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Application of the law

Contract law A review of the legal position regarding non-disclosure aims to strengthen protection for consumers in cases where genuine mistakes occur with policy applications, says Scottish Widows protection market director Nick Kirwan

The Law Commission recently announced a joint project with the Scottish Law Commission to review insurance contract law. This is long overdue, especially when you consider that the first recommendations for reform came as far back as 1957. The initial scope for the review is to tackle the particularly grey area of non-disclosure.

The primary aim is to close the gulf between the basis of non-disclosure as defined in insurance contract law and the way things usually happen in practice. Many people would probably be surprised if they found out just how wide this gulf really is and how much power the law places with the insurer when it comes to cases of non-disclosure.

Let us not forget this is one of the main reasons why claims are declined, so it is a crucial issue which affects the reputation of everyone in the industry. Under the law, insurers have no obligation to ask any questions of applicants but applicants have an obligation to disclose all material facts to the insurer – a material fact being one that would “affect the mind of the underwriter”.

In addition, the insurer can void the policy regardless of the reason for non-disclosure. I am sure you will agree this legal position is unduly harsh.

When a claim is declined due to non-disclosure and a complaint is made, it is the principles used by the Financial Ombudsman Service that will normally determine the outcome, not the courts. The FOS principles are based on the FSA rules and ABI codes which insurers agree to follow.

But current practice is really just a sticky plaster to cover the cracks and some people slip through this safety net and need to rely solely on the law. Cases in this category potentially include non-regulated sales such as travel insurance sold with a holiday package via travel agents and protection business sold to firms turning over more than 1m a year.

It is not only non-regulated sales which could fall into the black hole between industry practice and the law. Although under review, the compensation limit under the FOS is set at 100,000. But in today’s world, most people’s protection needs are far greater than this.

FOS rulings are not binding for any excess over the limit so, ultimately, if the insurer refuses to pay the excess, the consumer has to seek redress through the courts, where current law will be used to assess the case. So there is a clear need to ensure that the law provides appropriate protection to consumers who fall into the gap. This means bringing the law up to date.

The gap between current practice and the law is not the only issue at stake. The current system based on a mixture of old ABI codes, FSA rules and FOS principles, is unfathomable to most financial advisers, let alone consumers. There are glaring inconsistencies.

Insurers tend to follow the FOS principles as they generally exceed the FSA rules but some inconsistencies are hard to explain. For example, the FSA rules, taken from the old ABI codes, use three categories of non-disclosure – innocent, negligent and fraudulent – whereas the FOS uses four categories – innocent, inadvertent, clearly reckless and fraudulent. Confused?

Sadly, consumers only tend to find out about this tangle when things go wrong and they are facing the already tough position of finding out that their policy has not paid out when it was expected to. This is why sorting it out is very good news and should be another step on the long road towards winning back the trust of consumers. Let us hope we end up with a single set of rules in a single place.

It will be interesting to find out how far the Law Commission proposes to go. Will it merely close the gap between current practice and the law or will it go even further?

Some countries have a practice for dealing with non-disclosure which includes a maximum “look back” period. Unless a client has non-disclosed recklessly or fraudulently, the insurer cannot void the policy if it is older than, say, five years. If someone inadver- tently missed something on their application form, it should make no difference to whether their policy will pay out if a claim arises after it has been in force for five years.

Adopting such a practice means that cases of non-disclosure which are a genuine mistake could be priced into the products by insurers and accepted as something which will inevitably happen on occasions. The consumer would have the reassurance of knowing thatthey can rely on their long-term insurance policy.

Of course, this would not be an excuse for people not to fill in their application form properly – claims do frequently happen in the early years of a policy – but it would give consumers a fairer deal if something does genuinely go wrong.

The Law Commission is to publish a document in January to get opinions on what other areas should be included in the review. It expects to issue a consultation paper near the end of 2006 which will set out the issues identified and propose solutions. Sometimes, the wheels of the law seem to turn slowly indeed.


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