Out-Law Analysis 6 min. read
22 Oct 2015, 6:08 pm
Section 11 of the 2015 Insurance Act, which will come into force on 12 August 2016, only applies to terms which relate to a particular type of loss or a loss at a particular location or time. It states that insurers cannot rely on non-compliance with these terms to "exclude, limit or discharge" their liability, provided that the policyholder is able to show that the non-compliance with the particular term could not have increased the risk of the loss which actually occurred, in the circumstances in which it occurred.
This is a major change to the current law. Much has been made of Section 11 in its application to warranties, but it has the potential to apply to all policy terms including conditions precedent. Under the existing law a failure to comply with a condition precedent provides an insurer with a complete defence to a claim, regardless of whether that failure was the cause - or even a cause - of the loss being claimed. Section 11 of the Act effectively introduces a type of causation requirement, ensuring that a breach of a policy term must be related to the particular loss in question before an insurer can decline a claim.
Current law
Conditions precedent in insurance contracts generally fall into one of two categories:
In relation to the first category the insurance contract simply does not come into existence until the relevant condition is complied with. An insurer's remedy if the policyholder fails to comply with a condition precedent to liability will depend on the policy wording. Where the insurer's remedy is not clearly spelled out, common law principles apply and the insurer will be entitled to decline the claim entirely. Importantly, and often unfairly from the insured's perspective, an insurer does not need to show that it has suffered prejudice as a result of the breach. The insurance contract will remain intact meaning that future claims are potentially payable.
This remedy is only available to the insurer if the condition relied on truly is a condition precedent. Labelling is important but not necessarily determinative and labelling all policy terms as conditions precedent will not be effective if it is unsuitable to describe some of those terms as such. If the term in question is found to be a mere condition rather than a condition precedent the insurer has no right to decline the claim; it can only claim damages from the insured. This is of little use given that the insurer rarely suffers any significant loss.
In sum, under the current law, a condition precedent to liability allows the insurer to decline claims, hence their importance and wide use.
The 2015 Insurance Act
Section 11 of the Act covers terms not relevant to the actual loss to which the policyholder's claim relates, and is intended to prevent insurers from relying on obviously irrelevant policy terms to defeat claims. It applies to all terms, other than those which 'define the risk as a whole', if compliance with the term would tend to reduce the risk of one or more of:
Examples of such clauses include a requirement to install a burglar alarm in order to prevent theft (a loss of a particular kind); or a requirement to employ a night watchman (to reduce the risk of loss through theft or fire) while a factory (the location) is unoccupied (a particular time eg. outside business hours).
Section 11 goes on to state that if a term like those above has not been complied with, and an insurable loss subsequently occurs, the insurer may not rely on the non-compliance to exclude, limit or discharge its liability.
However, this depends on the policyholder being able to prove that non-compliance could not have increased the risk of the loss which actually occurred in the circumstances in which it occurred. So, what does this mean in practice? Only real life claims experience will truly bring this to life but one example given by the Law Commission is that of a policyholder who fails to comply with a requirement to install window locks and whose property is subsequently damaged by flood. Presumably, the policyholder would, in that example, be able to show that its failure to install window locks could not have increased the risk of flood and therefore be entitled to claim an indemnity under the policy.
This has the potential significantly to limit the insurer's ability to decline claims for breach of these terms. The insured, though, will also have its work cut out: it is not clear how much evidence the insured will need to adduce and how far it will need to go to prove the absence of any causal link between the breach and the loss. We may see a much heavier reliance by insureds on expert evidence to defeat ever more sophisticated arguments (e.g. a window lock that is robust enough to withstand gallons of water?). We are also likely to see insurers gathering evidence of a causal connection at an early stage in order to rebut any anticipated Section 11 defence. Clear policy wordings setting out exactly what risks policy terms are intended to reduce will help.
The fact that many insurers have chosen to go above and beyond what the Act requires (e.g. 'warranty free' policies) suggests that insurers will adopt a common sense approach to cases where there is obviously no link between the breach and loss. The higher value disputes involving commercial insureds will be left to be resolved by the courts.
Limitations of section 11
There are limitations to Section 11. It will only apply to specific risk mitigation clauses of the type defined above, and it explicitly excludes from its remit terms "defining the risk as a whole". The Law Commission give the example of a car, insured for social domestic pleasure purposes, which is damaged during commercial use. The insurer would have charged a much higher premium for insuring a vehicle used for commercial purposes – a different risk altogether. Here, the insurer would be entitled to refuse indemnity and the insured would not be able to pray in aid Section 11 in its defence. This is because the term it has failed to comply with is one which defines the risk as a whole and not one which would tend to reduce the risk of loss.
The Law Commission specifically anticipates litigation in this area, because some terms will of course be both terms which tend to reduce the risk of loss and which define the risk as a whole e.g. a condition precedent to liability that an insured does not sail into a war zone (reduces the risk of damage to the vessel and defines the risk as peacetime-only risks). Insurers will need to identify clearly the terms in their policies which define the risk as a whole in order to go some way to avoid disputes in this area.
Another important limitation to the Section 11 of the new Act is that it will not alter the law in relation to the insured's obligation to notify insurers of claims and circumstances. These are almost always expressed to be conditions precedent to an insurer's liability but they are not terms which tend to reduce the risk of loss; by the time it comes to notification the loss has already occurred. This is perhaps bad news for the insured in this frequently litigated area of coverage disputes.
Finally, it is possible to contract out of Section 11 of the Act when dealing with commercial insured provided the "disadvantageous" term is clear and unambiguous and the insurer takes sufficient steps to bring it to the insured's attention. Again, given that insurers are keen to go over and beyond what the new Act requires of them – and given the commercial reality whereby some insurers do not insist on their strict legal rights - contracting out is unlikely to be commercially attractive, certainly for mainstream general insurance products.
Implications for insurers
Insurers are likely to want to rely more heavily on conditions precedents in their wordings going forward given that warranties have such a bad reputation in the industry, with some insurers wanting to disassociate themselves from warranties altogether. Under the new Act, the insurer's right to decline claims where the insured has failed to comply with a condition precedent will be limited by Section 11. However, it is important to note that Section 11 is both limited in its scope and that the insured will have some evidential hurdles to overcome before being able to successfully rely on it as a defence to a declinature.
Rebecca Ransome-Lewis is an insurance law expert at Pinsent Masons, the law firm behind Out-Law.com.