What was fair in London in the 1700s? Insurance contracts were not fair: one party had more information than the other. If allowed to continue, this imbalance could have damaged the confidence in London’s fledgling insurance market so the English courts intervened, giving insurers special protection “because the underwriters know nothing and the assured knows everything”.
Insurance contracts are contracts of utmost good faith. In New Zealand, this means customers must disclose all material facts to their insurer prior to the insurance contract being formed or renewed.
Twenty-first century financial markets continue to struggle with information asymmetry but the perception of what is fair has changed.
Now, insurers must make disclosure to their customers. Customers must be given details of the insurer’s financial strength rating and any standard-form consumer policy must have “transparent” terms. Depending on the type of insurance, the customer may also receive a product disclosure statement and a disclosure statement about the person recommending the insurance.
The Financial Markets Authority has wide new powers to ensure that insurers deal fairly under the Financial Markets Conduct Act 2013 (FMC Act).
Misleading conduct prohibited
Prohibitions include conduct that is misleading or deceptive and conduct that is liable to mislead the public about the nature, characteristics, suitability for a purpose, or quantity of insurance.
A customer could be forgiven for thinking the duty of disclosure lies primarily with the insurer – not the insured. But the duty to disclose material facts remains firmly with the customer and the remedies for non-disclosure favour the insurer.
What happens when FMC Act’s “fair dealing” meets insurance law designed to protect an eighteenth century London underwriter?
The FMC Act’s fair dealing provisions are wide and backed by little guidance. How will the Financial Markets Authority use their new fair dealing powers to change conduct? Insurers must take great care to explain to customers the impact of the duty of utmost good faith. But how effective is that communication in the sea of other disclosure?
The lesson from overseas is that New Zealand insurance law may have to hurry to catch up: globally, the regulators and ombudsmen now control the rules of the game.
Disclosure in New Zealand
The doctrine of utmost good faith imposes a duty on a customer to disclose all material facts which are, or ought to be, known to him or her and are material to the formation of the contract. The test for materiality centres on the prudent insurer and whether the customer’s failure to disclose a fact might have influenced the insurer’s assessment of the risk.
There are two traps for the unwary New Zealand customer: failing to make any disclosure or making a misrepresentation by disclosing incorrect or incomplete information.
The common law remedy for breaching the duty of utmost good faith is that the contract is void ab initio – that is, it is as if the contract never existed. In our view, statutes modifying the common law position have not produced “transparency” for any customer or insurer considering remedies.
For most insurance contracts, the remedy for a misrepresentation is cancellation under the Contractual Remedies Act 1979. However, the circumstances where life insurance contracts can be cancelled are limited by the Insurance Law Reform Act 1977. The Contractual Remedies Act does not apply to marine insurance where the remedy for misrepresentation is still avoidance.
Commentators generally accept that the Contractual Remedies Act does not apply to circumstances of non-disclosure, so the remedy will also be avoidance.
If you think this seems confusing, that’s because it is. Luckily, the Contractual Remedies Act preserves the principle of party autonomy: provided the parties expressly devise their own remedies or stipulate the consequences for breaching the duty of utmost good faith (which usually they do), the legislated remedies do not apply.
The principles of utmost good faith were consistent across Commonwealth countries, but New Zealand is now an outlier.
Australia led the reform with the Insurance Contracts Act 1984 (Cth). Australian insurers cannot rely on the duty of disclosure in consumer cases unless the insurer asks the customer specific questions and avoidance is limited to circumstances of fraud.
In the United Kingdom (UK), the Consumer Insurance (Disclosure and Representations) Act 2012 abolished the duty of disclosure for consumers and modified the remedies for misrepresentation, limiting the remedy of avoidance to circumstances of dishonesty.
A New Zealand Insurance Contracts Act was supposed to be part of the regulatory reform that produced the FMC Act and other financial markets legislation. However, insurance law remains in abeyance while the other parts of our new financial markets regime have been set up.
The lesson from the UK is that the law may be forced to follow market practice. The catalysts for change in the UK were legion but none more so than a number of Financial Services Ombudsman (FSO) decisions.
The FSO has a statutory discretion to make determinations based on justice in each individual case and is not bound by precedent. As a result, the FSO’s decisions on the duty of disclosure ranged from the traditional prudential insurer test to something less stringent. In many situations the FSO held that the non-disclosure relied upon by the insurer was based on improper inferences, or that despite non-disclosure, other mitigating factors were present.
In New Zealand, Dispute Resolution Providers such as the Insurance & Savings Ombudsman (ISO) have been part of the statutory regulatory framework since 2008. The ISO makes decisions by reference to what is fair and reasonable in all the circumstances but will have regard to any applicable rule of law, such as utmost good faith.
Some change is also coming from within the insurance industry. The Insurance Council of New Zealand Fair Insurance Code (Code) will come into effect on 1 January 2016.
The Code does not ban general insurers from cancelling policies for non-disclosure. It requires general insurers to act “reasonably” when deciding whether to cancel a policy. It is arguable that this requirement introduces more uncertainty, as what is reasonable for an insurer may be to rely on its legal rights. This may not align with a customer’s expectations of reasonableness.
Life and health insurers are not bound by the Code, so the New Zealand market will remain with one foot in the 18th century while nervously eyeing the 21st century regulator.
Rebecca Sellers is special counsel at EY Law and is the convenor of the New Zealand Law Society’s Commercial and Business Law Committee. Luke Leybourne is a solicitor with EY Law.