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Wide-Ranging Reform Proposed by Review - International Law Office

International Law Office

Insurance - Australia

Wide-Ranging Reform Proposed by Review

August 24 2004

Review of Section 54
Review of Other Provisions


On September 10 2003 the minister for revenue and assistant treasurer, Senator Helen Coonan, and the parliamentary secretary to the treasurer, Senator Ian Campbell, jointly announced that the government would be undertaking a comprehensive review of the Insurance Contracts Act.

Review of Section 54

Given the particular concerns surrounding the operation of Section 54, the government requested that the panel reviewing the act provide an interim report on this section. Many of the submissions on Section 54 also commented on other provisions of the act, given their close relation, in particular Section 40.

On November 18 2003 the review panel released its report and recommendations on Section 54, followed by the release on March 8 2004 of the proposed draft of the Insurance Contracts Act Amendment Bill. The panel released a commentary on the proposed draft bill explaining the possible amendments to Sections 54 and 40.

Section 40 currently states:

"Certain contracts of liability insurance.

(1) This section applies in relation to a contract of liability insurance the effect of which is that the insurer's liability is excluded or limited by reason that notice of a claim against the insured in respect of a loss suffered by some other person is not given to the insurer before the expiration of the period of the insurance cover provided by the contract.

(2) The insurer shall, before the contract is entered into: (a) clearly inform the insured in writing of the effect of Subsection 3; and (b) if the contract does not provide insurance cover in relation to events that occurred before the contract was entered into, clearly inform the insured in writing that the contract does not provide such cover.

(3) Where the insured gave notice in writing to the insurer of facts that might give rise to a claim against the insured as soon as was reasonably practicable after the insured became aware of those facts but before the insurance cover provided by the contract expired, the insurer is not relieved of liability under the contract in respect of the claim, when made, by reason only that it was made after the expiration of the period of the insurance cover provided by the contract.
"

In relation to Section 40(2), it is proposed that insurers be required to notify insureds (both at the start of a policy and upon renewal) of the effect of Section 40(3). Section 40(3) gives insureds a statutory right to notify their insurer of circumstances which might lead to a claim prior to the expiration of the policy period.

It is proposed, in line with the report, that insurers must notify their insureds of this right under Section 40(3) no earlier than 30 days, and no later than seven days, before the insurance contract expires.

The commentary also discusses possible amendments to Section 40(3) of the act, which would give insureds a statutorily extended reporting period in which to notify of circumstances that might lead to a claim. It is proposed that the extended period be 45 days but that insureds be obliged to notify their insurer of such facts as soon as reasonably practicable after the insured becomes aware of them.

The commentary also discusses the introduction of a new Section 54A which would apply only to claims made and notified policies. This would aim to overcome the decision in FAI General Insurance Company Limited v Australian Hospital Care Pty Limited(1) by ensuring that Section 54 would not enable an insured to notify of circumstances which might lead to a claim outside of the policy period provided by the contract of insurance or the act. The commentary suggests that the proposed amendment would still permit an insured to rely on Section 54 to notify a claim made during the policy period outside of this period.

The proposed draft bill is intended to apply to contracts of liability insurance entered into 28 days or more following royal assent. The amendments to the act would apply only to a 'contract of liability insurance', defined in Section 11(7) as "a contract of general insurance that provides insurance cover in respect of the insured's liability for loss or damage caused to a person who is not the insured".

This raises the following points:

  • The obligation to notify the insured in writing of its rights under Section 40(3) does not apply where the contract was arranged by an insurance broker if the insurer becomes aware that the broker has informed the insured of its rights under Section 40(3) between 30 and seven days before the policy expires. Section 40(2)b does not make clear the level of such awareness;

  • The proposed Section 40(3) mentions the insured becoming aware "of facts that might give rise to a claim against the insured", picking up on the existing language of Section 40(3). A 'claim' is not currently defined in the proposed draft bill and its meaning is unclear. The act does not identify a standard of reasonableness to attach to the level of awareness of the insured, nor does it identify whether that awareness need be actual knowledge of the facts, actual knowledge that those facts might give rise to a claim or some lesser level of knowledge;

  • The proposed Section 54A excludes the operation of Section 54(1) where otherwise (i) the insurer's liability would be excluded or limited because a claim against the insured with respect to a loss suffered by a third party was not made before the insurance cover expired, or (ii) the insurer's liability was excluded or limited because such claim was not made and notified before the insurance cover provided by the contract expired;

  • The existing Section 40(3) imposes an obligation on the insured to notify of circumstances "as soon as was reasonably practicable after the insured became aware of those facts". It is proposed that this remain in the revised Section 40(3), notwithstanding that that subsection is now intended to include a cap of 45 days on the ability to notify circumstances late. This will be a hoop through which insureds will still need to jump in order to obtain the protection of Section 40(3).

It remains to be seen whether the proposed draft bill is adopted by the Parliament in the proposed form or in an amended form that takes into account the comments received from stakeholders.

Review of Other Provisions

Section 8 of the Insurance Contracts Act provides that the act extends to all insurance contracts the proper law of which is, or would be without an express provision to the contrary, the law of an Australian state or territory.

The review panel recommended that the act be amended to make clear that it applies to all contracts issued by direct offshore foreign insurers to Australian insureds or in respect of Australian risks. This would prevent insurers which do not conduct business in Australia from issuing a policy that would not otherwise be caught by the act.

It is unclear how this is to be achieved as, ultimately, the insurance contract may need to be enforced in an overseas jurisdiction and thus the requirements of the act may not be applied with regard to the contract of insurance. The issue may be partly assisted if the federal government seeks to regulate direct offshore insurers, as has been recommended by the Potts Inquiry.(2)

The panel also recommended that the Australian Securities and Investments Commission should be given a statutory right to intervene in any proceeding relating to matters arising under the act.

Insured's duty of disclosure
Section 21(1) imposes a duty on the insured to disclose every matter that is known to the insured:

"being a matter that the insured knows to be a matter relevant to the decision of the insurer whether to accept the risk and, if so, on what terms, or [that] a reasonable person in the circumstances could be expected to know to be a matter so relevant."

This is somewhat narrower than the common law test of materiality and involves a mixed subjective/objective test.

The panel noted that the main criticism of Section 21 is that it puts an unreasonable burden on insureds as they are expected to know what the insurer regards as relevant. This appears to overstate the requirements of the test. The test is what a reasonable person in the circumstances could be expected to know; this does not mean that unexpected requirements in underwriting guidelines are required to be known by an insured or prospective insured.

The panel proposed that Section 21 be amended so that the mixed subjective/objective duty of disclosure test is applied with regard to the following:

  • the nature and extent of the cover provided by the insurance contract;

  • the class of persons who would ordinarily be expected to apply for cover of that type; and

  • the circumstances in which the insurance contract is entered into, including the nature and extent of any questions asked by the insurer.

This proposal appears to add criteria to the test that create uncertainty rather than clarifying how the test should be applied.

Section 21A requires the insurer to provide the insured with specific questions that are relevant to it in deciding whether to accept the risk, thereby giving some assistance to the insured in fulfilling its disclosure obligations. However, it applies only to eligible insurance contracts, these being contracts of insurance for new business covering, among other things, motor vehicles, home contents and travel insurance.

The panel proposed that Section 21A should be amended so that (i) it applies to renewals, and (ii) Section 21A(4)(b) is repealed.

The repeal of Section 21A(4)(b) means that the insurer cannot comply with its disclosure obligations by asking a potential insured any general 'catch-all' type questions.

These criteria will be applied to limit further the insured's disclosure obligations.

The application of Section 21A to renewals is likely to result in substantial changes to insurer procedures and practices with regard to effective renewals. Although some insurers will be able to accommodate these changes, others will have difficulty. Section 21A was not originally intended to apply to renewals because of the significant difficulties perceived in relation to its implementation.

Insurer's disclosure obligations
Section 22 of the act requires the insurer to inform clearly the insured in writing of its duty of disclosure prior to the insurance contract being entered into. The regulations prescribe a form of writing to be used for such disclosure. However, Section 69 allows information to be given to an insured orally where it is not reasonably practicable for it to be given in writing. However, written information must be provided to the insured within 14 days of the insurance contract being entered into.

The regulations prescribe a form of words for oral disclosure, but this applies only to eligible insurance contracts. The panel recommended that the prescribed form of words for notifying an insured of the general nature and effect of the duty of disclosure for oral disclosures should apply to all insurance contracts.

Section 35 of the act requires an insurer to bring to the attention of an insured, before a contract is entered into, terms of the insurance contract that differ from the standard terms of the prescribed contract. This provision applies only to the following contracts:

  • motor vehicle insurance;

  • home building insurance;

  • home contents insurance;

  • sickness and accident insurance;

  • consumer credit insurance; and

  • travel insurance.

Section 37 of the act applies more generally to require an insurer to inform clearly the insured of any unusual policy terms before the insured enters into the contract. Unless the insurer does so, it may not rely on such terms. In Hams v CGU Insurance Ltd(3) Justice Einstein held that the requirement to inform clearly of unusual policy terms could be met by providing the insured with a copy of the policy wording. This approach was followed recently by the Northern Territory Supreme Court of Appeal in Marsh v CGU.(4)

The panel has recommended that the test to inform clearly should be replaced with a more comprehensive test that requires insurers to provide information required by Sections 35 and 37 in a clear, concise and effective manner. The panel noted its belief that the additional requirement of concise disclosure will simplify disclosure documents and greatly enhance the readability of non-standard and unusual policy terms. It is unclear whether, and in what circumstances, provision of the policy terms to the insured will satisfy these proposed, more onerous requirements. The panel appears to envisage that in some circumstances, the provision of the policy terms to the insured will not in itself be sufficient to comply with the insurer's obligations.

It appears that the test changes proposed by the panel may result in the courts re-examining whether the provision of a policy wording satisfies the requirement.

Under reforms to the Corporations Act 2001 (Cth), which took effect on March 11 2004, specific disclosure requirements apply to some insurance products. This disclosure regime applies where the product is sold to a retail client, as defined under Section 761G of the Corporations Act. In particular, a product disclosure statement is required and must contain information about any other significant characteristics or features of the product or of the rights, terms, conditions and obligations attaching to the product (Section 1013D(1)(f) of the Corporations Act).

The panel proposed that Sections 35 and 37 of the act should be specifically amended to allow standard cover disclosure through a product disclosure statement. It recommended that the government should also consider the need for regulations under the Corporations Act that would clarify that: (i) a product disclosure statement may include information that satisfies the disclosure requirements of the act's standard cover provisions; and (ii) where an insurer fails to fulfil its standard cover disclosure obligations through the provision of a product disclosure statement, the insured may rely upon remedies under the act, as well as remedies provided by the Corporations Act.

Remedies of the insurer
Section 28 provides that where a person who became an insured failed to comply with the duty of disclosure or made a misrepresentation to the insurer before entering into the insurance contract, the insurer is entitled to avoid the contract only if the act of the insured was fraudulent.

Section 28(3) provides that, although the insurer may not be entitled to avoid the policy, it can reduce its liability (in some cases to nil) by the amount that would restore it to the position it would have been in if the failure had not occurred or the misrepresentation not been made. This means that the insurer can rely on innocent non-disclosure only to the extent that it is prejudiced.

Where the insured fraudulently failed to comply with the duty of disclosure, Section 31 gives the court discretion in certain circumstances to allow an insured to recover in whole or in part if refusing indemnity altogether would be harsh and unfair.

The panel proposed that Section 31 should be expanded so that it applies where it is alleged that there has been innocent non-disclosure or misrepresentation. This proposal would appear to confuse the distinction between innocent non-disclosure or misrepresentation and fraud. In the case of fraud, an insurer is entitled to rescind the contract ab initio (from the beginning), whereas in the case of non-disclosure or misrepresentation, the insurer is entitled to be compensated only for the prejudice it suffers. It is unclear why it is necessary to give the court a power to relieve the insured of the consequence of non-disclosure or misrepresentation.

Third-party beneficiaries
There are significant reforms aimed at clarifying the right of third-party beneficiaries (ie, persons who are not a party to the insurance contract, but are named as beneficiaries). The panel has recommended that third-party beneficiaries should have access to the following provisions of the act:

  • recourse to dispute resolution bodies;

  • the same rights as an insurer for the purposes of subrogation;

  • the duty of utmost good faith; and

  • the same ability as the insured to give notice (eg, under Section 40(3) (notice of circumstances likely to give rise to a claim) and Section 74 (notice requesting a copy of the policy terms)).

However, the panel noted that there is a divergence of judicial opinion as to the meaning of Section 48(3). Section 48(1) confers upon a third-party beneficiary a right to recover directly from the insurer in accordance with the insurance contract. Section 48(3) provides that the insurer has the same defences to an action under that section as he or she would have in an action by the insured. The panel noted that the competing views of this subsection are that the words 'the same defences' mean: (i) that the identical defences available against the assured can be used against a third party; or (ii) that defences similar in kind to those which can be used against the insured are available against the third party, provided that they have arisen out of the conduct of the third party and not out of the conduct of the insurer.

If the latter interpretation is observed, then in some circumstances a third party may have greater rights than the insured. The panel recommended that Section 48(3) should be clarified so that it is clear that a third-party beneficiary is not in a better position than the insured. This would clarify that insurers are able to raise the conduct of the insured (whether pre or post-contract) in response to a claim brought by a third-party beneficiary.

Third-party claimant direct rights
The panel also recommended significant reforms affecting the rights of claimants against insureds who are insured under a liability policy covering their claim. The law in Australia relating to the rights of such claimants against insurers is in an unsatisfactory state. Limited rights exist at the Commonwealth level, including rights under Section 51 of the act. Section 51 provides a direct right of action against the insurer only in circumstances where the insured has died or cannot be found. Most significantly, it does not cover insolvency of the insured.

New South Wales, the Northern Territory and the Australian Capital Territory have more substantive remedial provisions in the form of a charge on any insurance proceeds that may apply to a claim. These remedial provisions provide a substantial benefit to claimants, but have generated much litigation, are uncertain in their operation and do not apply uniformly throughout Australia. The panel proposed that Section 51 be amended so that it provides for direct recourse against the insurer where a third party cannot recover under execution of a judgment obtained against the insured and overrides state and territory remedial provisions.

Subrogation
Finally, the panel proposed significant reforms to Section 67 of the act to overcome the uncertainty about the distribution of moneys recovered from third parties, either by the insurer under its rights of subrogation or by the insured following a partial indemnity from the insurer.

The panel proposes that Section 67 be amended so that the proceeds be distributed in priority to the party funding the recovery action or pro rata if both parties fund the recovery action. It proposes that moneys recovered first be allocated to cover the costs of the recovery action.

The proposal in relation to subrogation is a response to findings of the Australian Law Reform Commission inquiry into the Marine Insurance Act. The commission indicated that there should be an alignment between the Insurance Contracts Act and the Marine Insurance Act where possible, and that the rules relating to subrogation should therefore be aligned. The commission then suggested significant changes to those rules. There does not seem to have been a great deal of analysis as to the effect of those changes, and the proposal that the distribution of moneys should, in part, depend upon who funded the recovery action raises significant practical problems in its implementation.

Further information on the review and a copy of the panel review papers can be obtained from the Australian Treasury website at http://icareview.treasury.gov.au.


For further information on this topic please contact John Edmond or Stephen Sander at Allens Arthur Robinson by telephone (+61 2 9230 4287 or +61 02 9230 4605) or by fax (+61 2 9230 5333 or +61 02 9230 5333) or by email (john.edmond@aar.com.au or stephen.sander@aar.com.au).


Endnotes

(1) FAI General Insurance Company Limited v Australian Hospital Care Pty Limited, 2001, 204 CLR 641.

(2) Review of discretionary mutual funds and direct offshore foreign insurers, May 2004, conducted by Garry Potts.

(3) Hams v CGU Insurance Ltd, 2002, 12 ANZ Insurance Cases 61 to 525.

(4) Marsh v CGU, 2004, NTCA 1.



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