It's finally here: the draft bill to amend the Insurance Contracts Act

More than two and a half years after the final report of the Review of the Insurance Contracts Act, the Government has released a draft bill embodying most - but not all - of the changes coming from the report. During that time, there have been extensive consultations with the insurance industry and consumer groups, so the draft bill may be very close to the final version. In this Alert we'll highlight some of the main changes.

What contracts would be covered by the Act?

The draft bill proposes to ensure that the Act applies to

• contracts of insurance that are entered into with persons that are domiciled in a State or Territory to which the Act extends, irrespective of where the risk that is the subject of the contract is located; and
• contracts of insurance that cover risks of loss or damage occurring in a State or Territory to which the Act extends.

In practice, this change will impact foreign insurers the most.

When a contract bundles together types of cover that fall under the Act with those that don't, it's been unclear if the Act applies to the whole of the contract or not. The draft bill would deal with this by treating the contract as two different contracts, one exempt and the other non-exempt. This would apply to all bundled contracts except those that bundled compulsory workers' compensation with an employer's common law liability for damage caused by employment-related personal injury, so that all claims dealing with an employee's personal injury suffered on the job would be exempt.

Contracts of insurance over water transportation of property that is wholly or substantially used for personal, domestic or household purposes by the insured, his or her relative, or someone he or she lives with, would also fall under the Act.

Disclosure duties

Insureds have a duty to disclose certain matters to the insurer, but what are those matters? It is often difficult for insureds to know what those matters are.

The draft bill amends section 21 to say that an insured must disclose what "a reasonable person in the circumstances could be expected to know to be a matter so relevant, having regard to factors including, but not limited to:

• the nature and extent of the insurance cover to be provided under the relevant contract of insurance
• the class of persons for whom that kind of insurance cover is provided in the ordinary course of the insurer’s business; and
• the circumstances in which the relevant contract of insurance is entered into, including the nature and extent of any questions asked by the insurer."

The new section 21A also omits the exemption for eligible contracts of insurance entered into by way of renewal. This means that the disclosure duty applies not only at the inception of the relationship, but at every renewal of the policy (by, for example, providing the previous questions and answers and asking the insured to amend where necessary).

When an insurer breaches its duty of utmost good faith

Under the draft bill, a breach of the duty of utmost good faith would become a breach of the Act. This in itself would not be an offence or lead to a fine. It would, however, allow ASIC to sue on behalf of an insured who has suffered loss as a result of a breach of the duty and allow ASIC to impose other penalties such as a banning order or conditions on the insurer's financial services licence.

Claims against insurer in respect of liability of insured or third party beneficiary

If a person is owed damages by an insured under a contract of liability insurance, that contract provides insurance cover in respect of the liability, and the insured is either dead or cannot be found, that person currently can sue the insurer to recover an amount equal to the insurer’s liability under the contract in respect of the liability of the insured. The draft bill proposes to expand this right to sue an insurer in two ways:

• first, the provision would cover not only insureds who owe damages, but also third party beneficiaries under the contract of insurance; and
• secondly, the person could sue the insurer not only when the insured or third party beneficiary is dead or missing, but also if the person has obtained judgment against the insured or third party beneficiary and they have no money or assets to pay the damages.

What's new for life insurers

The draft bill unbundles life insurance contracts which have two or more kinds of insurance cover, and would remove the three year rule from risk-based life insurance contracts - it would apply only to contracts of life insurance with investment or mortality components.

It also would change one word in section 29(3), to great effect. Currently an insurer can avoid a life insurance contract where there has been misrepresentation or a failure to comply with the duty of disclosure "if 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 [emphasis added]". This has been interpreted to mean any contract at all. The draft bill would change this to "the contract" so that even if an insurer would have entered into a slightly different contract, it can still avoid the contract.

Finally, if a life insurance contract has been entered into by, for example, the trustee of a super fund, with the members of the trust fund as third party beneficiaries, those third party beneficiaries cannot sue the insurer. The draft bill would change this to allow third party beneficiaries to sue the insurer directly without the intervention of the policyholder.

Third parties and insurers - other issues

Third party beneficiaries will enjoy new rights under the draft bill.

First, insurers would bear a duty of utmost good faith to them once the contract of insurance has been made (although not before). This is particularly important if they need to make a claim under the policy.

Secondly, they get enhanced access to information from insurers about the scope of their coverage.

On the other hand, as noted below, they are lumbered with any misconduct by the insured when they make a claim.

Electronic communication

As electronic communication became ubiquitous, the Act failed to keep pace with technology. The draft bill pulls the Act into the cyber age by allowing electronic communication to be valid for more communications related to contracts under the Act, including notices or other documents.

Explaining non-standard provisions to insureds

Currently insureds must be "clearly informed" by insurers of non-standard terms in contracts covered by the Act. The draft bill would harmonise this requirement with similar ones in the Corporations Act, so that any explanation must be "worded and presented in a clear, concise and effective manner". This is arguably more onerous than the current requirement.

Claims made and notified policies

The draft bill proposes to deal with whether non-notification leads to relief under section 54 from the perspective both of the insurer and the insured. Insureds would be able to notify the insurer of facts that might give rise to a claim up to 28 days after the end of the policy period. If however an insured knows about those facts but fails to notify the insurer during the policy period or the subsequent 28 days, the insurer can refuse the claim.

When it gets to court - rights and remedies

The draft bill makes it clear that when a third party beneficiary of cover makes a claim, he or she is in no better position than the insured. This means that if the insurer has a defence against the insured relating to the insured's conduct (eg. non-disclosure), then it can use that defence against the third party beneficiary too.

It also seeks to extend the regime in section 31 regarding a court's disregard of an insurer's avoidance of a contract of insurance to claims reduction under section 28.

Dividing up the spoils of subrogation

A new section 67 sets out the division of moneys from a subrogated action between an insurer and insured (which would include a third party beneficiary). The current law allowing parties to come to their own arrangements however is preserved. Basically, the party that bore most of the risk and cost of the recovery action gets to enjoy any windfall:

• if you fund the action you are entitled to have your administrative and legal costs covered
• if the insurer funds the action, it gets the amount it paid out to the insurer, with any extra going to the insured to cover the difference between the payout from the policy and the actual amount of its loss
• if the insured funds the action, it gets enough to cover the difference between the payout from the policy and the actual amount of its loss, with any extra going to the insurer equal to that already paid out under the insurance policy
• anything left over is divided fairly between parties in proportion to the amounts they contributed to the cost of the recovery action
• any interest should be divided with regard to the amounts recovered and the periods of time each party was deprived of the use of its funds.

Excluded from the draft bill

The bill does not deal with the Review's recommendations concerning the rights of innocent co-insureds or standard cover regulations.

Now what?

Submissions on the draft package should be received by the Treasury no later than Friday 23 March 2007. Parliament will then be in recess until the May-June sittings, which would be the earliest any final bill could be introduced into Parliament.

Many of the changes would require changes in the business practices of insurers and insureds, so now is a good time for those to be reviewed and any necessary changes identified.