Contracting Out of the Insurance Act 2015

A renewal slip arrives in the broker’s inbox the day before inception. Three pages in, in the same font and weight as everything else, is a clause headed “Disclosure”. It reads, in part: “Notwithstanding section 3 of the Insurance Act 2015, in the event of any non-disclosure or misrepresentation by the Insured, whether or not deliberate or reckless, Underwriters shall be entitled to avoid this Policy ab initio and retain all premium paid.” The clause is, on its face, a reversion to the pre-2016 position. If incorporated, it strips the insured of the proportionate remedies regime in Schedule 1 of the Act. The question is whether the clause is effective — and that depends on Part 5 of the Insurance Act 2015 (“the Act”).

This article is the seventh in our ten-part series on the Insurance Act 2015. It examines when and how parties to a non-consumer insurance contract can contract out of the Act’s default rules, what the transparency requirements in s.16 require in practice, and how brokers should approach opt-out clauses in light of their FCA duty under ICOBS 5 to ensure that policy terms are presented fairly and clearly.

1. The default position

The Act’s rules apply to every contract of insurance and reinsurance entered into on or after 12 August 2016. In non-consumer contracts those rules are default rules — the parties may contract on different terms — but only if they comply with Part 5 (sections 15 to 18). In consumer contracts the Act does not apply to the same matters (consumer placements are governed by CIDRA 2012), and contracting out of CIDRA is, in substance, prohibited.

The default rules that are most commonly subject to contracting out are:

the duty of fair presentation (s.3);
the proportionate remedies regime (s.8 and Schedule 1);
the abolition of “basis of contract” clauses (s.9);
the modification of warranties (s.10) and the rule on terms not relevant to the actual loss (s.11); and
the new statutory remedy for late payment of claims (s.13A, inserted by the Enterprise Act 2016).

Part 5 governs the conditions on which insurers can derogate from any of these default rules.

2. Section 15: “disadvantageous terms”

Section 15(2) defines a “disadvantageous term” as a term of a non-consumer insurance contract that would, but for s.15, put the insured in a worse position as respects any of the matters dealt with in Parts 2 to 4 of the Act than the insured would be in by virtue of those provisions. Section 15(1) makes such a term ineffective unless the transparency requirements in s.16 are satisfied.

The reach of s.15 is broad. It captures any wording that:

expands the disclosure duty beyond fair presentation (e.g. reverting to the 1906 Act’s wider “every material circumstance” duty);
narrows the categories of persons whose knowledge is excluded from the insured’s knowledge under s.4;
restores avoidance for non-deliberate, non-reckless breaches (excluding Sch 1 paras 4–6);
excludes or modifies the relief from breach of warranty in s.10(2);
disapplies s.11 in respect of terms not relevant to the actual loss; or
(subject to s.16A) excludes or restricts the remedy for late payment of claims under s.13A.

It does not capture wording that puts the insured in a better position than the Act provides (sometimes called “contracting in”), which is permitted without formality. Nor does it catch wording that simply rephrases an Act provision without altering its substance.

3. Section 16: the transparency requirements

Section 16 sets out two cumulative transparency requirements that must be satisfied for a disadvantageous term to be effective:

s.16(2)(a) — pre-contractual notice. The insurer must take sufficient steps to draw the disadvantageous term to the insured’s attention before the contract is entered into (or, in the case of a variation, before the variation is agreed).
s.16(2)(b) — clarity. The disadvantageous term must be clear and unambiguous as to its effect.

The two limbs operate cumulatively: a term clearly drafted but hidden in the small print is no more effective than a prominent term in unintelligible language. Section 16(3) provides a partial safe harbour: if the insurer can show that the insured (or its agent) had actual knowledge of the term and its effect before the contract was concluded, the pre-contractual notice requirement is treated as satisfied.

3.1 What is “sufficient” notice?

The Act does not define “sufficient” notice. The test is broadly objective but informed by the characteristics of the actual insured (s.16(4)). Relevant factors include:

the sophistication of the insured and the extent of broker involvement;
whether the term is conspicuously placed (a heading, a separate clause, or a “key features” section rather than buried in standard wording);
whether the term is highlighted in the placement process — for example, in a market reform contract Risk Details rather than only in the Conditions section;
whether the broker has drawn the term to the insured’s attention in writing; and
whether the term is one which the insured would reasonably be on notice of given market practice (e.g. a marine market clause that is industry standard).

There is no formal “red hand” requirement of the kind discussed in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433, but the same logic applies by analogy. The more onerous the term — the further it derogates from the default regime — the greater the steps the insurer must take to draw it to the insured’s attention. A term that wholesale strips the proportionate remedies regime is at the high end of that spectrum and will require correspondingly clear signposting.

3.2 What is “clear and unambiguous”?

The clarity limb is concerned with the drafting itself. The term must be readable by a non-lawyer commercial insured (or its broker) and must spell out what the derogation is. A term that says “the parties contract out of section 3 of the Insurance Act 2015” without explaining the substantive effect will struggle to satisfy s.16(2)(b). A term that says “the Insured’s duty of disclosure is the wider duty under section 18 of the Marine Insurance Act 1906 rather than the duty of fair presentation under the Insurance Act 2015, with the result that an inadvertent failure to disclose any material circumstance may entitle Underwriters to avoid the Policy” is on much stronger ground.

The High Court has not yet given a definitive ruling on the s.16 transparency test, but the analogous common-law jurisprudence on incorporation of onerous terms is instructive. The principle in Interfoto — that an onerous or unusual term will not be incorporated unless fairly and reasonably brought to the other party’s notice — provides a useful baseline. The FCA’s expectations under Principle 7 (communications must be clear, fair and not misleading) and ICOBS 5.1 reinforce the same message in the regulatory sphere.

4. Section 16A: the late payment carve-out

Section 16A (inserted by the Enterprise Act 2016 and in force from 4 May 2017) deals with contracting out of s.13A — the implied term that insurers will pay sums due within a reasonable time. The position is as follows:

The parties may contract out of s.13A in a non-consumer contract subject to the transparency requirements in s.16.
However, s.16A(2) provides that any term that purports to exclude or limit the insurer’s liability for a deliberate or reckless breach of s.13A is of no effect. In other words, insurers cannot contract out of liability for late payment damages caused by their own deliberate or reckless conduct, even if the transparency tests are otherwise met.
For these purposes, a breach is “deliberate or reckless” if the insurer knew it was in breach or did not care whether it was — mirroring the wording of s.8(5) for breaches of the duty of fair presentation.

The result is that insurers can lawfully exclude liability for delays caused by ordinary negligence or honest error, provided the transparency tests are satisfied, but cannot exclude liability for deliberate or reckless delay in handling claims. This is in line with the policy basis of the Enterprise Act 2016 reforms.

5. Section 17: marine insurance

Section 17 makes special provision for marine insurance contracts. In short, contracting out of the Act in a marine context is subject to the same general regime as other non-consumer contracts (s.15 and s.16 apply), but the Marine Insurance Act 1906 continues to apply to marine contracts in matters not dealt with by the 2015 Act. The London marine market has historically been a heavy user of standard clauses (the JR series, the LMA clauses, and trade-specific wordings such as the Institute Clauses), and many of those wordings have been updated post-2016 to address Insurance Act 2015 issues squarely.

6. Section 18: variations

Section 18 applies the Part 5 regime to variations as well as to original contracts. If a variation introduces a disadvantageous term (for example, a mid-term endorsement that tightens the disclosure duty in advance of renewal), s.16 must be satisfied in respect of that variation. The transparency requirements apply afresh at each variation — an insured who agreed to a disadvantageous term at inception is not deemed to have agreed to the same term in a variation without proper notice.

7. Common contracting-out wordings

A non-exhaustive list of the contracting-out provisions most commonly seen in commercial markets:

Wider disclosure duty. A term restoring (or purporting to restore) the s.18 MIA 1906 duty of disclosure of “every material circumstance” or modifying the categories of persons whose knowledge is treated as the insured’s under s.4 of the 2015 Act.
Tighter remedies for non-disclosure. A term restoring avoidance ab initio for non-deliberate, non-reckless breaches; or, less aggressively, modifying the proportionate remedy formula (for example, by allowing the insurer to charge the increased premium for past periods rather than reducing the claim).
Automatic discharge for warranty breach. A term reinstating the pre-Act consequence that breach of warranty automatically and permanently discharges the insurer from liability, displacing s.10(2) of the 2015 Act.
Disapplying s.11. A term providing that the insured must comply strictly with risk control terms and that the insurer’s liability is excluded for any non-compliance regardless of whether the non-compliance was relevant to the loss.
Capping or excluding s.13A damages. A term either capping the damages payable for late payment of claims or excluding them altogether (subject to s.16A).
Expanded category of fundamental terms. Wordings that designate a range of conditions as “fundamental”, “essential” or “of the essence”, with the contractual consequence of release from liability on breach — effectively dressing up the discarded “basis of contract” approach in different clothes.

Each of these will be a “disadvantageous term” within s.15(2) and will only be effective if the s.16 tests are met.

8. Lloyd’s and the London market

The Lloyd’s Market Association has produced a series of model clauses to help underwriters comply with Part 5. The LMA5256 series (and subsequent iterations) provides drafting that signposts contracting-out provisions with appropriate prominence — typically a clause headed “Contracting Out of the Insurance Act 2015” followed by a short summary in plain English of the derogations and their effect. Where an LMA model is used and its prominence guidance is followed, the s.16(2)(a) pre-contractual notice test is generally satisfied. Brokers should nevertheless review each occurrence on its facts: the LMA models are guidance, not a magic formula, and a clause that is technically compliant in form may still fall short in substance if it is not actually drawn to the insured’s attention in the placement process.

9. The broker’s checklist

Brokers carry a regulatory duty under ICOBS 5 to ensure that policy terms are presented to the client in a way that enables an informed decision. Where a market reform contract or policy wording contains contracting-out provisions, the broker should:

Identify all clauses that purport to derogate from the Act — search for express references to s.3, s.8, s.10, s.11, s.13A or to “the Insurance Act 2015” generally, and screen the wording for the substantive opt-outs listed in section 7 above.
Assess whether each clause is a “disadvantageous term” within s.15(2) by reference to the substantive effect, not the label.
Push back in the placement where the derogation is unwarranted or unnecessary. Many opt-outs (for example, restoring avoidance for innocent non-disclosure) are negotiable.
Flag in writing to the insured every derogation that survives negotiation, explaining the substantive effect in plain English. A short table — “Default Act position / What this policy says / Effect on you” — is good practice and discharges the broker’s ICOBS 5 obligation while also helping the insurer to meet its own s.16(2)(a) burden.
Diary the variation point. Contracting-out clauses introduced mid-term by endorsement require fresh s.16 compliance under s.18. The broker should treat each variation as a discrete placement.
Keep the audit trail. The broker’s file is the contemporary evidence both of the s.16(2)(a) pre-contractual notice and of the broker’s compliance with ICOBS 5. Email confirmations, signed acknowledgements and dated placement files should be retained for the policy limitation period.

Frequently Asked Questions

1. Can parties contract out of the Insurance Act 2015? Yes — but only in non-consumer contracts and only in compliance with Part 5 of the Act. Consumer contracts are governed by CIDRA 2012, which cannot be contracted out of.

2. What is a “disadvantageous term”? A term of a non-consumer insurance contract that would put the insured in a worse position than the default position under Parts 2 to 4 of the Insurance Act 2015 (s.15(2)).

3. What are the transparency requirements in s.16? The insurer must (a) take sufficient steps to draw the term to the insured’s attention before the contract is entered into and (b) ensure that the term is clear and unambiguous as to its effect (s.16(2)).

4. Can insurers contract out of the late-payment damages regime in s.13A? Partially. Insurers can exclude liability for late payment caused by ordinary negligence or honest error, subject to s.16 transparency, but cannot exclude liability for deliberate or reckless breach (s.16A).

5. Does a clause have to be in a particular location to satisfy s.16? There is no prescribed location, but the more onerous the term the more conspicuously it must be presented. The principle from Interfoto v Stiletto [1989] QB 433 — that onerous terms require special notice — applies by analogy.

6. Are Lloyd’s standard clauses (e.g. LMA5256) automatically compliant? They are a strong starting point. The LMA model clauses are designed to satisfy s.16 if used as intended and given proper prominence in the placement, but the substantive test still has to be met on the facts of each placement.

7. Does s.16 apply to mid-term variations? Yes. Section 18 applies the Part 5 regime to variations as well as to original contracts. Each variation must satisfy s.16 in its own right.

8. What is the broker’s role under FCA ICOBS 5? Brokers must ensure that policy terms are presented to the client in a way that enables an informed purchase decision. Contracting-out clauses should be identified, explained in plain English and documented in writing.