, the policy in question would be providing 85% cover, and any claims under it could be reduced by an insurer by 15%. For a £500,000 loss, that would equate to £75,000 – which is a significant saving to the insurer, and potentially a hardship to the policyholder.
The concern is that insurers may be much more inclined to use these powers than previously. The pre-Act power to void a policy was very much all or nothing. Such a draconian step was not taken lightly, with all of the ethical and reputational consequences which would follow. As a result – and
despite the cases which led to the Act revisions – it was comparatively rare. The new position created by the Act is more proportionate, but it may be used much more frequently as a result.
There was a common professional indemnity (PI) insurance protection for non-disclosure issues prior to the Act – an “innocent non-disclosure clause” (IND) clause. The simplest form of an IND clause stated that if a non-disclosure was demonstrably innocent, the insurance policy would not be voided. More comprehensive versions of the clause had a second limb which allowed the notification of a circumstance which could give rise to a claim, which should have been notified to an earlier PI policy.
Following the Act, the simple IND clause is now less relevant than before as the instances in which the insurer has the power to void the policy are more limited. The protection of an IND clause to permit the notification of a pre-existing circumstance remains important.
However given the Act’s stipulations regarding payment of claims if the premium was under quoted due to non-disclosure, there is now a third situation to consider. Only a handful of PI policies in the present market deal with this situation and remove the insurer’s power to assert under-insurance in the event that the non-disclosure was demonstrably innocent.
As such suggestions to policyholders following the Act are these. Firstly, you should check whether your PI policy has an IND clause at all, as it is not standard. If the policy does contain an IND clause, you should ascertain which situations it addresses. Has it been updated to reflect the Insurance Act, and if so, does it specifically address under-insurance?
Of course, another risk management step is to avoid a non-disclosure situation in the first place. Firms should ensure that they understand the duty of Fair Presentation, and what constitutes a material circumstance for the purpose of this duty.
Nevertheless, risk management wisdom dictates that no single approach is fool proof or 100% effective, and therefore a comprehensive IND clause is an important backup to a conscientious approach to presenting your firm to an insurer at renewal.