RIP Pre-Contractual Disclosure

26 Oct 2021

As part of its response to the Financial Services Royal Commission (Royal Commission), the Federal Government passed the Financial Sector Reform (Hayne Royal Commission Response) Act 2020 (Cth).[1]  This Act made a number of amendments to various legislation including the Insurance Contracts Act 1984 (Cth) (ICA) and the law relating to pre-contractual disclosure and misrepresentation for insurance contracts. 

As part of these amendments, the pre-contractual disclosure duties on an insured for “eligible contracts of insurance” were repealed (may they rest in peace) and replaced with a duty to take reasonable care not to make a misrepresentation for “consumer insurance contracts”.[2]  On 5 October 2021, these amendments came into force.[3] 

Why the Change

Before addressing the changes themselves, it is helpful to understand why the changes were made.

It is relatively non-controversial to state that a policy of insurance, at its core, is a process where risk is transferred from one person (insured) to another (insurer). In accepting the risk, the insurer is paid a premium.  The theory behind pre-contractual non-disclosure is that the insured knows more than the insurer about the risk being insured; therefore, in order to properly understand the risk, an insured should disclose matters relevant to the decision of the insurer to accept the risk (or that a reasonable person in the circumstances would know to be relevant); further, the insured should not make any misrepresentations as to the truth of any matter.  If it eventuates that adequate disclosure does not occur or misrepresentations are made, then the insurer would be able to avoid or refuse coverage of the risk (should it eventuate).  

This position was incorporated in the ICA[4] and subsequent amendments for “eligible contracts of insurance” which only required an insured to answer specific questions asked by an insurer; if an insurer did not ask a question, then the insurer was taken to have waived any need to disclose the matter.[5]

In brief, the Royal Commission recommended that the ICA be amended for consumer insurance contracts, by replacing the duty of disclosure with a duty to take reasonable care not to make a misrepresentation to an insurer.[6]  The reasoning for the recommendation was to address the “information asymmetry between a consumer and an insurer”, or as put another way in the report “a duty framed in this way fails to recognise that insurers are always better placed than an insured to identify the categories of information that they consider to be relevant to their decision of whether to insure a risk”.  The Royal Commission also relied, and accepted the reasoning, of the UK and Scottish Law Commission reports that addressed the duty of pre-contractual disclosure in those jurisdictions and found that (a) the pre contractual disclosure obligations no longer correspond to the realities of modern consumer insurance, and (b) even if insureds respond honestly and reasonably, due to the generality of some of the questions and misunderstanding of the questions, legitimate claims were being denied. [7] 

What’s the Change?

In response to the recommendations, pre-contractual disclosure in ss 21A and 21B have been replaced with a duty to take reasonable care not to make a misrepresentation; however, this duty only applies to “consumer insurance contracts” being insurance wholly or predominantly for the personal, domestic or household purposes of the insured, or a contract which the insurer states, in writing, is a consumer insurance contract.[8]  To that extent, it is likely that most home and contents, and motor vehicle policies of insurance would likely fall within the definition.  However, noting some of the controversies that have arisen under the Trade Practices Act (as it was) and Australian Consumer Law as to whether goods or services were “ordinarily acquired for personal, domestic or household use or consumption”, the delineation may not be entirely clear and may capture policies well outside of the previously prescribed “eligible contracts of insurance”.  As pointed out by the learned authors of Suttons on Insurance Law, the range of policies covered by consumer insurance contracts could include pet insurance, insurance over a private jet or pleasure craft, and could include mixed use scenarios, for example,. a shop with upstairs accommodation.[9]

Putting such concerns aside, where applicable, the insured now has a duty to take reasonable care not to make a misrepresentation to the insurer before the relevant contract of insurance is entered into (s 20B(1) of the ICA).  The ICA then specifies that whether that duty has been discharged is to be determined with regard to all the relevant circumstances (s 20B(2) ICA) and the court may consider, without limitation, the following circumstances (s 20B(3) ICA):

1. the type of consumer insurance contract in question, and its target market;
2. explanatory material or publicity produced or authorised by the insurer;
3. how clear, and how specific, any questions asked by the insurer of the insured were;
4. how clearly the insurer communicated to the insured the importance of answering the questions and the possible consequences of failing to do so;
5. whether or not an agent was acting for the insured;
6. whether the contract was a new contract or was being renewed, extended, varied or reinstated.

To further complicate matters, any particular characteristics or circumstances of the insured of which the insurer was aware, or ought reasonably to have been aware, are to be taken into account (s 20B(4) ICA) and there is no misrepresentation merely because the insured failed to answer a question or gave an obviously incomplete or irrelevant answer to a question (s 20B(5)).  However, any misrepresentation made fraudulently is made in breach of the statutory duty (s 20B(6)).

Implications & the Reasonable Simpleton

To an extent, the new duty reflects some of the repealed ss 21A and 21B ICA requirements. Consistent with the previous obligations, questions need to be asked and answers given; however, as is evident from the criteria detailed above, whether an insured has made a misrepresentation will now include a factual analysis of the “relevant circumstances”.  To that extent, the advertising and material produced by insurers, in addition to the questions asked by the insurer, may weigh heavily in determining whether a misrepresentation has been made.

An issue that is not addressed in the legislation is whether the duty is to be determined by way of an objective or subjective reasonable “insured” or person.  The ICA is silent on this point and it may be that the Courts will be forced to reconsider similar arguments involved in the interpretation of “a reasonable person in the circumstances” (as they did for s 21(1)(b) of the ICA) and whether the Court will be required to consider how, or if, the new duty applies to a “reasonable simpleton”.[10]  To that extent, it should be noted that the state of law with respect to disclosure and a “reasonable person in the circumstances” and s 21(1)(b) of the ICA is that of an objective reasonable person but taking into consideration extrinsic factors, not the individual idiosyncrasies of the insured.[11]

A purely subjective test with respect to the duty may place a fairly high burden on an insurer to adequately consider most, if not all, of the factors identified in s 20B(3) when offering[12] its insurance products.  For example, the clarity and simplicity of any communications to a potential insured with limited literacy skills and understanding of English may differ significantly to the clarity and simplicity required and accepted as suitable for a tertiary educated insured with no literacy or language barriers.  

A purely subjective construction of the duty may lead to significant differences in outcomes where the only difference in circumstances relates to the insured, not the risk being covered.  Noting that similar UK legislation was used as grounds for this change, it may be that the development of the law in the UK will provide guidance on how the duty is interpreted by the Courts. On the other hand, as the UK legislation purports to expressly define an objective “reasonable consumer”[13] then it may be that due to the omission of a “reasonable consumer” in the ICA, the Courts take a different view.  It’s fair to say that until the first cases are litigated, insurers will have to do the best they can and this may be one of the first areas of reform necessary in order to address the issue.[14] 

Remedies

So what happens if the duty has been breached?  A failure to comply with the duty is now defined as a “relevant failure”.[15]  For the purposes of a consumer insurance contract, a relevant failure is a “misrepresentation made by the insured in breach of the duty to take reasonable care not to make a representation”.

As with the duty of disclosure, ss 28 and 31 of ICA still govern the remedies available to the insurer and the remedies have not changed in substance.  Section 28 of the ICA provides that if there has been a “relevant failure”:

1. but notwithstanding the relevant failure, the insurer would have entered into the contract for the same premium and terms and conditions, then no remedy is available to the insurer;
2. that is fraudulent (that is, a fraudulent misrepresentation is made), then the insurer may avoid the contract (subject to s 31 of the ICA); or
3. and the insurer cannot avoid the contract or has not done so, the liability of the insurer in respect of a claim is reduced to the amount that would place the insurer in a position in which the insurer would have been if the relevant failure had not occurred.

To that extent, the remedies for an insurer are familiar and have not changed in substance.

Summary

Putting aside the technical nomenclature of “disclosure” and “misrepresentation”; the pre-contractual landscape between and insurer and insured post 5 October 2021, has changed and become more consumer/insured friendly.  The creation of consumer insurance contracts has narrowed the scope of matters that a potential insured is required to disclose to an insurer and has placed an increased burden on the insurer to ensure, amongst other things, that its requests for information are specific enough to address the insurer’s needs, and be clear enough to be understood by any prospective insured.   This is especially so as the scope of coverage that may fall within a “consumer insurance contract” may extend well beyond previously prescribed “eligible contracts of insurance”.

[1] Enacted as the Financial Sector Reform (Hayne Royal Commission Response) Act 2020 (Cth) (“Reform Act”)

[2] This paper focusses on general policies of insurance, such as motor, home and contents, and does not address other forms of insurance, such as life insurance and how the changes have affected any such policies.

[3] See s 37 of the Reform Act, although it is noted that insurers were voluntarily able to comply it the new regime from 1 January 2021, when the ICA was amended to include the changes.

[4] See for example, ss 21 and 26 and associated remedial provisions such as s 28.

[5] These provisions were incorporated in ss 21A and 21B of the ICA. It should be noted that the disclosure provisions also includes specific provisions requiring the insurer to inform the insured clearly in writing of the duty of disclosure, see s 22 of the ICA.

[6] Along with associated consequential amendments to the remedial provisions – see recommendation 4.5

[7] See Royal Commission Report at 4.2.1

[8] See s 11AB of the ICA for the full definition.  It should be noted that pursuant to the definition, if it is alleged that a contract of insurance is a “consumer insurance contract” in a proceeding, then it is presumed to be so unless the insurer proves to the contrary (s 11AB(3))

[9] See Sutton on Insurance Law at [7.891]

[10] To borrow the phrase repeated by Brooking J in Twenty-First Maylux Pty Ltd v Mercantile Mutual Insurance (Aust) Ltd [1990] VR 919 at 925, although it should be noted that Brooking J did not state that the plaintiff in that matter was a “reasonable simpleton”.

[11] See for example, [21.10.8] and [21.10.9] ]of Manns Annotated Insurance Contracts Acts for a useful summary of the case law on this point.

[12] The term is used in the non legal sense of an offer.

[13] see Sutton on Insurance Law at [7.892].

[14] It should also be noted that as of the drafting of this paper, AFCA is still to update its “Approach to non-disclosure and misrepresentation” document.

[15] s 27AA of the ICA.

The content of this article is intended to provide a general guide to the subject matter. Specific advice should be sought about your specific circumstances.