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Maintaining cover: A guide to business insurance

Adam Bernstein discusses the ins and out of maintaining appropriate cover and the potential consequences of not meeting obligations to your insurer

This article can also be found in the Premium Editorial Download: MicroScope: MicroScope: November 2016

Insurance is an essential and inevitable cost which businesses need each year. It shouldn’t need stating, but a large claim or loss could have catastrophic consequences for your business. You need to ensure that you both have adequate insurance in place and understand the obligations which you owe to your insurers.

It’s for these reasons that Simon Brooks, a Partner and Head of Insurance at the Eversheds Insurance Group, says that firms need to know about the Insurance Act 2015, an important piece of legislation that came into effect on 12 August 2016. The changes the Act brings in are the most significant reform to insurance law – it partly replaces the Marine Insurance Act 1906 - in more than 100 years. Since 2013, consumers have had the benefit of the Consumer Insurance (Disclosure & Representations) Act 2012 and it was thought right that businesses also gained a fairer law to govern their commercial contracts of insurance

Brooks that the legislation is important: “The Act alters what businesses have to do to ensure that their insurance policies are effective and that claims are paid out in full. In part, it also seeks to address some of the perceived unfairness in the “old” law, which was viewed by many as favouring insurers over policyholders.”

New duty to make a fair presentation of the risk

When taking out an insurance policy, a business is under an obligation to disclose to the insurer all “material facts”. At law, these are facts which the insurer would want to know in deciding whether to accept the risk and, if so, on what terms. Brooks illustrates with an example: “When taking out a motor policy, information about the driver is likely to be material to the insurer. If this is not disclosed when the policy is taken out, an insurer may be entitled to “avoid” or cancel the policy, meaning that it is as if the policy never existed and the claim will be uninsured.”

Clearly this can be a difficult obligation for businesses to comply with as they have to consider what information is likely to be relevant to the insurer (and not what is important to it). The penalty in the event of a non-disclosure, whether innocent or not, is cancellation of the policy, which can be very draconian from the point of view of the policyholder.

Under the new Act, there is now a new duty governing the information that a business must disclose to an insurer before the policy is taken out - it is called the “Duty of Fair Presentation”. Brooks emphasises the need for full disclosure: “It is very important that businesses understand the practical implications of the new duty, as a failure to comply with this duty may provide insurers with grounds to refuse to pay a claim, or reduce the amount they are required to pay.”

He says that under this duty, businesses are still required to disclose every material circumstance which they know. “This key point hasn’t changed - a business still needs to ask itself whether it is aware of information which is likely to affect the judgment of a ‘prudent insurer’ in determining whether to cover the risk.” As ever, it is good practice for businesses to disclose everything in their knowledge to insurers to make sure they fall within the rules.

The new legislation goes further as one of the most important changes introduced by the Act is that a business will now need to disclose not only information which it knows, but also information which it ought to know. “This is a new concept,” says Brooks, “and, essentially, businesses will now need to disclose material information which should have been revealed by a ‘reasonable search’”.

The Act does not set out exactly what will be regarded as “reasonable”, and this is deliberate, as it is very difficult to legislate what will constitute reasonable in relation to different types of business and different classes of risk. The advice from Brooks is that in order to comply with this part of the duty, those individuals responsible for arranging insurance within a business will have to consider where material information could be stored, and search for this information to the extent it is reasonable to do so.

Interestingly, and a point many will miss, it’s important to note that the Act says that it may be “reasonable” in certain situations for a business to carry out searches of organisations other than its own. In other words, it may be considered reasonable to make enquiries of suppliers or professional advisers with regard to certain risks.

“Management will not be able to turn a ‘blind eye’ to areas inside or outside the business where they suspect material information may be held,” says Brooks, adding: “A failure to search for, and disclose, material information stored in these areas, could amount to a breach of the new duty.”

New “proportionate” remedies

The good news for purchasers of insurance is that the “old”, automatic remedy of avoidance of a policy in the event that a business fails to disclose material information to an insurer, has been replaced by a range of “proportionate remedies” based on what the insurer would have done had a fair presentation been made.

Nothing has changed if a failure to comply with the Duty of Fair Presentation was deliberate or reckless - the Act says that this may give an insurer grounds to avoid the policy.

However, as Brooks notes, if the failure was not deliberate or reckless, the insurer may:

  • Still avoid the policy, if the insurer would not have written it had a fair presentation been made;
  • Amend the terms of the policy to those it would have agreed had a fair presentation been made, and apply those terms to the claim; or
  • Pay only a proportion of the claim if it would have charged a higher premium had a fair presentation been made.

There is some industry discussion suggesting that the proportionate remedy for claims where there has been a material non-disclosure is not very fair. As is noted above, if the insurer would have charged a higher premium if they had known about the non-disclosed material fact they can reduce proportionately the settlement of a claim (and potentially previously paid claims). On small claims this is not too much of an issue, but consider this example – the insurer increases the premium from £1000 to £1500 (50%) and the client has a claim for £50,000, the additional premium of £500 is disproportionate to the client having their claim settlement reduced by £25,000. There are a handful of insurers (Zurich & Hiscox for example) that have ‘contracted out’ of this rule and instead will charge the client the additional premium but still pay the claim in full. Other good insurers will likely follow suit.

Changes to how warranties work

Insurance policies frequently contain various terms such as “warranties” and “conditions precedent”. These are conditions an insured business must comply with, for example, a buildings policy may contain a warranty that the fire alarms need to be fully operational.

“Under the ‘old’ law, a breach of warranty automatically permitted insurers to refuse to pay a claim,” says Brooks. However, and this is a change for the better as policyholders are concerned, the Act has the effect of transforming warranties into “suspensory conditions”. “This essentially means that, the insurer will not be liable to pay any claims while the insured business is in breach of warranty, but if the business later remedies the breach (if that is possible) then the insurer is generally liable for subsequent claims.” Under the ‘old’ law, it might typically have been the case that a property damage / business interruption policy required that the insured have a working fire alarm at all times. In the event of a flood, to the extent a working fire alarm was not in place, the insurer would have been automatically entitled to decline cover, even though the absence of a fire alarm may not necessarily have caused the loss. Under the “new” law, this is no longer the case.

“A further – and important - change introduced,” says Brooks, “is that an insurer will only be allowed to rely on a breach of a warranty or condition precedent in declining a claim if the loss is connected to the breach. For example, an insurer will not be able to rely on a breach of the fire alarm warranty, referred to above, in declining a flood claim; it could generally speaking only be relied on in declining a fire claim.” This change is a real help to businesses who temporarily lose sight of their obligations.

The overall message to businesses from Brooks remains - you should be familiar with, and understand, all of the terms in your policy and comply with them. However, the Act means that there may be occasions where an insurer will find it more difficult to decline a claim in the event that a term has been breached.

Contracting out

Another change, and one that may not be obvious, is that in business contracts, the parties to a policy are free to contract out of any part of the Act, apart from those relating to basis clauses - the declaration on an insurance proposal form or policy contract stating that representations made by the purchaser (the policyholder) are true and accurate. As Brooks notes, “contracting out removes the rights that the new Act has conferred on policyholders.”

However, the right to contract out isn’t simple and the insurer must overcome two hurdles. First, the insurer must take sufficient steps to draw the term to the business’ attention before the contract is concluded; and second, the term must be drafted so that it is clear and unambiguous as to its effect. In essence, this requires the insurer to explain the effect of the term.

Summary

The new rules do go a long way to making a more level playing field between customers and insurers and, with the addition of the Enterprise Act 2016 (which comes into force May 2017 and introduces the potential for damages being paid by insurers to claimants for late payment of claims), are a great improvement.

From Brooks’ perspective, the new proportionate remedies in the event of a breach of the duty to make a fair presentation of the risk should lead to fairer outcomes when claims occur. Similarly, the changes in the law relating to warranties and conditions precedent are welcome.

However, he offers advice to businesses. “Sit down with your insurance broker or lawyer when taking out or renewing policies to ensure that you fully understand what information you are required to disclose to insurers and what searches need to be carried out to reveal this information. This is potentially a difficult area, involving some new concepts and time may be required to bed down best practices.” 

Remember - if you need your insurance to extend to cover contractors working for you, any additional risks they and their business bring to your insurance must also be disclosed. Document the information gathering process, including a list of who counts as ‘senior management’ and who has provided the information. This is particularly important if you are relying on what someone else has told you and it later turns out to be incorrect. Firms that plan ahead will be on much safer ground.

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