February 20, 2019

The overhaul of the duty of disclosure in consumer insurance

In the Final Report (Final Report) of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industy (Royal Commission), Commissioner Hayne recommended that, for consumer insurance contracts, the duty of disclosure on insureds be replaced with a duty to take reasonable care not to make a misrepresentation to an insurer. This disclosure duty was outlined in Recommendation 4.5 (pre-contractual non-disclosure and misrepresentations) of the Final Report.

The purpose of the Recommendation is to address the knowledge imbalance between insureds and insurers regarding those categories of information which insurers consider to be relevant to their decision to underwrite a risk. The proposed amendments would put the onus on insurers to identify the relevant information they need to assess a risk. As a consequence insurers will need to refine their requests for information from insureds and examine their existing underwriting processes and pricing.

Overview of current duty of disclosure

For insurance contracts governed by the Insurance Contracts Act 1984 (Cth), the duty of disclosure regime is set out in sections 21, 21A and 21B.

Section 21 requires that prior to entry to an insurance contract, customers must disclose certain matters that they know, or that a reasonable person could be expected to know, would be relevant to an insurer's decision to insure the risk.

The Insurance Contracts Amendment Act 2013 (Cth) (2013 Amendment) introduced a number of changes to the duty of disclosure contained in the Insurance Contracts Act, which came into effect on 28 December 2015. Relevantly, sections 21A and 21B changed the duty of disclosure regime for 'eligible contracts of insurance'. The contracts specified to be 'eligible contracts of insurance' cover some, but not all, consumer insurance contracts. In respect of eligible contracts of insurance, an onus is placed on insurers to posit specific questions to the insured which are "relevant to the insurer’s acceptance of the risk".

Section 21A is relevant to disclosure on entry into an original insurance contract and section 21B is relevant to renewal of insurance contracts. Failure to comply with section 21A or section 21B means that the insurer is deemed to have waived the insured’s compliance with the duty of disclosure under section 21 of the Insurance Contracts Act.

The insurer's remedy for a breach of the duty of disclosure by an insured is set out in section 28 of the Insurance Contracts Act. The threshold question is whether, had the breach of duty not occurred, and if full disclosure had been made, the insurer would nevertheless have still entered into the insurance contract with the insured, on the same terms and conditions and for the same premium. If the insurer would have done so, then the insurer effectively has no legal remedy in respect of the breach. However, if the insurer would not have written the same risk for the same premium then the liability of the insurer is reduced to the amount that would place the insurer in a position which they would have been in if the failure to disclose had not occurred, or avoid the contract if the failure to disclose was fraudulent.

The debate about the duty of disclosure

Insurers often face difficulties when trying to calculate the risk of an event occurring where facts relevant to the risk are singularly within the knowledge of the insured. This 'moral hazard' was the basis upon which the Australian Law Reform Commission considered the concept of non-disclosure in respect of insurance contracts in 1982 and the premise for the section 21 regime.[1]

However, since the Insurance Contracts Act was introduced, the breadth and depth of information held by, or available to, underwriters has increased immensely. Insurers now have access to considerable statistical data to measure risk along with sophisticated underwriting systems. It is in this context that the duty of disclosure has come under scrutiny in recent times.

In 2012, the United Kingdom abolished the duty of disclosure for consumer insurance contracts in favour of a duty to answer express questions honestly and with reasonable care.[2]

When the 2013 Amendment was introduced to the duty of disclosure in Australia, consideration was also given to the option of abolishing the duty of disclosure in favour of a requirement to answer specific questions honestly and fully.[3] The perceived advantage of abolishing the duty of disclosure was that it would lead to fewer disputes because the subject matter would be limited to answers given to questions posed by the insurer.

While this option was favoured by some stakeholders at the time, it was rejected because of the risk that it would prove impractical, particularly in the context of large commercial insurance where insurers would be required to construct lengthy and complex specific questions to ensure that all relevant information was obtained. There was also concern that it could be a burden to insureds if they were required to answer these extensive questions.

Recommendation by Commissioner Hayne

In the Final Report, Commissioner Hayne concluded that the duty of disclosure in Australia for consumer insurance contracts fails to recognise the power imbalance between insurers and insureds regarding the categories of information insurers consider to be relevant to their decision to insure a risk.

In forming this Recommendation, the Commissioner drew on relevant case studies which demonstrated that it was difficult for consumers seeking insurance to appreciate those matters which may be relevant to an insurer's decision to underwrite the risk. The Commissioner stated:

In my view, the duty of disclosure presently contained in section 21 of the Act does not recognise the breadth and depth of the gap between what a consumer knows and what an insurer knows. That is, the duty fails to recognise the extent of the information asymmetry between a consumer and an insurer. And that gap is not closed by referring to what ‘a reasonable person in the circumstances could be expected to know to be a matter so relevant.[4]

Commissioner Hayne also considered the views expressed in the UK and Scottish Law Commission Joint Report on this topic[5] that most consumers are unaware that they are under a duty to volunteer information to insurers and they usually have limited data of what an insurer may think is relevant to the assessment of the risk to be insured against.

Commissioner Hayne identified that the current duty of disclosure regime may have implications for consumers wishing to claim on their insurance policies, as claims may be denied for non-disclosure in circumstances where consumers may have acted honestly and reasonably.

Commissioner Hayne concluded that the duty to take reasonable care not to make a misrepresentation to an insurer, is a more appropriate duty for consumer insurance contracts than the duty that currently exists in section 21 of the Insurance Contracts Act. Further, the proposed duty would be substantially less complex than the modified forms of the duty contained in sections 21A and 21B of the Insurance Contracts Act for eligible contracts of insurance. He also recommended changes to the availability of remedial provisions in Division 3 of Part IV of the Insurance Contracts Act.

Consequences of the Recommendation

The practical consequence of this Recommendation is that for insurers writing consumer insurance contracts, the insurer will need to elicit the information that it needs in order to assess whether it will insure a risk and at what price. Insurers will have to ask specific questions to insureds and will no longer be able to rely on the insured providing it with information that would be relevant to underwriting the risk.

The recommended change to the duty of disclosure in Australia means that a consumer will no longer need to assess and disclosure that information which may be important or relevant to an insurer in deciding whether to accept a risk.

Concerns have been raised by the industry and the Australian Prudential Regulatory Authority (APRA) that this change could affect the pricing of risk. The concern is that insurers will likely respond by including an additional risk margin in their pricing or may, in extreme cases, be unable to insure the risk and so withdraw from the market.

Commissioner Hayne's Recommendation is limited to consumer insurance contracts. We note that a defined class of consumer insurance contracts is not currently specified in the Insurance Contracts Act. We expect that the proposed amendments would likely apply to life insurance and certain general insurance products sold to retail clients. The Corporations Act 2001 (Cth) deems certain general insurance products provided to individuals or small businesses to be provided to persons as retail clients.[6]

Next steps

In the Australian Government's response to the Royal Commission, the Government has agreed to amend the duty of disclosure for consumers in the Insurance Contracts Act to ensure that obligations for disclosure do not enable insurers to unduly reflect the payment of legitimate claims. The Government observed that the current disclosure requirements fall short of adequately safeguarding consumers against having their claims declined where they have inadvertently failed to disclose their past circumstances or the insurer did not ask the right questions.

It would be prudent for insurers with retail business in Australia to start considering the impact of this proposed change on their pre-sale scripts and questionnaires, underwriting operations and pricing of insurance policies.

No specific comments were made about changing the operation of section 21 of the Insurance Contracts Act for classes of contracts other than consumer insurance contracts, however, this possibility has been discussed previously and may be raised again during the legislative process to implement this Recommendation.

1. ALRC 20 Insurance Contracts at [150] to [199].
2. Section 2, Consumer Insurance (Disclosure and Representations) Act 2012 (UK)
3. Explanatory Memorandum to the Insurance Contracts Amendment Act 2013 (Cth), at pp. 70-72.
4. Page 297 of the Final Report
5. The Law Commission and Scottish Law Commission, Consumer Insurance Law: Pre-contractual disclosure and misrepresentation, December 2009 [14]. 2.20.
6. Section 761G(5) Corporations Act