Extension of unfair contract term protections to insurance contracts: A challenging new landscape for insurers

On 27 June 2018, the Commonwealth Treasury released a Proposal Paper outlining the envisaged extension of unfair contract terms protections to standard form insurance contracts. The proposed reforms to the Insurance Contracts Act 1984 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) seek to ensure that consumers and small businesses that purchase insurance have the same access to protection from unfair terms in insurance contracts as they do for other contracts for financial products and services.

What makes a contract term unfair?

Legislation relating to unfair contract terms was first introduced in 2010. It applied to all sectors of the economy and to all businesses operating in those sectors that use standard form contracts in their dealings with consumers. A standard form contract will typically be prepared by one party to the contract and is not the subject of negotiation between the parties – it is offered on a "take it or leave it" basis.

Generally, a term of a consumer contract is unfair if it:

• would cause significant imbalance in the parties' rights and obligations arising under the contract;
• is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term; and
• would cause detriment to a party if it were to be applied or relied on.

While the unfair contract terms laws apply to most financial products and services, they do not currently apply to insurance contracts regulated under the Insurance Contracts Act. Unfair contract terms protections were the subject of discussion in the recently released Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. This Interim Report did not include the Commissioner's views on the issues raised in the insurance hearings in September. It is likely that Commissioner, the Honourable Kenneth Hayne AC QC, will again address this topic as it relates to insurance contracts in his final report, due in February 2019.

How unfair contract terms laws could apply to insurance contracts

The Government's proposal is to apply the existing unfair contract terms protections in the ASIC Act to insurance contracts regulated by the Insurance Contracts Act. This includes both general and life insurance contracts. The main elements of the proposed model include:

• amending section 15 of the Insurance Contracts Act to allow the current unfair contract terms laws in the ASIC Act to apply to insurance contracts regulated by the Insurance Contracts Act; and
• tailoring the unfair contract terms laws in the ASIC Act to accommodate specific features of insurance contracts.

With respect to the amendments to the ASIC Act, the "main subject matter" of an insurance contract would be defined narrowly by reference to the subject of the insurance, for example: a house, a person or a motor vehicle. The amendments to the ASIC Act would be based on the following propositions:

• a contract will be considered as standard form even if the consumer or small business can choose from various options of insurance policy coverage; 
• a term will not be unfair if it is reasonably necessary to protect the legitimate interests of an insurer. In other words, where that term reasonably reflects the underwriting risk accepted by the insurer in relation to the contract and reliance upon the term does not disproportionately or unreasonably disadvantage the insured; 
• examples specific to insurance will be added to the list of examples of kinds of terms that may be unfair, which could include terms such as those that permit the insurer to pay a claim based on the cost of repair or replacement under panel business arrangements accessible to the insurer, but which could not reasonably be achieved by the policyholder in the particular circumstances of the case; 
• where a term is found to be unfair, as an alternative to the term being declared void, a court may make other orders at its discretion; 
• to accommodate third party beneficiaries under insurance contracts, the definition of "consumer contract" and "small business contract" will include contracts that are expressed to be for the benefit of an individual or small business although the individual or business is not a party to the contract; and 
• to preserve the viability of life insurance, the amendments will make it clear that terms which allow insurers unilaterally to increase premiums are not inherently unfair, provided they are explicitly provided for by the terms of the policy. 

In addition to the proposed model involving amendment of section 15, the Proposal Paper outlines two alternatives for extending consumer protections in insurance contracts: 

• enhancing the existing Insurance Contracts Act remedies (particularly the duty of utmost good faith);
• introducing a standalone set of unfair contract terms protections in the Insurance Contracts Act which largely mirror those in the ASIC Act. 

Submissions to government on the issue of extending unfair contract terms protections to insurance contracts closed on 24 August 2018. Our view is that there probably will be further consultation before any legislative reform occurs.

Some insurance contract terms that could require a rethink

Consultation on the unfair contract regime and insurance contracts has revealed several insurance contract terms which may be "unfair" in that they potentially disadvantage consumers. These include:

• home building insurance: terms that provide that the maximum that the insurer will pay in the event of loss or damage to a building is the notional cost to the insurer of rebuilding or repairing the building, rather than the actual costs of the repair which may be higher if the insured is forced to commission repairs itself while waiting on the insurer;
• travel insurance policies: terms that allow claims to be denied on the basis of a blanket mental health exclusion;
• consumer credit insurance: terms that prevent an insured from making a disability claim if they were not diagnosed with the disability prior to ceasing work; and
• car insurance: terms that require the insured to provide the name, registration and contract details of an uninsured at-fault driver when making a claim.

What does this mean for insurers?

Ironically, all of the above provisions, if applied by insurers in the manner suggested by the report, would place those insurers in breach of existing law. So the actual amount of change to substantive law is probably not great. Insurers will, however, face significant upfront costs to review and amend policy terms and product disclosure statements, and ongoing complaint handling and compliance costs may also increase. Early investment in product compliance (ie. by re-drafting or removing clauses which have become potentially misleading and deceptive), may reduce future costs.

It is also likely that policyholder lawyers and consumer advocates will "tack on" an omnibus unfair contract term allegation, when disputing a claim payment or coverage denial. This may obviously contribute to more protracted disputes at greater expense to both the insured and the insurer.

It is hard to see how such additional expenditure would not feed into the overall cost of insurance and be passed on to policyholders, despite the Government's intention to keep premiums at a sustainable level in Australia and the insurance industry's own interest in doing so.

Given the increased scrutiny of insurers, particularly as a result of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, these reforms may be closer than previously anticipated. Faced also with the added complexity of engaging with the new Australian Financial Complaints Authority from 1 November 2018, insurers would be well advised to seek independent guidance from an early stage, in order to minimise the risk of further regulatory inquiry and frictional costs arising from the new provisions.