June 2014

Contracts Act amendments take effect

by Krystal Belcher, KT Journalism

The Insurance Contracts Amendment Act (ICAA) has become law more than a decade after two former federal senators conceived the need for an update.

Melbourne barrister John Tesarsch spoke to Resolve about the changes he viewed as most significant for the industry, including amendments to the duty of utmost good faith and the duty of disclosure.

He considered why section 54, the original cause for reform, was not amended.

Mr Tesarsch said the Insurance Contracts Act (ICA) was intended to ensure a fair balance between the interests of insurers and insureds.

When then revenue minister Helen Coonan and then parliamentary secretary to the treasurer Ian Campbell announced a review of the Act in September 2003, Mr Tesarsch said it was “a different economic climate. It was just after HIH collapsed and there was a perceived tort law crisis.

“It was a hard market for professional indemnity insurance. There were concerns pricing and availability were adversely affected by s54 and the 2001 High Court decision in FAI v Australian Hospital Care.

When the review was commissioned, there were two separate strands of investigation:

  • The effect of s54 - which was given priority and urgency; and
  • Provisions other than s54, to improve the overall operation of the Act and identify provisions that did not work well.

Former Australian Securities and Investment Commission (ASIC) chair Alan Cameron and insurance lawyer Nancy Milne were appointed to conduct the review. November 2003 saw the s54 review publicly released, with the second stage delivered to ministers in June 2004.

Draft legislation was introduced in 2007. In 2010 the amended bill passed through the House of Representatives, but was not read in the Senate before parliament was prorogued for the August 2010 federal election.

The current bill was introduced on March 14, 2013, and passed on June 28.


Staggered starts

There are staggered commencement dates up to December 2015. Several changes (to the duty of utmost good faith, bundled contracts, electronic notices and subrogation) have already taken effect.

Significantly, the amendments provide that a breach by an insurer of the duty of utmost good faith is a breach of the Act.

That change applies to insurance contracts entered into or renewed, or certain life insurance contracts varied, after June 28, 2013.

Mr Tesarsch said: “The term utmost good faith is still not defined in the Act, and must be interpreted with reference to common law principles. The practical application of those principles can at times be uncertain.    

“It is significant that ASIC now has the power to take potentially draconian action in relation to an insurer’s breach of the duty of utmost good faith. ASIC has the power to vary, suspend or cancel an insurer’s Australian financial services licence, issue a banning order, or  impose conditions on the insurer’s licence,” he said.

“The key question now is how ASIC will approach its responsibility to monitor breaches of the duty. As yet, there is uncertainty about the approach it will adopt and the types of sanctions it may impose for differing breaches.

“Another matter to bear in mind is that the duty of utmost good faith now also applies to claims by third party beneficiaries under a contract of insurance.

“The message for insurers is to update documentation and procedures, particularly claims handling procedures, to ensure no risk of censure from ASIC.”


Duty of disclosure

Other significant changes will apply to the duty of disclosure regime for contracts entered into, renewed, or certain life insurance contracts varied, after December 28, 2015.

“This significant lag time reflects the impact the changes will have on insurers’ underwriting procedures and documentation. The duty of disclosure provisions are central to setting the balance between the interests of insurers and insureds,” Mr Tesarsch said.

For contracts of general insurance, s21 imposes on an insured a duty to disclose every matter known to him or her, being a matter that:

  • The insured knows is relevant to the decision of the insurer whether to accept the risk and, if so, on what terms (a subjective test); and
  • A reasonable person in the circumstances could be expected to know to be a matter so relevant (an objective test).

Mr Tesarsch said the consequence of a failure to comply with the duty of disclosure was that, where an insured was fraudulent, the insurer could avoid the contract of insurance. Where the failure was innocent, an insurer might, in general terms, reduce its liability to the extent of any prejudice it had suffered.

The objective component of the test in s21 has been amended. In determining what a reasonable person could be expected to disclose, the amendments will provide that regard must be had to factors including the nature and extent of the cover provided, and the class of persons who would ordinarily be expected to apply for that type of cover.

“This amendment may prove to be problematic. It suggests courts may adopt a more lenient approach for some types of insurance than others, even if the different types of cover are [bought] by the same person. It creates practical difficulties, such as the nature of any evidence that may be required to establish what a reasonable person would be expected to disclose. The amendment may throw up more questions than it answers.”


Section 54

S54, under which an insurer may not refuse to pay claims under certain circumstances, was the initial imperative for reform. “It is noteworthy that it didn’t get any treatment in the Bill,” Mr Tesarsch said.

“The professional indemnity market has shifted since the review was announced in 2003. Many insurers have removed certain deeming clauses in claims-made policies (relating to the notification of circumstances which may give rise to a claim), with the aim of limiting the effect of the Australian Hospital Care decision.”

Mr Tesarsch said because the review was announced by the Howard government but the amendments were eventually enacted by the Labor government, the lack of any amendments regarding s54 may also reflect differing legislative priorities.

“In certain circumstances, s54 can be a difficult provision to apply to a particular set of facts. I would have welcomed some fine-tuning of it to provide greater clarity as to its application. It’s not unworkable, but there have been judicial decisions that show uncertainty remains,” he said.

Other amendments relate to unbundling contracts, the ability of insurers to provide electronic notices, subrogation claims, rights of third parties to recover against liability insurers, the duty of disclosure for eligible contracts, and notification to insureds about the duty of disclosure.

Mr Tesarsch said: “Insurers need to ensure their documentation and claims handling procedures are reviewed and updated to be consistent with the new regime. They should be mindful of the new provisions on the duty of utmost good faith, and be aware a breach of that duty could attract ASIC’s attention.

“Even though some of the amendments may be considered more in the nature of fine-tuning than wholesale reform, in certain instances they may result in radically different outcomes.”

Mr Tesarsch and HWL Ebsworth partner David Guthrie analysed the changes in an AILA Victoria presentation, Insurance Contracts Reform - 10 Years in the Making.