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How does the Insurance Act effect small business owners?

04 April 2016
The Insurance Act 2015 comes into effect on 12th August 2016 and will apply to all UK commercial insurance policyholders, from micro SMEs to much larger organisations. These changes have been welcomed by many, from business owners to industry officials, as it brings about the first major legislative reform to the commercial insurance market in over a century.

The Insurance Act makes significant changes to the way in which your insurance risks are presented to insurers, and the options available to insurers when handling claims.

The new legislation aims to rebalance the rights between insurers and policyholders, to make claims settlements more transparent and provide clear guidance on handling misrepresentations and fraud in the industry. Prior to this legislative reform, the Marine Insurance Act 1906 (MIA) set out clear rules for insurers in these areas, however, they do not necessarily reflect the needs of the modern day business owner, or the practises that should be adopted by insurers today.

Now, 110 years later, the new law will bring some much-needed updates to the commercial insurance industry, and works towards modernising relations between insurers, brokers and the businesses they protect.

What impact does it have on small business owners and what changes can we expect to see in August?
There are three main areas for consideration:
  • Duty of disclosure and fair presentation of risk – simply put this is the way in which details about your business should be disclosed and presented to an insurer
  • Claims settlements – there are now different options available to insurers when dealing with a claim when details of a business have not been fairly presented
  • Warranties and how insurers will deal with a breach of warranty going forward if a claim is to be made

The impact of each of these considerations is detailed below.

1. 'Duty of Disclosure' will be replaced by 'Fair Presentation of Risk'

The Insurance Act seeks to address the duty of disclosure imposed by the Marine Insurance Act 1906, which requires commercial policyholders to ‘disclose every material circumstance that is known, or ought to be known in the ordinary course of business’.

The introduction of the Insurance Act replaces the duty of disclosure with a requirement to make a ‘fair presentation of risk’. It is a development of existing legislation and aims to modernise the law to be more in line with modern day business needs and requirements.

But what does ‘fair presentation of risk’ mean and how does this differ from a 'duty of disclosure'?

A fair presentation of risk builds on the duty of disclosure, and seeks to identify the knowledge that is relevant and sufficient to prompt an underwriter to make further enquiries. Simply put, this means that all commercial policyholders must disclose all material facts including any unusual characteristics relating to their risk that may influence the decision of an underwriter in setting terms and calculating the insurance premium. It seeks to incorporate the knowledge of all individuals who play a significant role within a business when placing their insurance. This will help to eliminate the possibility of omissions in cover and benefit from the wealth of knowledge that all business owners or senior managers hold about the business activities to minimise the risk of a material circumstance not being disclosed.

Building relationships between businesses and insurers or brokers can assist in the presentation of risk information, and essentially promote better understanding of individual trading activities to highlight gaps in cover that could leave business owners exposed to unexpected losses, as well as improve the transparency of policy terms.

Essentially, to provide the best protection for any business owner, an insurer or broker needs in depth knowledge and understanding of their client’s business practises to ensure they can source the most comprehensive protection based on the business needs, highlight areas of exposure and recommend any additional covers that should be considered.

Building the relationship between insurer or broker and client will in turn support one of the Act’s objectives to improve the overall process of settling claims. It also changes the options available to insurers in the event that a fair presentation of the risk has not been made.

2. Claims Settlements and remedies available to insurers

One of the main objectives of the 2015 Act is to address the options available to insurers with regards to claims settlements. Currently, if a material fact or circumstance is not disclosed, an insurer has the right to void the policy and deny any claims payout. While this may be the correct solution for those that have made a fraudulent misrepresentation to obtain better terms or cheaper premiums, it does not cater for honest mistakes that can be genuinely overlooked when purchasing a business insurance policy.

The intention of the new Insurance Act is to introduce more proportionate settlement options to replace the outdated approach of the previous legislation. Going forward, insurers will instead follow principles set out by the new Act which allows flexibility in terms of remedial action.

So what does this mean for commercial policyholders going forward? If the duty to present a fair presentation of risk has been breached, insurers now have more options available to them in terms of settling the claim. Ultimately this is based on the nature of the breach, whether it’s considered to be deliberate, reckless or innocent. If the misrepresentation is deemed to be reckless or deliberate, the insurer may void the contract and refuse all claims, and is not obliged to return any of the premiums paid.

For non-deliberate or non-reckless breaches where the policyholder has made an innocent mistake, proportionate remedies will apply based on what the insurer would have done had all the facts been disclosed prior to entering into the contract. Going forward there will be three options available:

  1. If the insurer would not have entered into the contract – the insurer may void the whole contract and refuse all claims, but must return all premiums paid.
  2. If the insurer would have entered the contract but on different terms - at the discretion of the insurer they are to treat the contract as if those terms applied from the start of the contract despite whether or not the policyholder would have accepted those terms.
  3. If the insurer would have entered into the contract but charged a higher premium - the insurer may reduce the claims settlement payment in proportion to the additional premium that would have been charged.

These changes represent positive developments to industry practises within the commercial insurance market, and will help to balance the rights of insurers and policyholders to make the full life cycle of a policy more transparent, open and fair.

3. Warranties and remedies for breach of warranty

Historically, a warranty within an insurance contract is a clause or term that must be strictly complied with for the insurance to remain valid. It has been widely regarded by the industry as one of the most important terms within an insurance contract, and traditionally favoured the insurer when breached.

The existing legislation gives insurers the right to void a policy entirely in the event of a breach of warranty and reject claims regardless of whether the mistake was an honest oversight by the policyholder.

For example, commercial insurance contracts often contain a warranty requiring a fully maintained and monitored intruder alarm to be operational when the business is closed. If the alarm was not functioning at the time of a flood, the current system allows an insurer to reject the claim for the flood damage based on a breach of warranty, despite the incident being completely unrelated to the intruder alarm not working.

One of the objectives of the Insurance Act is to replace this one-sided approach with a more fitting and fair method of handling claims. Once the Act comes into effect in August, insurers will no longer be able to reject a claim based on a breach of warranty unless it relates directly to the loss.

Going forward, warranties will be replaced by ‘suspensive conditions’ meaning that cover will be suspended for the duration of time that the condition has been breached.

Going back to the example of the intruder alarm requirement, an insurer would only be able to reject a claim if the condition breached related directly to the loss. In this example, theft would not be covered for the duration that the alarm was not operational as this directly links to the breach. However flood, storm and any other unrelated insured events would still be covered.

4. So what does this mean for UK business owners?

The Insurance Act is fantastic news for all UK commercial policyholders and comes as a breath of fresh air to an otherwise outdated approach.

The Act applies to England, Wales, Scotland and Northern Ireland, but in respect of Northern Ireland there is a modification relating to road traffic legislation, so in practice any policy which is subject to the law and jurisdiction of these territories will be governed by the Act.

The Act will not apply retrospectively, so will only apply in relation to contracts of insurance entered into on or after 12 August, 2016 and to variations agreed on or after 12 August, 2016.

As a business owner you may not notice the changes directly, you may only experience being asked a few more questions at renewal or proposal stage. Whilst more of the responsibility has moved onto insurers and underwriters to ask the appropriate questions relating to the risk, you still have a primary duty to disclose everything material you know, or ought to know, that would affect the judgment of a prudent insurer. Failing that, you must disclose enough information to put the insurer on notice that it needs to ask further questions to uncover material facts.

The insurance market is updating policy wordings to reflect the impact and requirements of the Insurance Act 2015 and to ensure compliance with this significant piece of legislation. It is, therefore, important that you continue to review and understand your business insurance policies.

Working closely with your insurer or broker to help them understand your business can help to minimise the risk of uninsured losses and ensure you have comprehensive protection in place for your livelihood.

To see the Government’s official publication of the Act in full, click here.

It is important to make sure that you have the right insurance in place to protect the business that you have built. Every business is different and has its own business insurance needs, which is why we work with some of the UK’s most well-known insurers to ensure that you are getting the right insurance cover for your business.
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