Pre-contractual Duty of Disclosure | Analysis

Introduction

Prior to the Consumer (Disclosures and
Representations) Act 2012 and the Insurance Act 2015, the pre-contractual duty of
disclosure for insurance contracts attracted significant criticism for placing
an unfair burden of disclosure on the insured, the breach of which led to the
severe and disproportionate remedy of complete policy avoidance. The Law
Commissions have historically suggested that this duty be abolished for
consumer insureds and modified for business insureds, and these changes have now
been subsumed and introduced under the above-mentioned acts. Where there was
previously a general insurance law, these acts have now introduced a doctrinal
distinction between consumer and business insurance.[1] Given
the inherent weaknesses of the old law and differences between consumer and
commercial entities, this essay will seek to establish that the Law
Commissions’ recommendations are right, and have resulted in a more balanced
protection of insured interests.

This essay will first focus on the weaknesses
of the traditional regime and the juristic basis for reform to the
pre-contractual duty of disclosure. The essay will then move on to examine how the
current law has effectively addressed these inadequacies before finally
exploring the underlying doctrinal reasons for this divergence of consumer and
business regimes.  

The Traditional Regime

The pre-contractual duty of disclosure
originates from the uberrima fides doctrine of
utmost good faith in insurance contracts, as set out by Lord Mansfield in the
leading case of Carter v Boehm.[2]
This principle was subsequently codified[3]
in the Marine Insurance Act 1906 (the ‘MIA’), the basic effect of which imposed
upon insureds the duty to disclose all ‘material circumstances’ within his knowledge
to the insurer.[4]
The failure of the insured to demonstrate utmost good faith would allow the
insurer to avoid the policy ab initio.[5]

The Test of Materiality

The approach toward determining a ‘material
circumstance’ under the wording of the MIA has been a highly complex and
contentious affair, making it quite central to calls for reform. Under s.18 of
the MIA, a circumstance was material if it would “influence the judgement of a prudent insurer in fixing the premium, or
determining whether he will take the risk” – this requirement was made from
the perspective of the insurer, and imposes an onerous burden of disclosure on
the insured without providing any guidance. Despite the MIA’s maritime roots,
the Court of Appeal drew no distinction between marine and non-marine insurance
contracts and adopted this ‘test of materiality’ as a general principle in Lambert v Cooperative Insurance Society.[6]
Nevertheless, McKenna J, in empathising with the insured, made it clear
that this case ‘showed the unsatisfactory
state of the law’.[7]

The test of materiality was further
developed in Pan Atlantic Ins. Co v Pine
Top Ins. Co[8]where the House of Lords affirmed the
previously held view[9] that
the phrase “influenced the judgement”
referred merely to factual circumstances that the insurer would have liked to
know of, but not necessarily acted on, when assessing risks. This objective
test meant that insureds were required to disclose every piece of information which
would have an effect on the mind of the insurer. This caused two main problems.
Firstly, it meant that insureds were held to an impossibly high standard of
disclosure and were expected to effectively read into the mind of a prudent
insurer. Secondly, it meant that insurers could avoid policies despite there
being no causal link between the non-disclosure and actual loss.

To mitigate the harshness of the law, The
House of Lords introduced a second, independent limb of ‘inducement’ to the
test of materiality. This was a subjective test that required insurers to provide
evidence showing that a material circumstance had induced them to enter into
the contract. In St Paul’s
Fire & Marine Insurance Co v McConnell Dowell Contractors Ltd[10], this
was done using evidence from other insurers as well as expert witnesses.
Although it did impose an appropriately higher burden of proof on the insurer
in cases of non-disclosure, such an approach also added a degree of complexity
and artificiality to the materiality test.[11]
For example, in Marc Rich v Portman,[12]
Longmore J found the insurer in question to be “a most unsatisfactory
witness… (who) revealed a surprising ignorance or indifference to prudent underwriting
practice.” Nevertheless, the inducement requirement did allow the court to
limit insurers’ recourse to the drastic remedy of avoidance, as illustrated in Drake
Insurance Plc v Provident Insurance Plc.[13]
However, Merkin has criticised this approach as coming perilously close to
allowing the court to underwrite the policy itself.[14]
The subjective test of materiality, still very much insurer-centric, does
little to improve the clarity and scope of an insured’s disclosure obligations.

Other Weaknesses

The MIA made no distinction between
innocent non-disclosure, negligent non-disclosure, or fraudulent concealment.[15] This
meant that an insured could have acted well within the meaning of ‘good faith’,
but still fail to meet the standard of utmost good faith.[16] Moreover,
an insurance proposal form does not remove overarching disclosure obligations.
In Schoolman v Hall,[17] the insured’s
claim was rejected after it was found that he had previous convictions that
were not disclosed despite there being no prompt for such information on the
proposal form. In this regard, there is also no obligation for the insurance to
ask any questions.[18]

Perhaps the most glaring drawback with the
MIA would be that it only provided a single remedy of policy avoidance ab initio.
Given that the courts did not entertain the idea of damages in insurance law,[19] a
breach of disclosure obligations would allow the insurer to pay all premiums
back to the insured and act as if the policy had never existed. For obvious
reasons, this draconian[20]
approach was a “critical flaw… that
provide(d) insurers with remedies which in many circumstances (was)
disproportionate.”[21]

It is also important note that the law did
not distinguish between consumer and commercial insureds. Although there were
some protections[22]
offered to consumers, the state of the law was quite aptly described by
Tyldesley as being “archaic, unclear, and
unfair.”[23]

The Current Law

Consumer Insureds

The Consumer (Disclosures and
Representations) Act 2012 (the ‘2012 Act’) now governs all consumer insurance contracts,
and the provisions of the MIA no longer apply. Under the Act, consumers are
individuals contracting “wholly or mainly
for the purposes unrelated to the individual’s trade, business, or profession.”[24] The
Act introduces sweeping pro-insured reform to pre-contractual disclosure
obligations.

S.2 of the 2012 Act abolishes the pure duty
of pre-contractual disclosure, and instead introduces a duty for the consumer
to take reasonable care not to make a misrepresentation. This completely
removes the difficult concept of ‘material circumstance’ and redraws disclosure
obligations from the perspective of the insured. This greatly eases the
insured’s burden of obligations as they are only held to the objective standard
of a reasonable consumer,[25] and
do not have to meet the impossibly high standard of a prudent insurer under the
MIA.

The abolishment of disclosure obligations
means that the law on consumer remedies is completely rewritten as well. Remedies
are provided in ss.4 and 5, but only for ‘qualifying misrepresentations’,
namely, misrepresentations that are deliberate and reckless or careless. This
means that innocent and reasonable misrepresentations do not allow for complete
avoidance of the policy. Moreover, and in cases of careless misrepresentations,
the insurer is barred from avoiding the policy if (a) he would have entered the
contract on different terms or (b) if would have charged a higher premium. For
scenario (a), the insurer is taken to have contracted on the terms that would
have been applied if the careless misrepresentation was not made. For scenario
(b), the insurer is liable to pay the proportion of the claim against the actual
premium paid by the insured. In both these scenarios, the insurer can terminate
the contract – this prospective remedy means that an insured would be able to
enforce prior claims. The distinction between innocent, reasonable and careless
misrepresentation is a major step up from the traditional regime, and protects
insureds from unfair and exploitative treatment by insurers who seek to avoid a
policy on the most insignificant breaches.

Business Insureds

The Insurance Act 2015 (the ‘2015 Act’)
supplements the MIA instead of replacing it, and applies to all non-consumer
insurance contracts.[26]

The 2015 Act recasts the traditional disclosure
obligation – the duty to disclose and misrepresentation are subsumed under a single
holistic ‘duty of fair presentation’.[27] At
its heart, the Act retains the core test of materiality, albeit with some
modifications. The first major change involves a much needed provision of
guidance on the materiality of facts.[28] In
addition to the original MIA s.18(1) disclosure requirement, the 2015 Act also adds
a second element that builds upon case law developments[29] and allows
insureds who fail to meet the MIA disclosure requirement to merely make a “disclosure which gives the insurer
sufficient information to put a prudent insurer on notice that it needs to make
further enquiries for the purpose of revealing those material circumstances.”[30] This
allows the insured to make a somewhat ‘lesser’ form of disclosure, and signifies
a shift toward providing a more balanced, less insurer-centric disclosure
obligation where a breach of duty is not automatically assumed if the insured
fails to provide a piece of information. Finally, S.8(1) codifies the Pan Atlantic subjective materiality
test, which was in practice the real protection for the insured.[31]

Perhaps the most significant[32]
modification to the duty of disclosure lies in the remedies available for its
breach. Much like the 2012 Act, the 2015 Act introduces the concept of
proportionate remedies that draws a distinction between deliberate or reckless,
and careless breach of the duty.[33] The
only difference is that the 2015 Act does not distinguish between innocent and
negligent breaches, and the insurer remains entitled to a remedy in light of
such breaches.

A Doctrinal Divergence

The Law Commission has drawn a clear line
between consumer and business insurance contracts with the total abolishment of
a consumer’s disclosure duties and modification of a business’s duties. From a
juristic standpoint, these changes appear to have addressed the weaknesses of
the traditional law, namely the unfair test of materiality and the stringent
remedy of avoidance. However, it will be necessary to examine the impact of
these changes against the greater doctrinal backdrop of insurance law. Without
delving into too much socio-legal analysis, this essay will explore two areas:
the reasoning behind the divergence and potential problems of the reform.

Reasoning

The decision of the Law Commission to deal
separately with both branches of law was shrewd because rules suitable for mass
market consumer insurance would not be appropriate for larger scale businesses
who were generally very well informed.[34] Additionally,
it has been almost 250 years since Lord Mansfield first elucidated the
principle of utmost good faith,[35] and
advances in technology now mean that a varied range of insurance contracts are now
concluded very quickly and by parties from all sorts of backgrounds.

The Law Commissions were acutely aware that
each class of insured was unique; for example, the duty of disclosure was
retained for businesses in the UK because market practice meant that they did
not use proposal forms, undertook a wide range of unusual risks, and often
operated through professional intermediaries.[36] The
asymmetric bargaining position of consumers also meant that businesses did not
need protections such as the Financial Ombudsmen Service (FOS), and were
neither allocated the post reform remedial benefit of innocent
misrepresentations that was offered to consumers. In this respect, the FOS
provided perhaps the most effective pre-reform protection for consumers – the
service is not obliged to follow the law and do not enforce the duty of
disclosure.[37]
In fact, the FOS refused to allow avoidance for non-disclosure in cases where
no question was asked by the insurer. The Law Commissions chose to abolish the
consumer’s duty of disclosure to bring the law into line with this industry
practice,[38]
and the prevailing mentality was that insurers should have sufficient industry
expertise to adopt the burden of finding out information, rather than require
consumers’ positive disclosure.[39]
Moreover, technology has since altered the market for insurance, and initial
fears regarding ‘sharp practices’[40] by
consumers quickly dispersed upon the advent of telemarketing and canvassing.
Should a duty of disclosure have been retained, it would have led to an
undesirable amount of litigation and an increased FOS workload.[41]

Problems

The 2015 Act does not provide a definition
for a ‘business’, but rather applies generally to all non-consumers. This means
that smaller enterprises such as sole traders, who are more akin to consumers
than commercial entities, are caught under the provisions of the Act. Whilst some
may be able to seek recourse from the FOS, this is an illustration of how the
Law Commission has compromised their recommendations to accommodate the
insurance industry’s deep rooted resistance to reform.[42]

The nascence the 2015 Act means that one
can only speculate on its efficiency. Nevertheless, there is the potential for
increased commercial uncertainty, particularly with suggestions that the lack
of an explanation of ‘fair representation’ would lead to increased litigation.[43]
Moreover, the concept of proportionate remedies had been previously rejected by
the Law Commission on the basis that it was too difficult to calculate a
premium in hypothetical circumstances.[44] In
this respect, it has also been predicted that 
“risk would be determined not by
the free market but by judges exercising after-the-fact highly discretionary
(and arbitrary) judgments.”[45]
Although purely academic at present, these are potential problems that will
have to be ironed out in practice.

Conclusion

The Law Commissions’ recommendations are a
step in the right direction for the law of insurance. They have addressed the
flaws that the traditional insurance regime posed to two fundamentally
different classes of insured through the creation of two separate and doctrinally
divergent legal regimes.

On a juristic level, the abolition of the
consumer’s duty of disclosure and the recasting of disclosure obligations to
the insurer has greatly eased the previously asymmetric, unfair, and archaic
burden on the consumer. Modification to the business disclosure duty has meant
that the obligation is now clearer and less stringent. Moreover, the
introduction of a common proportionate remedy now means that insureds are no
longer subject to the single, draconian outcome of complete policy avoidance.

Although the new law is untested and by
extension, conceptually imperfect, the Law Commissions’ pragmatic approach to
reform has undoubtedly altered the traditional power balance in favour of the
insured. They have provided a tailored solution that improves the protections
accorded to insured – in this respect, the Law Commissions’ were right to have
recommended for an abolishment and modification to the disclosure duties of a
consumer and business insured respectively.

Bibliography

Legislation

• Consumer (Disclosure and Representations) Act 2012
• Insurance Act 2015
• Marine Insurance Act 1906

Case Law

• Banque Keyser v Skandia [1990] 1 QB 665, 781
• Carter v Boehm (1766) 3 Burr 1905
• Container Transport International Inc. and Reliance Group Inc. v Oceanus Mutual Underwriting Association (Bermuda) Ltd. [1984] 1 Lloyd’s Rep 476
• Drake Insurance Plc v Provident Insurance Plc [2004] QB 601
• Garnat Trading & Shipping (Singapore) Pte Ltd v Baominh Insurance Corporation [2011] 1 Lloyd’s Rep 589
• Lambert v Co-operative Insurance Society Ltd [1975] 2 Lloyd’s Rep 485
• Marc Rich & Co. A.G. And another v. Portman and Others. [1996] 1 Lloyd’s Rep 430
• Pan Atlantic Co v Pine Top [1994] 2 Lloyd’s Rep 427
• Roselodge Ltd. (formerly “Rose” diamond products, ltd.) v Castle [1966] 2 Lloyd’s Rep 113
• Schoolman v Hall [1951] 1 Lloyd’s Rep 139
• St Paul’s Fire & Marine Insurance Co v McConnell Dowell Contractors Ltd [1995] 2 Lloyds Rep 116

Journal Articles

• B Soyer, ‘Consumer Insurance Reform: Reforming the assured’s pre-contractual duty of utmost good faith in insurance contracts for consumers: are the Law Commissions on the right track?’ JBL (2008) 385 – 411
• G Blackwood, ‘The pre-contractual duty of (utmost) good faith: The Past and the Future’ (2013) LMCLQ 320
• J Hjalmarsson, ‘The Insurance Act 2015 – a New Beginning or Business as Usual?’ (2015) 15(2) Shipping and Trade Law 5
• K Lewins, ‘Going Walk about with Australian Insurance Law: The Australian experience of reforming utmost good faith’ 1 JBL 2013, 1 – 22
• Merkin, Insurance Law Monthly, (2004) Vol 16 No 2
• Merkin, ‘The Insurance Act 2015: Rebalancing the Interests of Insurer and Assured’, Modern Law Review (2015) 78(6) MLR 1010
• T J Schoenbaum, ‘Key Divergences between English and American Law of Marine Insurance: A Comparative Study’ Cornell Maritime Press (1999)

Books

• Birds, Bird’s Modern Insurance Law (2016, Sweet & Maxwell)

Websites

• P J Tyldesley, ‘Archaic, Unclear and Unfair? – Part 1’, (New Law Journal, 3 July 2009) <http://www.peterjtyldesley.com/publications/2009_Archaic,_unclear_&_unfair.pdf> accessed 6 January 2017
• P J Tyldesley, ‘Archaic, Unclear and Unfair? – Part 2’, (New Law Journal, 2 October 2009) <http://www.peterjtyldesley.com/publications/2009_Archaic,_unclear_&_unfair.pdf> accessed 6 January 2017

Government Papers

• Law Commission and Scottish Law Commission, Insurance Contract Law: Misrepresentation, Non-disclosure and Breach of Warranty by the Insured (Law Com 182, 2007)
• Law Commission, Insurance Law Non-Disclosure and Breach of Warranty (Law Com No 104, Cmnd 8064, 1980)

[1] Birds, Bird’s Modern Insurance Law (2016, Sweet &
Maxwell) 16

[2] Carter v Boehm (1766) 3 Burr 1905

[3] Marine Insurance Act 1906, s.17

[4] Marine Insurance Act 1906, s.18

[5] Marine Insurance Act 1906, ss.18 – 20

[6] Lambert v Co-operative Insurance Society Ltd [1975] 2 Lloyd’s
Rep 485

[7] Lambert v Co-operative Insurance Society Ltd [1975] 2
Lloyd’s Rep 485 (MacKenna J)

[8] Pan Atlantic Co v Pine Top [1994] 2 Lloyd’s Rep 427

[9] Container Transport International Inc. and Reliance
Group Inc. v Oceanus Mutual Underwriting  Association (Bermuda) Ltd. [1984] 1 Lloyd’s
Rep 476

[10]St Paul’s Fire & Marine Insurance Co v McConnell
Dowell Contractors Ltd [1995] 2 Lloyd s Rep 116 1995

[11] G Blackwood, ‘The pre-contractual duty of (utmost)
good faith: The Past and the Future’ (2013) LMCLQ 320

[12]Marc Rich & Co. A.G. And another v. Portman and
Others. [1996] 1 Lloyd’s Rep 430

[13]
Drake Insurance Plc v Provident Insurance Plc
[2004] QB 601

[14] Merkin, Insurance Law Monthly, (2004) Vol 16 No 2

[15] Birds, Bird’s Modern Insurance Law (2016, Sweet &
Maxwell) 125

[16] Roselodge Ltd. (formerly
“Rose” diamond products, ltd.) v Castle [1966] 2 Lloyd’s Rep 113 (McNair
J)

[17] Schoolman v Hall [1951] 1 Lloyd’s Rep 139

[18] P J Tyldesley, ‘Archaic, Unclear and Unfair? – Part 1’,
(New Law Journal, 3 July 2009) <http://www.peterjtyldesley.com/publications/2009_Archaic,_unclear_&_unfair.pdf> accessed 6 January 2017

[19] Banque Keyser v Skandia [1990] 1 QB 665, 781 (Slade
LJ)

[20] K Lewins, ‘Going Walk about with Australian
Insurance Law: The Australian experience of reforming utmost good faith’ 1 JBL
2013, 1-22

[21] P J Tyldesley, ‘Archaic, Unclear and Unfair? – Part
1’, (New Law Journal, 3 July 2009) <http://www.peterjtyldesley.com/publications/2009_Archaic,_unclear_&_unfair.pdf>
accessed 6 January 2017

[22] In particular, the Financial Ombudsmen Service, as
will be discussed later in the essay

[23] P J Tyldesley, ‘Archaic, Unclear and Unfair? – Part
1’, (New Law Journal, 3 July 2009)
<http://www.peterjtyldesley.com/publications/2009_Archaic,_unclear_&_unfair.pdf>
accessed 6 January 2017

[24] Consumer (Disclosure and Representations) Act 2012,
s.1

[25] Consumer (Disclosure and Representations) Act 2012,
s.3

[26]Insurance Act 2015, s.1

[27] Insurance Act 2015, s.3

[28] Insurance Act 2015, s.7(4)

[29] Notably, on the dictum of Clarke J in Garnat Trading
& Shipping (Singapore) Pte Ltd v Baominh Insurance Corporation [2011] 1
Lloyd’s Rep 589

[30] Insurance Act 2015, s.3(4)(b)

[31] Merkin, ‘The Insurance Act 2015: Rebalancing the
Interests of Insurer and Assured’, Modern Law Review (2015) 78(6) MLR 1010

[32] G Blackwood, ‘The pre-contractual duty of (utmost)
good faith: The Past and the Future’ (2013) LMCLQ 318

[33] Insurance Act 2015, s.8 & sch. 1

[34] P J Tyldesley, ‘Archaic, Unclear and Unfair? – Part
2’, (New Law Journal, 2 October 2009)
<http://www.peterjtyldesley.com/publications/2009_Archaic,_unclear_&_unfair.pdf>
accessed 6 January 2017

[35] Carter v Boehm (1766) 3 Burr 1905

[36] Law Commission and Scottish Law Commission, Insurance Contract Law: Misrepresentation, Non-disclosure
and Breach of Warranty by the Insured (Law Com 182, 2007) para 5.27

[37] P J Tyldesley, ‘Archaic, Unclear and Unfair? – Part
2’, (New Law Journal, 2 October 2009) <http://www.peterjtyldesley.com/publications/2009_Archaic,_unclear_&_unfair.pdf>
accessed 6 January 2017

[38] Law Commission and Scottish Law Commission, Insurance Contract Law: Misrepresentation,
Non-disclosure and Breach of Warranty by the Insured (Law Com 182, 2007)
para 4.14

[39] Law Commission and Scottish Law Commission, Insurance Contract Law: Misrepresentation,
Non-disclosure and Breach of Warranty by the Insured (Law Com 182, 2007)
para 4.20

[40] Law Commission, Insurance
Law-Non-Disclosure and Breach of Warranty (Law Com No 104m, Cmnd 8064,
1980) paras 4.34 – 4.42

[41] B Soyer, ‘Consumer Insurance Reform: Reforming the
assured’s pre-contractual duty of utmost good faith in insurance contracts for
consumers: are the Law Commissions on the right track?’ JBL (2008) 385 – 411

[42] Birds, Bird’s Modern Insurance Law (2016, Sweet
& Maxwell) 131

[43] J Hjalmarsson, ‘The Insurance Act 2015 – a New Beginning or Business as Usual?’ (2015) 15(2) Shipping and Trade
Law 5

[44] Insurance Law Non-Disclosure and Breach of Warranty.
1980. Law Com. No.104. Cmnd.8064, para.4.8.

[45] T J Schoenbaum, ‘Key Divergences between English and
American Law of Marine Insurance: A Comparative Study’ Cornell Maritime Press
(1999) p 127