Insurance Act: Beware the increased use of conditions precedent

Published on Tue, 01/11/2016 - 08:50

Changes brought about by the Insurance Act 2015 in relation to basis clauses, warranties and other terms may have the knock-on effect of seeing the increased use of conditions precedent in policy wordings.  Paul Lewis and Laura Moorhead of Herbert Smith Freehills LLP explain.

Conditions precedent:  a quick reminder

A condition precedent is a contractual term which, if breached, may entitle an insurer to reject a claim (regardless of whether prejudice is suffered) or may mean that cover never attaches. 

As a result, it has always been in a policyholder's best interests (i) to ensure that conditions precedent are kept to a minimum; and (ii) where conditions precedent are necessary, to identify such terms expressly and to understand the potential consequences of any breach. 

Some policies include a "sweeper" clause which seeks to re-characterise all policy terms as conditions precedent.  Policyholders should check for and seek to remove any such "sweeper" clauses.  They might also wish to consider the inclusion of a clause requiring that any condition precedent should be labelled as such to be effective.  This best practice is all the more important since the Act came into force for the reasons discussed below.

Possible policy wording changes in light of the Act

The abolition of basis clauses

The Insurance Act abolishes basis clauses, which operated to turn a policyholder's pre-contractual representations (including proposal form answers) into warranties. 

One consequence of this is that policy wordings may instead begin to introduce conditions precedent in relation to the accuracy of certain pre-contractual statements.  In fact, the Lloyd's Market Association (LMA) has addressed the issue in its suite of model clauses which it has produced for use under the Act. 

The LMA's "Critical Information" clause (LMA5253) states the following:

"It is a condition precedent to the Insurer’s liability under this insurance contract that the following matters are true and accurate at the time of inception of the contract: {Insert critical information – e.g. no criminal record of directors/officers}"

It is intended for use when an insurer wants the policyholder to make a contractual promise that a particular matter is true.  The clause is expressed as a condition precedent to the insurer's liability under the policy. 

Such a clause is not necessarily controversial; an insurer may have good reason for wanting an effective remedy in the event that key information provided by the policyholder during the placement process turns out to be inaccurate.  

That said, Airmic members should review their policies carefully to ensure they understand the impact of any critical information-style clauses that have been introduced and make an informed decision as to their inclusion.

Warranties as suspensive conditions

Prior to the Act coming into force, a breach of warranty discharged an insurer’s liability under the policy in its entirety. The position has improved for policyholders under the Act, since section 10 makes warranties “suspensive conditions” whereby an insurer’s liability is suspended only while the insured remains in breach of a warranty.  It may be that terms that were previously described as warranties may in the future be described as conditions precedent and plainly need to be identified and understood.

Terms not relevant to the actual loss

Section 11 of the Act provides that an insurer may not rely on the policyholder's breach of a risk mitigation term (including warranties and conditions precedent) to reject a claim if the breach could not have increased the risk of the loss.  

Section 11 does not apply to terms which define the risk as a whole.  Policyholders should be on the lookout for attempts to frame policy provisions, including conditions precedent, in a way that increases their chance of being found to apply to the risk as a whole, thereby falling outside the scope of section 11.  In addition, section 11 is unlikely to assist with regard to conditions precedent that relate to notification, so particular care needs to be taken in relation to these.

Paul Lewis is a partner at Herbert Smith Freehills LLP and Laura Moorhead is a senior associate at Herbert Smith Freehills LLP.