Contracting out of the IA 2015: key learning points for insurers, brokers and insureds

Introduction

Those on either side of an attempt to contract out of the provisions of the Insurance Act 2015 (IA 2015) should be wary of the strict requirements associated with doing so. It is in the best interests of both insurers and insureds (and their brokers) to ensure that these requirements are met, to avoid complicated and messy arguments about compliance down the line (along with the expensive litigation that is likely to follow).

In brief

The key learning points which we want to highlight are that:

1. It is intentionally difficult for insurers to contract out of the IA 2015.

2. Insurers can only "contract out" of the IA 2015 in accordance with the transparency requirements of section 17 of the IA 2015. These requirements essentially: (a) oblige the insurer to take sufficient steps to draw the disadvantageous term to the insured’s attention before the contract is entered into or the variation agreed; and (b) ensure that the disadvantageous term is clear and unambiguous as to its effect. It is as yet uncertain how the transparency requirements will be interpreted by the courts.

3. If an insurer is attempting explicitly to "contract out" of the IA 2015, unless this involves marine insurance, the insured should be mindful of the fact that the insurer is likely only doing so because the "contracting out" is to the disadvantage of the insured; the insurer therefore has to fulfil the stipulated transparency requirements.

4. The role of the broker can give rise to difficulties, particularly if the broker is the one proposing the contracting out wording. There is, as yet, no market standard "contracting out" wording. In taking sufficient steps to draw each disadvantageous term to the insured’s attention, the insurer should usually satisfy this requirement by disclosing the existence of the term to the broker. However, this still leaves insureds with the problem of how to ensure that they have recourse to the broker if the broker then fails to inform the insured of any disadvantageous term.

5. If an insurer does want to contract out of the IA 2015, it should follow the guidance proposed by the Lloyd’s Market Association and comprehensively disclose the effects of "contracting out" of each term.

6. The complexity and expense of "contracting out" suggests that it may be better for both parties to comply with the IA 2015, which was clearly what the legislation had in mind anyway.

Analysis

1. Contracting out is intentionally difficult

The IA 2015 was part of a raft of reform intended to improve the position of insureds and bring insurance law into the 21st century. The IA 2015 aimed to improve the position of commercial insureds in important areas such as disclosure, warranties and good faith, abolishing "basis of the contract" clauses and otherwise preventing insurers from relying on ‘technicalities’ (such as breach of a term unconnected to the loss) to avoid liability under a policy. Therefore, insurers should not be able easily to contract out of the IA 2015 to the disadvantage of their insureds, seeking to avoid the whole act by inserting a few words into their existing policy wording.

In fact, the reason that "contracting out" was permitted at all appears to be lobbying by the marine insurance industry, who believed that their position was very particular and protected by the Marine Insurance Act 1906. They therefore wanted to reserve the right to contract out and then reinstate in the policy the provisions of the MIA as required. Nevertheless, despite this, the IA 2015 contains strict requirements for "contracting out" to protect the insured.

2. Transparency requirements

When an insurer wishes to contract out of the IA 2015 to the disadvantage of the insured, it has to comply with certain "transparency" requirements found in section 17 of the IA 2015, namely to: (a) take sufficient steps to draw the disadvantageous term to the insured’s attention before the contract is entered into or the variation agreed; and (b) ensure that the disadvantageous term is clear and unambiguous as to its effect.

To clarify, a "disadvantageous term" for these purposes is a term which would put the insured in a worse position than the insured would otherwise have been in by virtue of the IA 2015. It is also worth noting that an assessment of the two limbs of section 17 should take into account the characteristics of the insured and the circumstances of the transaction (for example, "sufficient steps" might be a less onerous test in respect of insureds which are experienced in the market).

3. Inherently disadvantageous

If an insurer is purporting to contract out of the IA 2015, the insured should be alert to the fact that, by the very nature of the "contracting out" provisions, the alternative will likely be less advantageous to the insured than the rights provided for under the IA 2015. This is a point not always appreciated by insureds.

4. Brokers and taking "sufficient steps"

In practice, limb (a) of the transparency requirements may not be difficult to satisfy for many insurers, as the broker (as agent of the insured) may well suggest (or at least comment on) the contracting-out wording, so will have actual knowledge of the term. However, this raises a problem for the insured - namely, how to ensure that the broker does disclose the existence of disadvantageous terms and, if it does not do so, that the insured still has recourse against the broker. The terms of business agreement (TOBA) between the insured and the broker will therefore be key - the insured should check that the broker has not attempted to exclude its liability if it fails to disclose the existence of disadvantageous terms to the insured. In any case, however, the insured should review the policy itself for any provisions attempting to "contract out" of the IA 2015 and raise further queries if required.

It is worth noting, however, that there has not yet been any case law on what constitutes an effective attempt to "contract out" of the IA 2015. Nor is there market standard wording; parties have only been negotiating such provisions for a few months, so no norm has emerged. Instead, individual brokers appear to be devising their own "contracting out" wording, which does not necessarily reflect the requirements of the IA 2015. Some examples that we have seen attempt, for example, to contract out of the whole IA 2015 in one paragraph. Of course, using generic wording might at first appear the simplest approach and some brokers have claimed that this is "market standard" (an unsupported statement which, if true, would seem contrary to the whole purpose of the IA 2015). However, the wording of section 17 of the IA 2015, and the associated Lloyd’s Market Association Guidance, would suggest that such generic wording is likely to be found insufficient when tested in court.

The involvement of the broker in drafting "contracting out" wording also raises old questions of conflicts of interest - should the broker really be drafting wording which favours, not their client insured, but the insurer (though the TOBA may be worded differently, the IA 2015 seems to assume that the broker is agent of the insured). Connected with this, is the question of whom the insurer will be able to pursue if the wording is ineffective (after all, the broker will be the insured’s agent). What is clear is that an increased number of claims against the brokers might be an unexpected consequence of the IA 2015.

5. Clear and unambiguous as to its effect

The more complex analysis will be in relation to limb (b) of the transparency requirements - that is, whether the disadvantageous term is "‘clear and unambiguous as to its effect." The Lloyd’s Market Association Guidance supplements the IA 2015 on this point by suggesting that, in respect of each provision of the IA 2015 that the insurer wishes to contract out of, it must clearly state, not only the provision being contracted out of, but the effect of that contracting out. For example, the following wording has been suggested by the Lloyd’s Market Association Guidance: “Section 10 of the Insurance Act 2015 shall not apply to any warranty in this insurance contract. If any such warranty is breached, the Insurer’s liability shall be discharged from the time of the breach of warranty, regardless of whether the breach is subsequently remedied.” The insured should be left in no doubt as to what the effect of accepting the amendment will be. If an insured sees this sort of provision and is not familiar with the IA 2015, they may wish to take legal advice to ensure that they are fully informed about the difference between their rights under the IA 2015 and their rights when the IA 2015 is disapplied.

Insurers wishing to contract out of the IA 2015 should be careful to ensure that their "contracting out" wording satisfies the transparency provisions of the IA 2015, by following the approach of comprehensive disclosure advocated by the Lloyd’s Market Association Guidance. This will inevitably be an expensive exercise, as it will have to be considered on a policy by policy basis, thus making it plain that a generic wording is unlikely to be sufficient. Insurers otherwise run the risk that their contracting out provisions will not be effective and they will not have the contractual protections that they thought they had.

6. Conclusion

With all this complexity and expense in mind, it may be that both insured and insurers follow the path of least resistance and agree to follow the IA 2015. The clarity that this approach offers will benefit both parties, at least until official guidance is provided.

One thing is for certain - we are likely to see much litigation in due course arising out of attempts to "contract out" of the IA 2015, unless both insurers and insureds (and their brokers) pay much more attention to the strict requirements of section 17 than they appear to have done so far.