For Australian insurers, the 5 April 2021 heralds a new regulatory landscape, in which for the first time, the industry’s Insurance Contracts Act 1984 (ICA) will be subject to unfair contracts terms provisions, known as ‘UCT Laws’.
A NEW ERA
As it stands, section 15 of the ICA operates to prevent a contract of insurance from being the subject of relief under ‘any other Act’.
This means that the unfair contract terms laws, save for some very limited exceptions, do not currently apply to insurance contracts.
But the pressure to have this changed has been building for some time and the Hayne royal commission brought the momentum to a tipping point.
‘Since 2017, successive reviews, reports and recommendations by parliamentary and regulatory bodies have argued for the unfair contract terms regulations to extend to all insurance contracts,’ says Wotton + Kearney Partner Cain Jackson.
FACING UP TO REFORM
Jackson will co-present an ANZIIF webinar on 21 October with the Insurance Council of Australia’s John Anning about how insurers can understand and respond to the new regime.
‘The findings of the Hayne royal commission prompted the current government to enact the Financial Sector Reform (Hayne Royal Commission Response — Protecting Consumers (2019 Measures) Act 2020,’ he says.
‘Essentially, the Act makes unfair contracts terms provisions in the Australian Securities and Investments Commission (ASIC) Act 2001 apply to all insurance contracts subject to the ICA.’
WHAT IS AN UNFAIR TERM?
But, how can insurers understand and define unfair contract terms?
Jackson says broadly speaking, a term of an insurance contact is unfair if it disadvantages the insured in circumstances where the term is not reasonably necessary to protect the legitimate interests of the insurer.
‘The legislation sets out three elements for the test of unfairness,’ he explains.
‘A term of an insurance contract will be unfair if it (1) causes a significant imbalance in the parties’ rights and obligations, (2) is not “reasonably necessary” to protect a party’s legitimate interests and (3), causes detriment to a party if it was relied on.’
The legislation also provides a series of examples of potentially unfair terms.
All relate to one-sided contractual terms which operate to one party’s (the insurer’s) benefit and the other party’s (the insured’s) detriment.
‘In promoting the need for the UCT Law to apply to insurance contracts, a number of examples have been cited by government agencies as problematic insurance scenarios which are likely to be addressed by the UCT Laws,’ Jackson says.
- Terms of home building insurance which provide the cost to the insurer of replacement or repair rather than the actual cost of repair which might be higher for an insured
- Terms in home building insurance that require the insured to pay an excess before the claim in paid by the insurer
- Terms in car insurance policies that require an insured to provide the name, registration and contact details of an uninsured at-fault driver when making a claim
- Terms in consumer credit policies which prevent an insured from making a claim if they were not diagnosed with a disability prior to leaving work.
CASE BY CASE BASIS
However, Jackson points out in citing these examples, proponents of the legislation have been keen to not state definitively that these examples are unfair but, rather, that they present ‘problematic’ scenarios for insurers and insureds which can be better addressed with the benefit of the UCT Laws.
‘It is clear that insurers must deal with policies on a case by case basis, bearing in mind that a term can create an imbalance between insurer and insured and operate to the detriment of an insured,’ Jackson says.
‘Determining what is reasonably necessary and what constitutes a legitimate interest is likely to be where the most controversy arises and presents one of the more significant challenges under the new regime.’
A SIGNIFICANT DEPARTURE
For insurers, the reforms are a significant departure from the current regime and Jackson describes them as ‘undoubtedly a win for consumers and small business’.
‘The UCT Laws provide an additional layer of protection and remedial options for consumers and small businesses,’ he says.
‘Where the UCT Laws apply, and an insured challenges a contractual term as unfair, insurers will need to justify any limitations on cover (subject to some exceptions) as reasonably necessary to protect their legitimate interests.
‘Previously, an insurer could simply rely on policy terms providing adequate disclosure has been made and to do so was not inconsistent with its duty of utmost good faith,’ he says.
DUTY OF GOOD FAITH?
General insurers have always been subject to the duty of utmost good faith and an obligation to act fairly, efficiently and honestly (in so far as the insurer is an Australian Financial Services Licensee).
However, the UCT Laws impose a specific set of rules which will require insurers to approach the design and implementation of policies sold to consumers and small business through a different, or additional, lens.
‘It also seems clear that the UCT Laws sit uncomfortably in an insurance setting and will be accompanied by a degree of uncertainty for insurers,’ Jackson says.
‘Issues such as what is “reasonably necessary” and what is a “legitimate interest”, will present significant challenges.
‘In addition, identifying when a small business is purchasing insurance to which the UCT Laws will apply, and to what extent some exceptions require their application will also be a complex task.’
IMPACT ON POLICY DESIGN
Jackson says insurers will need to have specific regard to the UCT Laws in designing and applying policies issued to, or for the benefit of, consumers and small businesses.
For traditional, domestic classes of business this may not be a particularly challenging or even new approach in the post-Hayne environment.
However, for specialty lines where SMEs are the target audience, the UCT Laws could have a profound impact.
THE ROLE OF BROKERS
‘Take, for example, management liability insurance which is sold to small business by online platforms or professional indemnity insurance sold to members of professional bodies who are small businesses,’ Jackson says.
‘There may need to be a complete review of the products being offered and the basis upon which limitations on cover are rationalised and justified.
‘This is despite insurance brokers often being involved in this process.
‘A broader question arises as to whether a contract term can be unfair if an insured has been represented by an insurance broker.’
Jackson adds that questions will inevitably arise about where an insurance contract ceases to be standard form and, therefore, not subject to the UCT Laws.
‘For example, if an insurance broker requests an endorsement to financial planner’s PI policy, does that mean the cover is no longer standard form?
‘It seems likely that insurers will need to have a narrative around each standard product which identifies the risk being managed, the internal rationale for the underwriting approach and the commercial consequences of that approach.
‘This narrative will be directed at establishing that the relevant limitation on cover is reasonably necessary to protect the insurer’s legitimate interests.’
MAIN SUBJECT MATTER
Another issue which will need to be addressed is the exception to the UCT Laws for the ‘main subject matter’ of the insurance contract.
‘The main subject matter of an insurance contract will not be subject to the UCT Laws and has been described as the “thing being insured”—for example, a car or a house.
‘The ability to identify the main subject matter of a policy and separate that from limitations on cover is more difficult in relation to liability policies.’
SMALL BUSINESSES AFFECTED
Ultimately, all classes of insurance business subject to the ICA sold to consumers or small businesses need to be reviewed with regard to the UCT Laws.
‘Insurers will need to consider whether each product is captured by the UCT Laws and, if so, whether there is a risk that its provisions outside of the main subject matter may be unfair,’ Jackson says.
‘This will be a particularly challenging exercise outside of the domestic or retail sphere where those products are already the subject of greater regulation.’
PRODUCT REVIEW REQUIRED
Jackson adds that indemnity insurers who issue policies to small business will be particularly affected and need to carefully review the implications of these changes for product design and the application of and justification for limitations on cover which adversely impact an insured.
‘The UCT Laws are significant and far-reaching,’ he says.
‘Most insurers will be impacted. They need to understand the scope and impact of these reforms in order to assess what needs to be done internally to properly address the changes.’