Welcome to Part 3 of Insurance After Hayne, a six part series on our Insurance Law Tomorrow blog focusing on the implications for insurers following the release of the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

This week, we shift our focus to one of the less-anticipated areas of reform: an insured’s duty of disclosure.

Hayne’s report proposes changes to two provisions of the Insurance Contracts Act 1984 (Cth) (ICA), which will shift the responsibility of making sure all relevant facts are known to the insurer before a policy is entered into from consumers to insurers. The amendments will effectively end an insured’s positive duty of disclosure for consumer products, and will have potentially significant ramifications that will require both life and general insurers to re-visit and overhaul the questions asked of prospective insureds before policy inception.

Recommendations 4.5 – “ask no questions, hear no lies”

Section 21 of the ICA currently requires insureds to, prior to entering into a contract for insurance, disclose every matter known to them which they know (or a reasonable person could be expected to know) to be relevant to the decision of the insurer in deciding whether to accept the risk and on what terms.

Recommendation 4.5 (Duty to take reasonable care not to make a misrepresentation to an insurer) proposes that the current obligation of disclosure placed on consumers be changed to a duty to take reasonable care to not make pre-contractual misrepresentations to an insurer. This will bring an end to an insured’s positive duty of disclosure, and firmly place the burden of ensuring that all relevant facts are known to underwriters prior to the policy being entered into on insurers. If an insurer does not ask the right questions, it will have no remedy in respect of an insured’s failure to disclosure relevant information. The new regime promises to introduce a simplified standard intended to safeguard consumers from what the Commissioner viewed as onerous requirements imposed by insurers.

Certain types of general insurance products may not see a significant change if the recommendation is implemented. Sections 21A and 21B of the ICA currently provide that ‘eligible contracts of insurance’ are governed by similar rules for entering into and renewing policies, restricting the pre-contractual disclosure process to the insurer asking specific questions relevant to its decision to assuming, and the terms of assuming, risk in the agreement. The ‘eligible contracts of insurance’ currently covered by section 21A and 21B of the ICA include motor vehicle insurance, home building insurance, home contents insurance, sickness and accident insurance, consumer credit insurance and travel insurance.

However, Recommendation 4.5 goes further, however, applying to all consumer insurance contracts (although that term is not currently defined in the ICA), not just the current ‘eligible contracts of insurance’. Most significantly, this means the new regime will extend to life insurance as well as common retail general insurance products.

Commissioner Hayne’s rationale is that the current duty neglects the asymmetry of knowledge between the insurer and insureds. Insurers employ a set of targeted questions to retail customers backed by sophisticated actuarial data, which are designed to provide underwriters with the relevant knowledge needed to assess risk.

UK-based research invoked by Commissioner Hayne in support of this recommendation suggests that the information gap between the insurer and their retail customers may be so stark as to see policyholders denied claims even when they have acted honestly and reasonably, purely by virtue of the fact they lack the requisite knowledge to ascertain exactly what targeted questions are asking. As a result, customers often have to surmise what might or might not be relevant, when insurers almost invariably are better placed to know what is relevant in making their decision.

In light of this disparity, the Commission has taken the view that it is inappropriate for insurers to continue to have access to a statutory remedy which effectively acts to provide insurers another avenue to deny claims on the ground of non-disclosure, despite the insurer failing to adequately elicit this information before offering the policy. This approach broadly mirrors the UK approach governed by the Consumer Insurance (Disclosure and Representations) Act 2012 (UK).

Recommendation 4.6 – “would it change your mind if I told you…”

As it stands, section 29(3) of the ICA provides that upon becoming aware of an insured’s non-fraudulent misrepresentation or non-disclosure, a life insurer may, within three years after entering into the insurance contract, avoid the contract if they would not have offered the contract on the same terms had the misrepresentation or non-disclosure not occurred.

This is a departure from the pre-2014 wording which imposed a more stringent standard on life insurers seeking to avoid an insurance contract, with the pre-amended section 29(3) requiring the insurer to show not only that it would not have offered the same contract to the insured, but rather that it would not have entered into a contract for insurance “on any terms”. Commissioner Hayne now proposes in Recommendation 4.6 (Avoidance of life insurance contracts) that section 29(3) of the ICA return to its pre-amended form. The removal of the words “on any terms” has seen life insurers enjoy a protection with a very wide ambit, with Commissioner Hayne going so far as to say the amended legislation resulted in “…an ‘avoidance’ regime that is unfairly weighted in favour of insurers”.

On first glance, this change appears to be a mere reversion to the pre-2014 law. However, in the post-Hayne landscape, these changes will be coupled with renewed scrutiny on insurers, not only in the general conduct of financial service providers in the eyes of the media and the public, but also in the interpretation of the legislation. Life insurers now face the prospect of being compelled to provide indemnity for insurance contracts even where misrepresentations have been made, provided the misrepresentation was not sufficiently severe to have precluded the insurer from offering an insurance policy at all. Merely demonstrating that the terms of insurance would have been different is no longer enough, even where the changes would be radical.

Implications, and five issues insurers need to re-think

Although APRA, insurance bodies and insurers warned that premiums would likely rise to accommodate the Commissioner’s recommendations, Hayne considered this a worthwhile trade-off for providing consumers with “effective” insurance as a result of the recommendations.

It now behoves insurers to ensure they are equipped to respond to the Recommendations when they come into effect. Here are five issues for insurers to re-think when making inquiries of insureds prior to entering into an insurance contract:

  1. What to ask – the recommendation will end the positive duty on insured’s under consumer insurance contracts to make disclosures. The insurer must ask questions to illicit the information it needs, and its remedies depend solely on the information provided in respect to questions. As such, insurers will need to consider what information is required, and ensure that questions are asked in respect of all relevant information. There will undoubtedly be need to balance the effectiveness of sales procedures with the legal implications of these changes. 
  1. How to ask it – now more than ever before, both general and life insurers must be precise when asking questions of consumers. Knowing the relevant categories of information sought from potential insureds will always be of paramount importance, but so too is asking for this information in the clearest way possible: if vital information relevant to assessing risk is lost because an insured could not understand the questionnaire, it may be that the misrepresentation would not be found to have resulted from the absence of reasonable care.
  1. Open-ended questions are likely not sufficient – insurers now need to be aware that the Courts and AFCA will likely take a dim view on broad, open-ended questions. As the revised legislation will be interpreted in substance, not merely form, questionnaires with broad questions requesting that an insured divulge information within a given category may be viewed as attempting to circumvent the spirit of the new sections 21 and 29(3) of the ICA. A failure to thoroughly answer a broad open ended question may not constitute a failure to exercise reasonable care.
  1. Don’t go too narrow, either – insurers should also be conscious of asking questions that do not allow an insured adequate scope to provide relevant information. This will be particularly important as automated underwriting application processes increase as a primary interface for would-be insureds. When the consumer is provided with drop down boxes to choose nominated options, insurers need to ensure that consumers have the ability to elaborate where necessary to provide the relevant information.
  1. Life insurers, be ready to explain your answer – relying on non-fraudulent non-disclosure or misrepresentation to avoid a policy will soon become a far more difficult prospect. To show that a pre-contractual non-disclosure or misrepresentation would have resulted in no policy being offered at all, rather than merely offering a policy on different terms, life insurers should conduct a detailed review on the objective markers that would, either in isolation or in conjunction, result in no coverage being offered.

Prudent Australian-based insurers would do well to heed the lessons learned by UK-based insurers following similar reforms to disclosure and misrepresentation introduced by the Consumer Insurance (Disclosure and Representations) Act 2012 (UK). Given Hayne explicitly adopted the reasoning of the UK and Scottish Law Commissions in the context of Recommendation 4.5, legal advice on the practical ramifications of the change may prove invaluable. The global footprint of Norton Rose Fulbright’s dedicated insurance practice provides the cross-jurisdictional perspective to avoid the same pitfalls that accompanied the system from which the new Australian regime emanates.

Stay tuned for Part 4 of Insurance After Hayne which will be released next week.

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