Why it matters

“The [Marine Insurance Act 1906] is written in clear, forthright terms which can constrain the courts’ ability to develop the law.”

This criticism was made in the “Explanatory Notes” provided to members of the House of Lords when scrutinising the Insurance Bill which became the Insurance Act 2015 (“the Act”). The criticism is pregnant with the suggestion that a virtue of the new Act was that it would be less clear than, and more malleable by the courts than, the earlier legislation. Whether that objective is of comfort to those who have to apply the Act is open to question. It is certainly the case that, in one fundamental respect, the Act is ambiguous.

Perhaps the most important change to the law made by the Act is the reworking of the obligations of pre-contractual disclosure and of the remedies for breach of those obligations. The core obligation from which the new architecture springs is “the duty of fair presentation”. As s 3(1) of the Act makes clear, this duty is owed by “the insured”. Satisfaction of this duty requires, amongst other things, “disclosure of every material circumstance which the insured knows or ought to know.”

So, in terms of achieving compliance with the duty of fair presentation, it is quite important to identify just who is subject to that duty: ie “the insured”. That has potentially profound practical consequences for policyholders and insurance brokers. Identifying the insured can’t be that difficult, can it?

Why it isn’t straightforward

A potential problem emerges as early as s 1 of the Act with the definition of “insured” as “the party to a contract of insurance who is the insured under the contract” (emphasis added). The use of the singular is significant in suggesting that, on the insured side at least, there can be only one party to a contract of insurance. This, as noted above, ties in with imposing the duty of fair presentation upon “the insured”. But this language could, surely, just be meant to apply to whichever insured’s conduct is being considered and doesn’t rule out the possibility of contracts with more than one insured?

However, ss 4(5) and (7) suggest otherwise. They recognise a distinction (as phrased in the former) between “the insured and any other persons for whom cover is provided by the contract” (emphasis added). A potential alternative to “other persons for whom cover is provided by the contract” would be “other insureds”. So the fact that the Act doesn’t adopt the latter formulation may well be significant. What seems to be clear at least is that the starting point for the Act appears to envisage a single insured with anyone else benefitting from the cover having the separate status of “other person for whom cover is provided” (“a Covered Person” – not a term used in the Act but a shorthand we adopt for the purposes of this note).

The consequences seemingly envisaged by the Act

The distinction is important because, for the purposes of the duty of fair presentation, the insured is fixed with knowledge of what a reasonable search would have revealed as to information held by any Covered Persons. Therefore, a Covered Person appears to be no more than a source of information for the insured’s attempt to satisfy the duty of fair presentation. The insured alone has the much greater burden of complying with that duty: eg deciding from whom to seek information and then going ahead and obtaining that information. The duty also involves requirements as to how the information is presented to insurers and other burdens which, on the face of it, Covered Persons are spared.

It could be said in favour of such a scheme that it reflects the reality of how organisations already go about compiling their disclosure. The beneficiaries of the proposed policy are not left to their own devices to submit information to the broker. Instead, someone, often but not always a risk manager, is given the responsibility for compiling the disclosure material. So, surely, the Act will treat the entity employing the risk manager as “the insured” and everyone else with the benefit of the cover will be a Covered Person.

This might be a perfectly acceptable, sane, outcome. However, the Act provides no guidance whatsoever as who might be designated “the insured” by applying the provisions of the Act alone. The pragmatic outcome identified in the previous paragraph may be what the courts find the Act to mean, but in the meantime there is a risk that they will not reach that conclusion. And there is a potential stumbling block in the way of that conclusion, which is derived from the fact that, absent any guidance in the Act, the only other potential source of enlightment as to the identity of the insured would appear to be what the proposed policy says.

This solution is what was envisaged by the “Explanatory Notes” provided to the House of Lords with which we began, and which state:

“In some situations one party may enter into a contract on behalf of others. Who is the “insured” in such cases is, and will continue to be, a (sic) determined by reference to the particular contract.”

But what if that particular contact says something that flatly contradicts the “single insured” scenario the Act and its “Explanatory Notes” appear to presume?

Many policies do not have a single “insured” identified as such. Instead “insured” is often a defined term covering a number of individuals and entities. So pending court guidance, what is the consequence of that? Given that the Act is new, and it does appear a little odd that it proceeds on the basis that there can be only one insured, would it be prudent for a risk manager to conclude that all but one person identified in the proposed policy as an “insured” is exempt from the duty of fair presentation? How the risk manager reacts to that challenge is going to have serious practical and, potentially, legal consequences.

First of all, how does the risk manager choose the single insured with confidence that the decision will be vindicated by the application of the Act? Furthermore, a disclosure exercise where every beneficiary of the cover is treated as an insured is likely to be much larger and far more complex than one which involves one insured and where everyone else is a Covered Person. This is because every insured will have to satisfy the duty of fair presentation, rather than merely act as a source of information. Following on from this, a disclosure exercise may end up being way off the mark (either unnecessarily intensive or, at the other extreme, hopelessly inadequate) if it proceeds on the wrong footing as to the status of the beneficiaries of the proposed policy.

A quick fix, or storing up trouble for the future?

The solution is obvious, isn’t it? Draft the policy to designate one person as “the insured”!

But will that work?

Most policies covering more than one person take pains to make clear that they are “composite” policies pursuant to which each covered person is insured individually and for their own interest. That way, traditionally, the consequences of a pre-contractual misrepresentation and non-disclosure (absent any additional protections conferred by anti-avoidance provisions) are confined to the person who generated the misrepresentation or who failed to make disclosure: the other covered persons do not lose their cover by reason of that breach.

Disenfranchising all but one “insured”, and so reducing them to the status of Covered Persons without, at the same time, attending to the language which makes the policy composite may facilitate an interpretation which renders the policy joint. The effect of that will be that the concealment or misrepresentation of information by one of the Covered Persons prejudices the policy for all. That is hardly a desirable outcome where the Act is supposed to be making life easier for the beneficiaries of cover.

In any event, such a drafting solution might depart from reality in a way which prejudices the insured unless the insurer is properly bound into that drafting approach. For instance, consider a simple Directors and Officers (“D&O”) liability policy taken out by a single company on a Side A Only basis (ie it covers only the directors and there is no cover for the company). How do you decide which of those directors, each of whom would want to be an “insured” in the usual scheme of things, will the the insured for the purposes of the Act with all the burden of the duty of fair presentation which the others are spared?

The problem is not escaped if the company, via its risk manager, undertakes the disclosure exercise. It would be a nonsense to designate the company as the insured because a Side A Only policy cannot, by definition, provide cover for it. Indeed, the company is the most likely potential claimant in most actions covered by the policy. Further, it may be insufficient for the directors to rely on the risk manager’s information gathering and presentation exercise without proper input by them: this is because it is the insured who is subject to the duty of fair presentation, and that cannot be the company that employs the risk manager in a Side A Only policy.

Complex questions of agency may arise, further complicated by the innovations of the Act, in the event that the policy does not respond as hoped. Both the company and the directors have good reason for a Side A Only D&O policy to work. The directors for the most obvious of reasons. The company because, being the most likely claimant in the majority of the types of claim the policy covers, it will want the policy to respond in case the directors cannot meet the scale of any liability to the company. What the company won’t want complicating any claim against the directors is a counterclaim or set-off argument based upon the alleged negligence of the company in arranging the D&O cover. The Act may have increased the risk of companies facing such arguments.

Policies which insure companies, but which also provide cover for individuals

To recap, satisfaction of the duty of fair presentation requires, amongst other things, “disclosure of every material circumstance which the insured knows or ought to know.”

For the purposes of what the insured knows or ought to know, s 4 of the Act draws a distinction between an insured “who is an individual” and an insured “who is not an individual”. The Law Commission Report that inspired the Act explains that this distinction reflects a desire to apply different rules to sole traders purchasing commercial insurances, on the one hand, and to entities (incorporated or otherwise) making an equivalent purchase, on the other.

What this leaves open is the following: what happens when a policy taken out by one or more corporate entities insures not only those entities, but also individuals who are, for example, directors, officers and employees of those companies? What then becomes of the distinction referred to in the previous paragraph: particularly given that the rationale for that distinction as identified by the Law Commission Report is, in our view, not remotely discernible on the face of the Act? As a result, an objective reading of the Act may lead to it being applied to achieve outcomes which the Law Commission did not intend or contemplate.

Does the fact that the policy is primarily taken out by, and to cover the business activities of, corporate entities mean that, when seeking to comply with the Act, one should default to the rules applicable to the insured “who is not an individual”? So are the non-corporate individuals just Covered Persons for the purposes of attribution of knowledge to the corporate insured?

Alternatively, is it necessary to apply the rules applicable to insureds who are individuals, for those who are, and also apply the separate rules applicable to insureds who are not individuals to those who fall within that category. So should both sets of attribution rules apply to a policy covering both types of insured? But how does that fit with there only being one insured so far as the Act is concerned?

Given the uncertainties identified above, it would seem sensible that drafting solutions be attempted in the language of the policy itself in order to agree the status of those who will have the benefit of the cover and also agree the consequences of those choices for, amongst other things, the approach to satisfying the duty of fair presentation and determining whether the policy is composite or joint. But the issues are quite subtle, so the drafting will require care in order not to create more problems than it potentially solves. The alternative would seem to be to hope for the best until such time as the courts clarify the issues addressed above: however, that could have unexpected and unpleasant concsequences, not least for the policyholders involved in any such “test case”.

This post is intended to provide guidance of a practical nature but does not contain legal advice or advice as to what action you should or should not take specific to your insurance needs or those of your business, or with regard to any particular situation.