Overview

A number of amendments to the Insurance Contracts Act 1984 (ICA) have been proposed as part of the Financial Sector Reform (Hayne Royal Commission Response—Protecting Consumers (2020 Measures)) Bill 2020 in response to the recommendations of the Financial Services Royal Commission (the FSRC).

The first of the proposed changes will replace the duty of disclosure, in regard to consumer insurance contracts (itself a new concept), with a duty to take reasonable care not to make a misrepresentation.

The second proposal will limit the current application of the avoidance scheme in terms of s 29(3) avoidances and essentially return the situation to its pre-June 2014 status.

Changes to the Duty of Disclosure –Recommendation 4.5

Recommendation 4.5 of the FSRC Final Report states that:

‘Part IV of the ICA should be amended, for consumer insurance contracts, to replace the duty of disclosure with a duty to take reasonable care not to make a misrepresentation to an insurer (and to make any necessary consequential amendments to the remedies in Division 3 [of the ICA]).’

Commissioner Hayne elaborated on the recommendation by noting that in his view:

‘the duty of disclosure 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.’

The duty of disclosure (DoD) is a product of common law, codified most recently into the ICA in the 1980’s and part of the insurance landscape for over 250 years - see Carter v Boehm (1766).

Aspects of the DoD have long attracted criticism because on its face, it can be seen as requiring consumers to predict information required. However, a deeper look at the current DoD reveals it is in fact, in practice already shaped and limited by the questions asked by the insurer – see for example Stealth Enterprises Pty Limited trading as The Gentleman’s Club v Calliden Insurance Limited [2015]. Indeed, by and large consistent with this case law, life insurers do not usually seek to assert a breach of the DoD absent asking a clear question on the matter.

It should follow that in theory, the removal of the DoD should not have a major impact –however, how the new duty has been formulated creates some practical complexities.

Exposure Draft: The New Duty

The Exposure Draft (ED): Financial Sector Reform (Hayne Royal Commission Response – Protecting Consumer (2020 Measures)) Bill 2020: FSRC Rec 4.5 (Duty of Disclosure to Insurer), which has a proposed commencement date of 5 April 2021 (same day as UCT and D&D changes), proposes the following changes in relation to Consumer Insurance Contracts:

• removal of the DoD
• removal of the requirement to provide notice of the DoD
• introduction of a new duty to take reasonable care not to make a misrepresentation.

The ED is broadly based on the Consumer Insurance (Disclosure and Representations) Act 2012 (UK) but with some notable exceptions.

Relevantly, the new duty will only apply to the new concept of ‘Consumer Insurance Contracts’. If a contract is not a Consumer Insurance Contract, then the existing DoD regime and misrepresentation regime will apply to it.

What are Consumer Insurance Contracts?

The ED defines Consumer Insurance Contracts (CIC) as ‘insurance obtained wholly or predominantly for the personal, domestic or household purposes of the insured’ (Section 11AB(1)). Notably, CIC can also include new business where an insurer elects to notify the insured that the contract is to be treated as a CIC before the insured enters into the contract. Generally, all retail/direct life insurance policies will be CIC to which the new duty will apply.

Group insurance policies do not appear to be captured by the actual definition of CIC. Section 27AA(2) provides that the duty will apply to a life insured under a group insurance contract, but this section is contained within Division 3 of the ICA relating to remedies. However, the factors for considering if an insured has acted with reasonable care apply in Division 2 and only apply to CIC.

The Explanatory Memorandum (EM) specifically states that the contract as held by the underlying life insured under a group policy will fall within the definition of CIC. The primary contract between the superannuation trustee and the group insurer will not be a CIC because it is not taken out by the trustee for personal use.

Consequently, the position for group insurance contracts appears to be as follows:

• life insured/insured members under a group policy are intended to be subject to the new duty to take reasonable care (though clarification of this within the ED would be beneficial); and
• trustees of superannuation funds who are the policy owner will be subject to existing DoD obligations and misrepresentations regime.

As such, group insurers should continue to provide the DoD notice to trustees in the context of pre-contractual negotiations with the trustee.

The New Duty: Duty to take reasonable care

It is worthwhile looking at the definition of the new duty in its entirety:

20B The insured’s duty to take reasonable care not to make a misrepresentation

1. An insured has a duty to take reasonable care not to make a misrepresentation to the insurer before the relevant contract of insurance is entered into.

2. Whether or not an insured has taken reasonable care not to make a misrepresentation is to be determined with regard to all the relevant circumstances.

3. Without limiting subsection (2), the following matters may be taken into account in determining whether an insured has taken reasonable care not to make a misrepresentation:

a) the type of consumer insurance contract in question, and its target market;
b) explanatory material or publicity produced or authorised by the insurer;
c) how clear, and how specific, any questions asked by the insurer were;
d) how clearly the insurer communicated the importance of answering those questions and the possible consequences of failing to do so;
e) whether or not an agent was acting for the insured.

4. 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 in determining whether an insured has taken reasonable care not to make a misrepresentation.

Under the new duty, an insured must take reasonable care not to make a misrepresentation to the insurer. This duty applies up until a contract is entered into. Consumers are therefore not obliged to voluntarily disclose material facts absent a relevant question.

The content of the new duty is not static and will vary according to:

• all of the relevant circumstances of a particular case (s 20B(2))
• specific factors identified that may impact the extent of the duty (s 20B(3))
• specific factors that must be taken into account in determining whether the duty has been met (s 20B(4))

The current duty of disclosure is a hybrid objective/subjective test which can have regard to the actual insured’s idiosyncrasies.

Interestingly, the new test does not refer to the standard of care being based on a ‘reasonable consumer’ unlike the UK legislation. The absence of ‘reasonable consumer’ wording in the new duty may mean that the standard of care could turn on the insured’s subjective circumstances (for example, a person’s occupation) rather than from the standpoint of a hypothetical reasonable person. In the current DoD regime, subjective elements apply in the context of matters the insurer ought to have been aware of regarding the characteristics of the insured.

The EM specifies that it should generally be assumed that an insured is an ‘average person with no special skills or knowledge.’ This implies that the test is objective, however the proposed wording in the ED does not necessarily lead to that conclusion. As such, the ED and EM may not be consistent as to the test which is to be applied.

Matters that may be taken into account when determining the new duty

Under the proposed changes, s 20B(3) of the ICA lists a number of factors that may be taken into account in determining whether an insured has fulfilled the new duty:

• The type of consumer insurance contract in question, and its target market;
• Explanatory material or publicity produced or authorised by the insurer;
• How clear, and how specific, any questions asked by the insurer were;
• How clearly the insurer communicated the importance of answering those questions and the possible consequences of failing to do so; and
• Whether or not an agent was acting for the insured.

The type of consumer insurance contract in question, and its target market

Contracts may have different subject-matter, terms, pricing and application processes (such as online or not), which will impact the new duty. For example, where the application process is online, speedy and provides little opportunity to check answers before being submitted, the duty may be lowered. Another example is that an IP policy might be better understood as requesting disclosure of short term medical problems.

Whether the insured falls into the target market may also influence whether the new duty is met by the insured. If an individual enters into a consumer insurance contract for which they are not a part of the target market (for example, if they are unemployed) this may lower the standard of care required on the insured’s behalf to discharge their duty. This factor does not appear to be an overly influential factor in the life insurance context because most consumers will fall within the target market.

Explanatory material or publicity produced or authorised by the insurer

The EM states that the provision of easily comprehensible, accessible material by the insurer that explains the specific consumer insurance contract in question would generally be expected to result in raising the standard of care required. The EM also notes that questions accompanied by relevant examples and a video of the type of information that the insurer considers relevant will generally result in a higher duty.

This factor allows an insurer to take steps to ensure the duty is at a minimum maintained and potentially enhanced. Hence, this factor offers insurers flexibility as to the extent to which they are prepared to increase or lower the duty. For example, an insurer may choose to explain certain questions in more detail or may consider that they are prepared to water down explanations and lower the duty for certain channels.

How clear, and how specific, any questions asked by the insurer were

The clarity and specificity of questions asked may be taken into account when determining whether the insured took reasonable care not to make a misrepresentation to the insurer. For example, in an online questionnaire, an insurer may ask questions about medical history without any reference to a relevant time period. The long duration of the open time period may be considered relevant as the insured may have had many medical appointments over the course of their life. This circumstance would generally lower the standard of care required on the insured’s behalf to discharge their duty.

The questions asked will often be the most critical factor in determining if the new duty has been breached. Therefore, the more obvious and directed the questions are, the more chance the insurer has to prove an insured has not acted with reasonable care where they have made a misrepresentation. This may lead to insurers revisiting:

• compound questions that are open-ended, general or long;
• questions that are difficult to understand or interpret;
• general catch all questions;
• questions that do not specify time periods; and
• matters where there is currently a potential duty to disclose despite no questions asked (for example, criminal convictions).

How clearly the insurer communicated the importance of answering those questions and the possible consequences of failing to do so

An insurer can maintain the standard of duty to take reasonable care where it takes active steps to inform the insured of the duty and the consequences of failing to answer questions correctly.

There is no mandated requirement to provide pre-contractual notice to an insured regarding the duty in order to rely on the new duty. However, clearly a failure to provide notice will lower the standard of care required by the insured to discharge their duty. Insurers can choose the form of notice wording, however it is important that the wording clearly communicates:

• the importance of answering questions correctly;
• the consequences of a failure to answer questions accurately; and
• that the new duty continues until entry into the contract and the steps to take if a representation has changed before the contract starts

Notice of the consequences of not meeting the new duty should be prominent during the application process.

Whether or not an agent was acting for the insured

One of the factors that is relevant in determining whether the insured has fulfilled the new duty to take reasonable care not to make a misrepresentation to the insurer is whether or not an agent is acting for the insured.

Based off a reading of the EM, the insured’s duty is not changed by virtue of the appointment of an agent. However, depending on the nature of the agent’s involvement, this may be evidence that the insured has taken reasonable steps to fulfil their duty.

At present, it is unclear as to the extent to which the actions of an agent, who is the agent of the insured, impacts the duty. The duty should not be lowered in that case, regardless of the agent’s actions, consistent with agency law. Further guidance is required as to how the actions of an agent impacts the duty.

Particular characteristics that must be taken into account when determining the new duty 

Section 20B(4) requires that particular characteristics or circumstances of the insured that are known by the insurer must be taken into account in determining whether an insured has discharged the new duty. For example, if an individual has advanced Alzheimer’s disease and applies for insurance over the phone and it becomes apparent during the phone call that they are unable to remember simple facts, this would lower the standard of care on the insured’s behalf to discharge their duty.

This requirement has caused concern in the industry particularly as to what extent insurers will need to be aware of previous disclosures an insured has made. However these changes do mirror, in part, existing DoD requirements that an insured does not need to disclose what the insurers knows in the ordinary course of its business.

Cases establish that what an insurer ought to know cannot extend to unreasonable lengths. Cases also establish that if an insurer is put on a course of enquiry through certain representations, then the duty is complied with. This is the case where the insured refers an insurer to a doctor for further details.

Factors that haven’t changed

The following elements of the new duty are in line with current law:

• The insured is not to be taken to have made a misrepresentation merely because they failed to answer a question or gave an obviously incomplete or irrelevant answer to a question (ss 20B(5)). The insurer therefore still bears the onus to follow up in such cases.
• Any misrepresentation made fraudulently is taken to be a breach of the new duty, with the corresponding remedies under Division 3 of Part IV of the ICA available to the insurer (ss 20B(6)). It is notable that in the UK the test is ‘dishonest', a lower threshold than “fraudulent’. FSC submissions have pointed this discrepancy out, however, a change is unlikely.

ICA Remedies

In broad terms, the existing remedies available for a breach of the duty of disclosure or misrepresentation, being avoidance and variation, will also apply to the new duty.

However, the remedies in the ICA will now apply to a ‘relevant failure’ by the insured, which is defined by reference to whether the contract is a CIC or not:

• if the contract is a CIC: a misrepresentation made by the insured in breach of the duty to take reasonable care not to make a misrepresentation; or
• for other insurance contracts: a failure by the insured to comply with the duty of disclosure or a misrepresentation made by the insured to the insurer before the contract was entered into.

The net effect of the way ‘relevant failure’ is defined is that s 31 of the ICA, which allows the Court to disregard avoidance in certain circumstances, appears to have been broadened. Currently, s 31 allows the Court to disregard an avoidance which is fraudulent if it would be harsh and unfair not to do so. Under the proposed changes, s 31 will now refer to the Court having that power in relation to a 'relevant failure’, which will include a a non-fraudulent failure to satisfy the duty to take reasonable care.

The presence of s 29(6), which allows variation at any time and unbundling under s 27A should ensure that effective remedies remain for non-fraudulent misrepresentations. However, of note are the many unresolved issues with s 29 (which largely results from the patchwork way it has been amended over the years) which include:

• Does s 29(6) work like s 28, meaning can life cover be ‘varied to nil’ like general insurance cover?
• Why do we have two sub-sections, (4) and (6) which essentially do the same thing, i.e. permit variation of cover? How should insurers choose between the two, noting that different outcomes may flow?
• How generally should choices in s 29 remedies be made?
• Is there a potential inability of incoming group insurer to avoid cover entered into by outgoing insured?

Changes to the Avoidance of Life Insurance Contracts - Recommendation 4.6

Recommendation 4.6 of the FSRC Final Report states that:

‘Section 29(3) of the ICA should be amended so that an insurer may only avoid a contract of life insurance on the basis of non-disclosure or misrepresentation if it can show that it would not have entered into a contract on any terms.’

The Financial Sector Reform (Hayne Royal Commission Response Protecting Consumers (2020 Measures)) Bill 2020: Avoidance of life insurance contracts (FSRC Rec 4.6) aims to restore the pre-2014 wording to subsection 29(3) of the ICA.

Commissioner Hayne noted that the 2013 amendments to subsection 29(3) resulted in an ‘avoidance regime that was unfairly weighted in favour of insurers.’

Once again, it is worthwhile looking at the new section in its entirety:

29 Life insurance

(3) If:
(a) the failure was not fraudulent or the misrepresentation was not made fraudulently; and
(b) the insurer would not have been prepared to enter into a contract of life insurance with the insured on any terms, if the duty of disclosure had been complied with or the misrepresentation had not been made the insurer may, within 3 years after the contract was entered into, avoid the contract.

The EM provides the following example:

Jason purchased life insurance two years ago. When applying for the policy Jason made a non-fraudulent misrepresentation to the insurer with regard to symptoms of ventricular tachycardia (an irregular heartbeat) he had previously experienced. The insurer’s internal underwriting policy, which was consistently followed in practice, stated that all applications for cover that disclosed symptoms of ventricular tachycardia should be declined. As such, the insurer can avoid the insurance contract.

Issues raised by the change

The relevant change back to ‘a contract’ from ‘the contract’ essentially means a return to the pre- June 2014 s29 (3) issues which were known to many life insurers.

That is, the new remedy is only in play if the relevant response by the insurer had been (had the true facts been known) that no cover at all would have been issued in response to the application. Currently, the section allows an avoidance with any modification to cover, for example, an exclusion.

Of course, the requirement to unbundle cover before re applying a relevant non-disclosure/misrepresentation remedy will avert much of the difficulty which arose in relation to bundled cover under s29(3) following the CoA decision of Schaffer v Royal Sun Alliance Life Assurance Australia Ltd [2003].

That said, issues still to be resolved include whether in attempting to show it would not have issued ‘a contract’ an insurer needs to prove that a prospective insured was completely uninsurable across its entire insurance offering or just the actual type of cover applied for. Minds differed on this question prior to June 2014 and it’s safe to say, they will again as we return to a pre June 2014 situation.