A guide to the overhaul of insurance contract laws

Alph Edwards takes a look at the recent introduction of the Insurance Contracts Amendment Bill 2010 and the critical changes it will have on the Insurance Contracts Act.

On March 17, 2010, the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP, introduced into the House of Representatives the Insurance Contracts Amendment Bill 2010 (the ICAB) to be read for a second time.

The ICAB is legislation amending the Insurance Contracts Act 1984 (the ICA). This marks one of the final steps of reform of the ICA, which commenced in 2003 with the announcement of an expert committee to review and comment on its operation.

This article focuses on the critical changes to the ICA that will be brought about by the ICAB.

Scope and application of the Act

Duty of utmost good faith

The failure to comply with the duty of utmost good faith imposed by section 13 of the ICA will become a breach of the ICA. Third party beneficiaries to the policy will acquire the right to enforce that obligation as well as be subject to it.

Additionally, a new section 14A of the ICA makes it explicit that the Australian Securities and Investments Commission (ASIC) may exercise its powers (under Subdivision C of Division 4 of Part 7.6 of the Corporations Act 2001 or Subdivision A of Division 8 of Part 7.6) in respect of a failure by the insurer to comply with its duty of good faith in the handling or settlement of a claim or potential claim under the policy, as if the insurer’s failure to comply with the duty of good faith were a failure to comply with a financial services law.

Workers compensation contracts

Workers compensation policies will continue to be exempt from the ICA, but the ICAB will provide that the exemption will now extend to any part of the policy that also provides employers with common liability cover.

Bundled contracts

The ICAB amends section 9(1) of the ICA to introduce a new subparagraph (1A), which states that where a contract of insurance or a proposed contract contains provisions that if they were a single contract would not be covered by the ICA, as well as provisions that if they were a single contract would be covered by the ICA, then for the purposes of section 9(1) each set of provisions is treated as a separate contract.

Electronic communications

The Review Committee supported updating the ICA to allow for electronic communication with the insured. The effect of Schedule 2 of the ICAB, together with amendments to be made to the Electronic Transactions Regulations 1999 (to remove the current exemption in relation to the ICA), will allow for notices or other documents or information required to be given under the ICA to be given in electronic format.

Powers of ASIC

Intervention in legal proceedings

Schedule 3 of the Bill inserts a new section 11F into the ICA, which gives ASIC powers to intervene and acquire the status of a party in any legal proceedings ‘relating to a matter arising under this Act’.

Disclosure and misrepresentations

Section 21 clarification of the subjective/objective test

Schedule 4 of the ICAB proposes to amend the mixed objective/subjective test of the duty of disclosure in paragraph (b) of section 21(1) to give an example of the types of matters that should be taken into account in determining what ‘a reasonable person in the circumstances’ can be expected to know was relevant to the insurer’s consideration of the risk.

The amended provision will add on the end of section 21(1)(b) the words ‘having regard to factors including but not limited to the nature and extent of the insurance cover to be provided under the relevant contract of insurance’.

Eligible contracts of insurance

Section 21A of the ICA sets out the terms of the disclosure obligations that apply to personal lines of insurance such as motor vehicle, home contents and travel insurance, which are classified as ‘eligible contracts of insurance’ under the IC regulations.

The section currently requires the insurer to ask specific questions or forfeit the right to disclose by the insured.

However, it is also currently permissible for the insurer to ask the insured a ‘catch all’ question, which requires an insured to disclose ‘exceptional circumstances’ that a reasonable person could be expected to know would be relevant to the insurer’s decision as to whether to accept the risk, and that would be unreasonable for the insurer to specifically question.

The Review Committee recommended that this confusing exception be removed and the ICAB proposes its deletion.

Section 21A to apply to renewals

Section 21A currently also only applies when a contract is initially entered into and does not apply to renewals that trigger the general duty of disclosure provisions under section 21. The ICAB proposes to introduce a new section 21B, which in effect expands the new rules in section 21A to renewals.

New form of notification of the duty of disclosure

Under the present section 22 of the ICA, an insurer that wishes to seek a remedy for a failure to comply with the duty of disclosure must have given the insured a notice of that duty ‘before the contract is entered into’.

Part 3 of Schedule 4 of the ICAB repeals the former section 22 entirely and substitutes a new set of provisions with substantially the same effect.

These make it clear that any notification given should explain the effect of the new section 21A or section 21B and the new section 31A for life insurance (see below), and that the duty of disclosure applies right up until the time that the proposed contract is entered into.

The new section also states that in contracts of life insurance, the life insured (when different from the insured) must also be provided with the section 22 notice.

Consistent with this, the ICAB replaces the current section 22(3) with a new subsection, which provides that where the insurer’s acceptance or offer on terms in relation to the proposed policy is made more than two months after the most recent disclosure, then along with the acceptance or counter-offer the insurer must also provide a reminder that the duty of disclosure applies until the contract is entered into.

As is currently the case, failure to comply with all the relevant notice provisions of section 22 will prevent the insurer from obtaining a remedy for a breach of the duty of disclosure, unless the breach is fraudulent.

Also with respect to the new section 22(3) notice, the insurer only waives its right to act with respect to ‘new matters’, being matters the insured became aware of after the most recent disclosures.

Life insured to have duty of disclosure

The life insured is not necessarily also the policy owner under a policy of life insurance, but the policy owner is the only relevant insured for the purposes of the ICA. Part 4 of Schedule 4 of the ICAB will add a new section 31A to the Act, which will provide that when a person who would become a life insured under a life insurance policy fails to disclose the same matters that an insured must disclose under section 21, the effect will be the same as if the failure to disclose had been by the insured.

Remedies

Unbundling of contracts

The ICAB proposes the introduction of a new section 27A that will enable life insurance products to be ‘unbundled’ into their respective covers for the purposes of exercising remedies in relation to each type of cover.

The fact that various types of life insurance benefits are sold ‘bundled’ in the one policy has created significant issues for life insurers seeking to enforce remedies under section 29 of the ICA since the 2003 decision of the Queensland Court of Appeal in Schaffer v Royal & Sun Alliance Life Assurance Australia Ltd [2003] QCA 182.

In Schaffer, the court determined that the insurer’s obligation under section 29(3) of the ICA was such that it had to demonstrate that it would not have issued a policy of life insurance on any terms before it could obtain the remedy of avoidance that the subsection provides.

Differing underwriting criteria will apply to the various parts of the bundled product so that insurers have been placed in a difficult situation where they would have been prepared to offer some, but not all, of the types of benefits provided by the policy if the true position was known.

This, of course, significantly reduces the availability of the remedy for insurers and may produce unfair outcomes in practice, as the insured may be able to enforce a claim for a benefit the insurer would never have been prepared to offer if the insured had complied with their duty of disclosure.

The new section 27A aims to overcome this deficiency by splitting the policy into its component benefit types for the purposes of obtaining remedies for non-disclosure and misrepresentation.

This will enable the insurer to make a proportionate response to a non-disclosure or misrepresentation, as it can seek to avoid only those parts of the cover it would not have issued if the true position had been known.

Additionally, the new section 27A allows for unbundling where two or more lives are insured under the same policy, as well as the unbundling of a policy that contains underwritten and non-underwritten cover such as is common in group insurance where an insured with automatic acceptance limit cover tops this up with additional underwritten cover.

A new ‘proportional’ remedy for non-disclosure or misrepresentation in relation to living insurance products

The ICAB proposes that section 28 of the ICA be amended so that the remedy provided by this section applies to life policies other than two excluded types of life policies.

The excluded life policies are those that have a surrender value and those that provide cover in respect of the death of the life insured (excluded life policies). The existing section 29 regime will continue, but only for excluded life policies.

The intention of the amendment is once again to achieve a proportionate response to the insured’s failure to comply with their duty of disclosure.

Consequently, the provision will enable insurers to reduce their liability in the event of non-disclosure or misrepresentation proportionately to the amount that ‘would place the insurer in a position in which the insurer would have been if the failure had not occurred or the misrepresentation had not been made’.

Presently, the ICA places life insurers in the position of having to find grounds to avoid the whole of an insured’s contract in these situations.

However, if an insurer would have been prepared to underwrite a policy subject to exclusion and it cannot therefore establish it would not have issued a life policy on any terms, it leaves the insurer without any form of redress.

In other words, the ICA as currently framed may provide too much remedy or none at all. The proposal to add a new proportionate remedy is consequently very welcome.

Amendments to section 29

The ICAB proposes to amend section 29(3) by removing the reference to ‘a contract’ and replacing it with ‘the contract’, with the result that the insurer will only need to demonstrate that it would not have issued the same cover on the same terms.

This is consistent with the current position in relation to general insurance contracts under section 28.

However, this liberalisation has to be viewed in the context of the narrower scope of section 29 under the ICAB, which will only apply to excluded life policies.

Misstatements of age

Section 30 of the ICA currently provides for the sum insured or the premium charged to be appropriately adjusted to reflect the correct age of the life insured, if their age was misstated when the policy was entered into.

This is not always a sufficient remedy where the policy will remain in force or benefits will continue to remain payable during a period that has been determined on the basis of the incorrect age.

In response to this deficiency, the ICAB proposes a new section 30(3A), which will offer insurers an alternative remedy of varying the contract period.

Cancellation of life contracts

Cancellation of general insurance contracts is expressly dealt with by section 60 of the ICA, but there is nothing in the ICA at present that sets out if or when an insurer may cancel a life policy.

The ICAB proposes a new section 59A that allows an insurer to cancel a life policy in the same circumstances in which an insurer may cancel a contract of general insurance, with the exception of cancellation for non-payment of premium, which is carved out on the basis that cancellation on this basis is dealt with by section 210 of the Life Insurance Act.

A new section 63 also provides that a life insurer may only cancel a life policy under the ICA or section 210 of the Life Insurance Act.

Third party beneficiaries

Definition of third party beneficiary

Central to the reforms in this area is the proposal to introduce a new definition of a third party beneficiary, who is: ‘A person who is not a party to the contract but is specified or referred to in the contract, whether by name or otherwise, as a person to whom the benefit of the insurance cover provided by the contract extends.’

Third party beneficiaries to have expanded rights

The ICAB gives effect to the Review Committee’s recommendations that third party beneficiaries should have access to the following privileges currently reserved to the insured under the ICA:

• the same rights and obligations as an insured for the purposes of subrogation;
• the power to enforce (and to be subject to) the duty of utmost good faith (but not pre-contractually); and
• where the Act presently allows the insured to give certain notices to the insurer, a third party beneficiary should be equally able to give such a notice.

The notices in question are:

• a notice of circumstances that may give rise to a claim under section 40(3);
• a notice to elect to indemnify and take over the conduct of proceedings under section 41; and
• a request for a copy of the policy document under section 74.

The ICAB also reflects the desire of the Review Committee that section 48(3) of the Act should spell out that a third party beneficiary is in no better position to enforce the policy than the insured and confirm that insurers will be able to raise both the pre and post-contractual conduct of the insured in defence to a claim brought by a third party beneficiary.

Life insured — right of action as third party beneficiary

The ICAB proposes to amend section 48A to provide that where a contract of life insurance is expressed to be for the benefit of a third party beneficiary, that person may commence proceedings to enforce the policy.

The amended provision largely reflects the existing section 48A; however, the new definition of third party beneficiary means that section 48A will now have wider reach.

Amendments to section 48A carry across the same changes to policies in connection with retirement savings accounts (RSAs).

Liability policies — right of injured party to recover directly against insurer

The ICAB proposes to expand the rights of claimants to recover directly against an insurer under a liability policy under section 51 to claims against the third party beneficiaries. Consequently, a right of direct action will now arise under the Act whenever the insured or a third party beneficiary has:

• died; or
• cannot, after reasonable inquiry, be found.

Non-disclosure or misrepresentation by a member of a group life insurance scheme

Section 32 of the ICA has been out of step with the practical realities of group insurance cover for some time.

In particular, the fact that the section deemed the duty of disclosure to apply from the date the life insured joined their superannuation fund, rather than the date they actually obtained cover under the fund’s policy, could produce absurd results.

The decision of Virag demonstrates some of the judicial gymnastics courts have had to perform in order to avoid such absurd results.

The ICAB will remedy these problems by bringing the timing of the life insured’s disclosure obligations into line with the application for cover under the policy.

The ICAB will also clarify that an individual’s cover under a group policy can be separately avoided and expand the section to apply to group life arrangements generally, and not just to policies issued to superannuation funds.

Subrogation

The arrangements that currently apply to actions conducted by an insurer in the name of an insured under a right of subrogation are also to be expanded by the ICAB so that they apply to third party beneficiaries.

Commencement

The amendments contained in the ICAB will generally only apply to insurance contracts entered into or renewed after the commencement date of the ICAB. In cases where a life contract was originally entered into before the commencement date but varied after commencement, the amendments will generally only apply to the extent of the variation.

There are, however, some amendments that apply to contracts entered into before commencement of the ICAB.

These amendments are those dealing with Electronic communications — Schedule 2, Powers of ASIC — Schedule 3, Unbundling of contracts — Schedule 5, Part 1 and Representative actions by ASIC on behalf of third party beneficiaries — Schedule 6, Part 5.

Alph Edwards is a partner at TurksLegal.