DLA Piper's Practical Guide for Claims Managers in 2022 - Part 4Insurers and fair handling of claims
In our fourth monthly edition of our Practical Guide for Claims Managers, we review obligations imposed on insurers to handle claims fairly under English law and UK regulation, and the possible consequences if insurers fail to comply.
The exercise of contractual discretion in claims handling
Policy terms often confer discretionary powers on insurers – for example, in the context of their rights arising under claims control clauses. In addition, innocent non-disclosure clauses are now commonplace in many lines of business and these also typically afford insurers broad discretionary powers. The exercise of these discretionary powers affects not only the insurer's interests but also the interests of the insured.
However, it has long been established that contractually derived discretions are not absolute or unfettered and the English courts will seek to imply terms into contracts in order to limit such discretionary powers. As outlined below, in recent years legislation has also been passed to protect consumers (and SMEs of a certain size) by imposing obligations on insurers to handle claims fairly and in a timely fashion.
Claims control clauses
Claims control (or cooperation) clauses are common, in both the liability insurance context as well as in facultative reinsurance contracts. They typically afford the insurer the right to exercise control (or require cooperation) over the investigation, adjustment and defence of a third-party claim against the underlying insured or reinsured.
As long ago as 1939 the Courts recognised that there are limits on the wide powers conferred under a claims control clause. In Groom v Crocker , the insurer had "absolute conduct and control of all or any proceedings against the insured." The underlying claim arose out of a road traffic accident. Interpreting its powers under the provision literally, the insurer instructed defence counsel to admit negligence even though the insurer knew that the insured was not liable. The insured was not informed of this admission of liability and subsequently sued defence counsel for negligence.
The insurer's motive for admitting liability of their insured (where there was no basis for doing so) was to settle an entirely unrelated claim involving the same insurer on the other side. The Court of Appeal held that the claims control clause was subject to an implied term that the insurer (and their counsel) should act reasonably in the interests of both the insured and the insurer. In the current case, by instructing defence counsel to admit liability, the insurer had clearly acted to protect their own interests only, to the detriment of the insured. The Court concluded that the insurer was not entitled to do this under the claims control clause and, specifically, was not entitled to instruct defence counsel to admit liability when there was no basis to support this course of action.
This principle was further developed in a reinsurance context in the case of Gan v Tai Ping (Nos 2 and 3 . The claims cooperation clause required the reinsurer to consent to a settlement proposed by the reinsured. The Court of Appeal held that the exercise of reinsurers' contractual rights under the claims cooperation clause was a "right to be exercised in good faith after consideration of and on the basis of the facts giving rise to the particular claim, and not with reference to considerations wholly extraneous to the subject matter of the particular reinsurance or arbitrarily."
In Travelers Insurance Co Ltd v XYZ , insurers had a right to control the defence of covered claims brought against the insured in accordance with the claims control clause in the policy. However, the claims against the insured consisted of both uninsured and insured claims. In exercising its contractual discretion, insurers withheld consent for the insured to make an admission of liability in respect of the uninsured claims. The insured subsequently went into administration and the claimants in respect of the uninsured claims, having obtained judgment against the insured, sought to obtain a non-party costs order against insurers.
The Supreme Court held that the trial judge had erred in making a non-party costs order against insurers. Lord Sumption stated that as long as the insurer acts in good faith and in the interests of the insured in relation to all insured claims, the insurer should not be subject to liability for non-party costs orders. Lord Sumption's key focus in his analysis was the insurer's obligation to act in the interests of the insured, and not to protect their own interests.
Good faith obligations in contracts
The obligations of good faith and rationality in general contractual settings have also been addressed by the Supreme Court in a non-insurance context. But the principles identified are likely to apply to contractual discretions generally, including where they arise under an insurance or reinsurance policy.
In Braganza v BP Shipping Ltd , the Supreme Court confirmed that where one party is given a power to exercise a discretion, a term is to be implied that the decision must not be "arbitrary, capricious or perverse." Furthermore, the decision-making process must also be carried out in good faith and must be made rationally eg the decision maker must not take into account extraneous considerations, and focus on relevant factors only. This duty is now commonly known as the Braganza duty.
Innocent non-disclosure clauses
A more recent development in this area arises from the High Court's decision in April 2020 in UK Acorn Finance Limited v Markel (UK) Limited . This decision confirmed that the Braganza duty of rationality also qualifies innocent non-disclosure (IND) clauses, requiring insurers to exercise their discretion rationally and not arbitrarily.
In the Acorn Finance case the High Court held that the following IND clause, which is commonly found in insurance policies, gave rise to an implied obligation to act rationally:
"a) In the event of non-disclosure or misrepresentation of information to Us, We will waive Our rights to avoid this Insuring Clause provided that:
(i)You are able to establish to Our satisfaction that such non-disclosure or misrepresentation was innocent and free from fraudulent conduct or intent to deceive."
The coverage dispute involved claims under a professional indemnity policy insuring a property valuation surveyor. The insurer claimed it was entitled to avoid the policy due to a number of non-disclosures and misrepresentations contained in risk profile documents which were generated by the insured as part of the renewal process. Following an investigation, the insurer concluded that the non-disclosures had been made dishonestly, and that it was therefore entitled to avoid the policy.
The Court considered that the words "you are able to establish to our satisfaction" placed the burden on the insured to prove that its non-disclosure was innocent. However, the decision-making process as to whether or not the non-disclosure was innocent and not made fraudulently fell to the insurer.
The Court agreed that the insurer must not exercise its decision-making powers arbitrarily, capriciously or irrationally. This required the insurer not to take into account in its decision-making, matters it ought not take into account; and reach a conclusion that no reasonable decision maker could ever come to.
On the facts, the Court found that, in assessing the claim, the insurer's claims manager had failed to approach the dishonesty issue with an open mind, or bearing in mind that it was more probable that a misrepresentation made by the insured would have been made innocently or negligently, rather than dishonestly. Further, irrational decision making had led the claims manager to conclude that certain misrepresentations made in previously submitted risk profile documents were fraudulent.
However, the Court went out of its way to absolve the claims manager of any personal criticism. The claims manager had been placed in an invidious position because no training had been given by the insurer in how to approach decision making,1 nor were there any internal claims handling guidelines in place for the claims manager to follow. The Court concluded: "Once it is accepted that clauses such as the IND clause are qualified by a Braganza duty, the decision making to be applied will need to be much more focused than has perhaps been the case in the past."
Compliance with policy terms: The "duty to speak"
Generally speaking, an insurer is under no duty to warn an insured as to the need to comply with policy conditions. However, in certain circumstances, an insurer may be under a duty to speak to the insured and explain what is required from the insured, otherwise the insurer may be estopped or prevented from subsequently seeking to rely on an insured's breach of policy conditions.
The duty to speak is illustrated by the Court of Appeal's judgment in Ted Baker v AXA Insurance UK Plc . Ted Baker made a claim under its Business Interruption policy. A condition precedent term of Ted Baker's policy was that particulars of the claim (including all relevant supporting evidence as may be reasonably required) were to be provided within a fixed time, otherwise no claims shall be payable.
During the course of the claims review and investigation process that followed after the claim had been notified, Ted Baker understood the insurers had effectively “parked” some of their requests for documentary evidence relating to the claim, pending the insurers' review of coverage under the policy.
However, in the subsequent coverage dispute, the insurer sought to rely on a breach of the condition precedent to provide all the documentation required by the insurer.
The Court of Appeal ruled that, in the particular circumstances of this case, Ted Baker could reasonably expect the insurers to say if they required all documentation relating to the claim, particularly if failure to provide the information was to be said to be fatal to the claim. Therefore, Ted Baker were entitled to expect that, if the insurers considered there was outstanding documentation relating to the claim, then they should have informed Ted Baker of this. As the insurers had not spoken out, it would be unjust to allow the insurers to escape any liability on the basis of Ted Baker’s non-compliance with a condition precedent.
Fair claims handling: Regulatory considerations
As well as general common law obligations, insurers are under regulatory duties relating to fair claims handling.
Claims in respect of business carried on from an establishment in the UK must be handled in accordance with the FCA's Insurance Conduct of Business Sourcebook (ICOBS) (in particular ICOBS 8).
ICOBS 8.1.1R provides that insurers must:
- be prompt and fair when handling claims;
- give reasonable guidance to policyholders to assist them in making claims, as well as provide appropriate information on the progress of their claims;
- not unreasonably reject a claim (and this includes by avoiding or terminating policies); and
- be prompt in settling claims once the terms of settlement are agreed.
ICOBS only applies to direct non-investment insurance contracts. ICOBS will not apply to an insurer if the following all apply: the intermediary in contact with the customer is not established in the UK; the customer is not habitually resident in the UK; and, if applicable, the state of the risk is outside the UK. (The state of the risk will be relevant if the insurance relates to a building (in which case the state of the risk is the location of the building) or a vehicle (in which case it is the state of registration).)
Insurers should also note that ICOBS will not apply:
- in respect of reinsurance contracts; or
- generally in respect of contracts covering large risks for commercial customers. The claims handling provisions in ICOBS 8 will only apply in relation to large risks where the risk is located in the UK and the customer is a consumer.
Insurers are also subject to the FCA's high level Principles for Businesses (PRIN 2), which include requirements to pay due regard to the interests of their customers and treat them fairly, to pay due regard to the information needs of their clients, and to communicate information to them in a way which is clear, fair and not misleading.
These specific requirements (and requirements of the FCA principles relating to management of conflicts of interest and suitability of advice and discretionary decisions) apply in relation to clients who are categorised as "customers". For clients categorised as "eligible counterparties" these specific requirements are generally disapplied, although it remains a requirement that communications must be "not misleading."
An insurer is able to choose to categorise certain clients, including (amongst others) insurers and other regulated financial services firms and some larger commercial clients, as eligible counterparties (specific FCA rules apply to how insurers categorise eligible counterparties, and whether and how they need to notify clients that they are being treated as such).
The FCA has also been consulting on a new "Consumer Duty" (which is currently intended to have the same scope as the ICOBS provisions considered above, and therefore in certain circumstances will also apply to commercial customers). The rules expected to apply from the end of July 2022 will impose a duty on insurers to "deliver good outcomes for retail clients," and are likely to impact all aspects of insurers' business within the scope of ICOBS, including how they handle claims.
The duty to pay claims due within a reasonable time
Since s.13A of the Insurance Act (Act) came into force on 4 May 2017, it is an implied policy term in an insurance policy (both consumer and non-consumer) governed by English law that if the insured makes a claim under its policy, the insurer must pay any sums due in respect of the claim "within a reasonable time." That includes a reasonable time to investigate and assess the claim.
What is "reasonable"?
What is reasonable for these purposes will depend on all the relevant circumstances, but the following are examples of factors which may need to be taken into account:
- the type of insurance, including the level of cover
- the size and complexity of the insured
- the structure of the insurance programme
- the size and complexity of the claim
- compliance with relevant statutory or regulatory rules
- factors outside of the insurer's control – for example, where the insured or a third party fails to provide information to the insurer
If the insurer is able to demonstrate that there were reasonable grounds for disputing the claim (for either liability or quantum), then the insurer does not breach the implied obligation to pay the claim within a reasonable time merely by not paying the claim while the dispute is continuing.
However, the conduct of the insurer in handling the claim may be a relevant factor in deciding whether there has been a breach of the implied term and, if so, when.
The practical consequence of insurers' obligations under the Act is that claims handling, coverage disputes, litigation tactics, and strategies (including decisions to take coverage defences) are likely to come under close scrutiny by the Court. Insurers may well find themselves having to justify their decision to dispute coverage and the defences they sought to raise.
As discussed below, the consequences of a breach are no longer limited to the payment of interest on the claim, but now include damages for losses the insured can show it has incurred as a result of the breach of the implied term.
Consequences of a breach
Where the duty is breached, in addition to any right to interest on the claims due, the insured can claim damages for late payment of insurance claims, ie financial loss suffered by the insured as a result of insurers' failure to pay a valid insurance claim within a reasonable time. This could potentially expose insurers to substantial claims which might be considerably in excess of the value of the claim under the policy. For example, if an unjustifiable delay by the insurer in dealing with and paying a valid claim results in the insured's business failing or becoming insolvent, or incurring finance charges to stay afloat, the resulting losses may be capable of being recovered from insurers in damages.
There has been very little judicial comment on the impact of the Act. In the most recent and first decision which considered the application of the implied obligation (Quadra Commodities S.A. v XL Insurance Company SE and Others ) the Court held that the question of what constitutes a "reasonable time" is not an easy one to decide. The answer to such a question is also very fact specific.
Having regard to the list of factors set out above, the Court concluded, on the facts of the case, that a reasonable time was "not more than about one year from the Notice of Loss" for the insurers to have investigated and evaluated the claim, and to have paid it, assuming that the investigation had indicated no reasonable grounds for disputing it or part of it. However, the Court emphasised that each claim will turn on its own facts, so this should not be taken as a definitive guide as to what is (or is not) a "reasonable time."
Fair claims handling: Practical takeaways
Here are our top tips for insurers to help ensure the fair handling of claims:
1. Claims control clauses: Ensure that claims handling decisions are undertaken in the insured's interests, and not solely in insurers' interests.
2. Innocent non-disclosure clauses:
- Undertake a fair and balanced assessment when determining whether any non-disclosures or misrepresentations were made innocently or not, taking into account all of the relevant material and making sure not to take into account irrelevant/extraneous factors.
- Approach the assessment of any non-disclosures or misrepresentations with an open mind, taking into account that it is more probable than not that a non-disclosure or misrepresentation has been made innocently or negligently, rather than dishonestly.
- Ensure that the assessment process (and all steps taken) are fully documented in the event that the decision is challenged subsequently.
- Ensure that internal claims handling protocols and guidelines include details of the assessment process and a checklist of steps to be followed.
- Provide adequate training to claims teams in relation to the assessment process and decision making.
3. Policy terms/condition precedents: Clear communication to/with the insured is required/best practice in the event that insurers are intending to rely on specific policy terms or condition precedents. Insurers should also consider putting in place an express reservation of rights (see our third edition of our Practical Guides for Claims Managers here).
4. Claims which are covered by FCA regulations: Ensure that particular care is taken for insureds who fall with the scope of the FCA regulations set out above. These insureds should be identified on receipt of a claims notification so that separate claims handling protocol/guidelines can be applied in order to comply with these rules, including treating customers fairly.
5. Duty to pay claims "within a reasonable time": As a result of the Act, Insurers are now potentially exposed to significant liabilities over and above policy limits and any interest that may also be payable.
- In these circumstances, internal claims handling protocols and procedures should be reviewed to ensure that all steps in the claims handling process are managed expeditiously.
- As the conduct of the insurer in handling the claim may be a relevant factor in deciding whether there has been a breach of the obligation to pay claims within a reasonable time, claims management processes and decisions should be fully documented/evidenced in the event that the handing of the claim/conduct of the claims managers is subsequently challenged by insureds. The burden of proof is on the insurers to show there were reasonable grounds for disputing claims and justifying the way in which the claims were handled.
- Ensure that the claims handling process of any third parties (eg TPAs or coverholders) are monitored to ensure that they handle claims in accordance with the requirements of the Act.
- Consideration should be given in relation to making any interim or on account payments where appropriate.
DLA Piper UK LLP
Andrew Symons is a Partner, George Mortimer is a Legal Director and Louisa Lieng and Rhea Ingram Smith are Associates in the Insurance and Reinsurance Disputes team in the UK. The UK Insurance and Reinsurance Disputes team forms part of DLA Piper's leading, multi-disciplinary, global insurance sector, consisting of over 400 lawyers representing major insurance and reinsurance companies internationally on all aspects of their business, including claims, disputes and investigations, transactional, regulatory and all forms of commercial advisory work.
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This publication is intended as a general overview and discussion of the subjects dealt with under English law at the time of original publication and does not create a lawyer-client relationship. It is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation.
1 For more details of DLA Piper's claims handling training seminars please contact Andrew Symons.