Cicero Policy Briefer

Issue 19, December 2007

The Law Commission Review of Insurance Contract Law

By John Rowland

Remarkably, the piece of legislation that governs insurance contracts in England and Wales is the 1906 Marine Insurance Act. The Act is treated as codifying all relevant law in the area and is therefore applied widely to all insurance contracts. According to the Law Commission, which is reviewing the law, it is written in clear, forthright terms, which the courts have found difficult to apply in the modern world. Indeed its strict application would lead to considerable injustice, offering insurers 101 reasons to avoid a claim—even on the flimsiest of pretexts.

While the courts judge cases on the basis of the 1906 Act, the Financial Ombudsman Service (FOS) makes its decisions on insurance cases based on more modern standards, such as the provisions of the Financial Services and Markets Act (2000), and the FSA’s rule book which includes Principle 6 that firms should Treat Customers Fairly.

This inconsistency between courts and Ombudsman bothers the Law Commission for several reasons. First, it is clearly perverse that the FOS and courts could come to entirely different decisions on exactly the same case. Second, the FOS can only award a maximum of £100,000 meaning court action could be the only option for some consumers pursuing larger claims. Third, businesses with a turnover of more than £1 million do not have access to the FOS and therefore are stuck with the strict law, warts and all. Many of the Law Commissions proposals therefore aim to bring the law into line with best practice and to ensure greater consistency—and are to be welcomed.

But, as ever, it is the detail that causes the biggest headaches. One particular area which could prove to be thorny is that of ‘agency’—namely whether the intermediary is considered to be acting for the insurer or the insured when collecting pre-contract information such as existing or previous medical conditions.

This is important because if an intermediary is considered to be acting as an agent of the insured, any failure to record information by the intermediary is deemed to be non-disclosure on part of the insured and thus the insurer could avoid the claim. On the other hand if the intermediary was adjudged to be acting for the insurer, the insurer would be deemed to be aware of the information and thus could not avoid the claim on the basis of non-disclosure. These sorts of problems account for 13 per cent of cases of non-disclosure referred to the FOS.

So when is an intermediary an agent of the insured, and when are they an agent of the insurer? The law - being 100 years old - is not very helpful, so to clear this up the Law Commission proposes:

“…that an intermediary should be regarded as acting for an insurer for the purposes of obtaining pre-contract information, unless it is clearly an independent intermediary acting on the insured’s behalf.”

But this prompts a further question: how does one define an independent intermediary? The Law Commission proposes that the ‘fair analysis’ definition employed in the Insurance Mediation Directive should be the test of independence:

“When the insurance intermediary informs the customer that he gives his advice on the basis of a fair analysis, he is obliged to give that advice on the basis of an analysis of a sufficiently large number of insurance contracts available on the market, to enable him to make a recommendation, in accordance with professional criteria, regarding which insurance contract would be adequate to meet the customer’s needs.”

This is fair enough—but industry watchers will be wondering how this might relate to the proposals being discussed as part of the Retail Distribution Review. There has been a considerable debate as part of the RDR as to how the advisory sector might be segmented and which criteria should be used to define independence. Should it be by reference to remuneration; scope of advice (i.e., whole of market on the basis of fair analysis); or whether it should relate to professional qualifications? A divergent view of independence between the courts and the FOS, with its own jurisprudence, is hardly desirable and could cause confusion and inconsistency in non-disclosure cases.

The consultation period on the Commission’s review has now closed, and it is now down to the legal eagles at Theobalds Road to wrestle with some of these problems. It is a challenging task—the law might not be revisited for another hundred years!

John Rowland can be contacted on +44 (0)20 7665 9539 or click here to email.

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