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Changes to insurance contracts give power back to consumers

4 Mar 2022

| Author: Jenni McManus

The insurance sector is undergoing a major shake-up – the first in nearly 100 years – with the release late last week of the draft Insurance Contracts Bill.

The bill, which had its genesis in a Cabinet paper prepared in 2019 for then Commerce and Consumer Affairs Minister Kris Faafoi, will rewrite the rule book on disclosure and risk in insurance contracts if passed in its present form. And insurers who currently hold the upper hand, will find the balance of power has shifted to policyholders and consumers.

All parties – insurers, advisers and business and consumer policyholders – are being urged to have their say on the draft legislation, though most industry players believe the key changes have already been set in stone by a government intent on insurance law reform and opportunities for further industry input will be limited.

As MinterEllisonRuddWatts notes on its website: “…it is likely changes made during the parliamentary process, including at the select committee stage, will be more in the nature of implementation detail, rather than underlying policy.”

Interested parties have until 4 May to make submissions on two options being proposed by the government.

Only one aspect of the Bill – the proposal to remove the insurance industry’s exemption from the Fair Trading Act’s ban on unfair contract terms (UTC) – is up for further discussion. Along with the government’s proposed changes to the duties of disclosure for consumers, the plan to scrap or severely limit the UTC exemption has drawn the most ire from the industry.

Seismic change

Market-watchers describe the draft bill as a game-changer, warning of potential premium hikes and less availability of consumer insurance cover as insurers try to figure out what the changes will mean so they can recalculate and re-price their risk.

Lloyd Kavanagh, a partner at MinterEllisonRuddWatts and a financial services specialist, describes the bill as a ‘big deal’, saying it will have a profound impact on the entire insurance sector.

“If it’s passed largely in its current form, which we have every belief it will be, it’s going to make fundamental changes to duties of disclosure, it will introduce unfair contracts terms and regulation to insurance for the first time, it’s going to have a whole lot of requirements about the way consumer insurance contracts are presented and it will consolidate a raft of itsy bitsy legal reform going back to the 1930s,” Kavanagh says. “It shifts the power away from the insurer to the insured.”

The legislation will cover the entire licensed insurance industry – life, health, general and travel. It repeals five statutes, pulling New Zealand’s fragmented insurance law together into one Bill and bringing our insurance contract law into line with Australia and the United Kingdom.

For insurers and advisers, Kavanagh notes that the insurance contracts legislation is being introduced in tandem with the Financial Markets (Conduct and Institutions) Amendment Bill (COFI), both of which are likely to come into effect in 2025. “So, there will be a fundamental shift in the regulatory environment which will make quite a big difference to insurers and to insureds.”

COFI has been designed to ensure financial institutions comply with the principles of fair conduct. It also provides for conduct licensing for the first time for retail insurers.

Uncertainty

The draft insurance legislation has been two years in the making but there are still some significant loose ends. Bell Gully partner David Friar points to the introduction of a statutory duty of good faith in the Bill, with no attempt to codify it or otherwise address its scope. “It is unclear whether this new statutory duty is intended only to restate the position at common law or whether it is intended to go further,” he says.

Kavanagh says much of the detail around policyholders’ disclosure obligations is still unclear. “These will be significant but the detail will be in regulations which we haven’t yet seen. So that means even after the Bill is finalised and perhaps introduced into Parliament, a lot of the key detail and requirements will still be a work in progress, so that will be a challenge.”

One of the most significant changes is an about-turn on the duty of disclosure. Under the current law, those seeking insurance cover are required to disclose all information that would influence the judgment and risk assessment of a prudent underwriter. Failure to do so means the insurer is entitled to avoid the policy when a claim is made, even though the non-disclosure might have nothing to do with the claim.

The Bill puts the onus back on the insurer who will no longer be able to avoid a consumer insurance policy when there is non-disclosure by a policyholder. Rather than demanding consumers tell them everything the insurer might consider relevant, the insurer will now be required to ask specific questions, which the prospective policyholder must take reasonable care to answer honestly and correctly. If this duty of care is breached, the insurer will have proportionate remedies which will depend on whether the misrepresentation was innocent, fraudulent or reckless. But insurers say it will be costly and difficult to prove a customer has acted unreasonably.

For non-consumers, such as business policyholders, the disclosure duty will be replaced by a duty to make ‘a fair representation of the risk’. They must disclose all material circumstances they know about, or ought to know about, and every representation must be substantially correct.

Plain language

Another controversial change is the requirement for insurance policies to be written and presented clearly so consumers can understand them. Many larger insurers have already moved in this direction, but others face the time-consuming and costly job of reviewing and editing their policies, with these costs likely to be passed on to policyholders in the form of higher premiums. Insurers will need to comply with a specific presentation and publishing format which is intended to help consumers compare products from different insurers.

If the Bill is passed, the Financial Markets Authority will share responsibility with the Commerce Commission for enforcing the unfair contract terms provisions in relation to contracts for financial services and financial advice products.

Industry opinion differs widely on whether this change, along with the plan to exempt insurance from unfair contract terms provisions of the Fair Trading Act, will achieve the intended result.

In a note on its website, Bell Gully says a highly prescriptive approach is likely to come at a high cost, with little benefit to the insureds. It notes: “It is inherently challenging to accurately translate complex insurance terms into plain language and there is a risk that doing so may dilute the clarity and effectiveness of insurance policies.”

Kavanagh says he thinks the Bill is taking the right approach to UTCs by offering two options. “Both of those need to be carefully evaluated and there are merits on both sides of the argument. Fundamentally, for consumers, we’ve moved most other sectors to a place where providers understand that they need to review their contract terms to make sure they meet the standard of not containing unfair contract terms.

“There’s a lot of work to do on that but once the work is done, I think you actually settle on a fairer balance where the clauses that are in there are in there for a good reason and with a justification rather than someone simply saying, ‘what’s the most protective position we can take?’

“The interesting thing for insurers will be [with] those protective clauses that leave the risk with the policyholder rather than the insurer. When those change, their question will be ‘how do we price that additional risk we’re taking on board, and can we reflect that in premiums?’ which depends on a competitive dynamic.”

On the prospect of unintended consequences from the Bill, Kavanagh says it’s too early to tell. “Earlier consultation has all been hypothetical. Now the words are on paper, people will really focus on that, in conjunction with their likely responsibilities on the conduct of financial institutions amendment bill.”

It is important, he says, that the minister listens carefully to what the insurance industry tells him. The government might then avoid the debacle surrounding the pre-Christmas changes to the Credit Control & Consumer Finance Act.

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