One of the recommendations of the banking royal commission that flew under the radar was the proposed amendment to the duty of disclosure and the remedy for innocent non-disclosure in life insurance.
Under the Insurance Contracts Act, an insured has a duty to disclose any matter he or she knows, or a reasonable person in the insured’s position would know to be relevant to the insurer’s decision whether to accept the risk.
The test effectively requires someone who is applying for insurance cover to have the knowledge of a life insurance underwriter. The person might know what medical conditions they’ve suffered from but is an entirely different question as to whether those medical conditions are relevant.
Insurers often ask questions on application forms, but the burden or duty on the applicant extends beyond what is asked by the insurer in direct questioning.
The royal commission found that the duty of disclosure was outdated. It did not properly balance the legitimate interests of insurers to price risks with safeguarding consumers against having claims declined when they may have inadvertently failed to disclose something or when insurers failed to ask the right questions.
The Commission recommended that the duty be replaced with a duty to take reasonable care not to make a misrepresentation to an insurer. The effect of the change could be to place a greater burden on insurers to ask specific questions about matters necessary for them to assess risk and not ask questions open to interpretation or “catch all” questions. If a claim was denied for misrepresentation, an insured could argue he/she took reasonable care in answering questions that were asked, even if the answers were inaccurate.
The recommendation, which adopts the UK model for life insurance disclosure, effectively flips some of the disclosure burden at the point of sale from the insured to the insurer. It is a welcome acknowledgement of the imbalance in knowledge on matters relevant to underwriting between the parties.
However, perhaps more problematic is the recommendation to amend Section 29(3) of the Act to restore its pre-2014 amendment wording. Section 29(3) deals with an insurer’s remedy for what is commonly referred to as innocent non-disclosure or misrepresentation i.e. where an insured failed to disclose or misrepresented a matter which a reasonable person would have disclosed but which the insured did not deliberately or recklessly withhold.
Prior to 28 June 2014, an insurer had a right to avoid a life insurance contract within three years of the policy commencing for innocent non-disclosure or misrepresentation but only if it would not have been prepared to enter into a contract of life insurance on any terms had the non-disclosure or misrepresentation not occurred.
However, some Australian courts have interpreted this to mean that an insurer could only avail itself of the avoidance remedy for innocent nondisclosure if it could establish that at the relevant time the insurer would not have offered any type of life insurance.
The concern was that this rendered Section 29(3) impotent as it would be very difficult for an insurer to establish that, for example, it would not have issued an accidental death policy or an investment policy to an insured who had failed to disclose an existing back injury.
The problem was identified in the Cameron-Milne review of the Act in 2004 and, after a number of false starts, the Act was amended with effect from 2014. The remedies for innocent non-disclosure and misrepresentation were extended, including by amending Section 29(3) to allow an insurer to avoid the contract within three years as long as the insurer could show that it would not have offered the same contract on the same terms.
In addition, the insurer could vary the contract for innocent non-disclosure or misrepresentation if it and at least two other “reasonable and prudent” life insurers would have offered the contract on different terms.
The royal commission has effectively found that the amendment to Section 29(3) went too far and recommended the restoration of the pre-2014 wording. In doing so, the Commission has revived the problem for insurers seeking to enforce remedies for disclosure breaches and this has caused some disquiet in the life insurance industry.
However, the recommendation is only in respect of the ultimate sanction of avoidance. The royal commission report is silent on any other remedies open to an insurer, including the 2014 amendments regarding variations in cover under the reasonable and prudent insurer test.
There may be a case for modifying the pre-2014 Section 29(3) wording to “the contract of insurance applied for on any terms” and the unbundling provisions under Section 27A may also ameliorate any lingering problems
A bridge too far
However, the royal commission got it right in finding that the amended Section 29(3) was a bridge too far.
The proposed changes to the disclosure obligations and the remedy for breaches, coupled with the 2014 amendments to the Insurance Contracts Act, strike a good balance that will hopefully restore some lost confidence in the life insurance industry.
Insurers will need to be aware of any changes to the Act and adopt claims and underwriting processes to deal with questions as to what type of cover or policy (if any) that insurer and other reasonable and prudent insurers would have offered.
Policy documents, PDS’s and disclosure notices will also have to be updated. Staff will need specialised training in underwriting and in what constitutes reasonable care on the part of an insured.
Further, any decision to avoid or vary a policy will have to be considered within the parameters of the “reasonable care” disclosure test on the one hand and the narrower Section 29(3) test on the other hand.
Both major political parties have committed to implementing the relevant recommendations of the royal commission, although it will be important for insurers to check the fine print: an irony that won’t be lost on policyholders. Watch this space!