From 4 May 2017 insurers have been under a duty to pay valid insurance claims within a reasonable time. If they fail to comply, they may be liable to pay damages to an insured who has suffered additional losses as a result of the delay in payment. This obligation only applies to insurance and reinsurance contracts taken out, varied or renewed from 4 May 2017.
This potential liability in damages is a significant U-turn in the law, which, until recently, provided little sanction to an indemnity insurer who was slow to pay under an insurance policy without just cause. Insurers, including those who are distrustful of their insured, will find it more difficult to defend a claim cheaply by doing nothing or to impose unnecessary hurdles on the claim in order to test the claim or the insured’s resolve.
A blot on English law is erased
In contract law, the general rule is that if one party breaks a contract, the other party may claim damages for any foreseeable loss that results from the breach. However, at common law, this rule did not apply to indemnity insurance due to an unhelpful special rule, referred to by the English and Scottish Law Commissions as a legal fiction, which rendered an indemnity insurer’s primary obligation under the insurance contract a duty to prevent the insured event from happening (and not to pay claims in return for a premium). This meant that an insurer was in breach of contract upon the happening of the insured event and was liable to pay damages in the form of the insurance monies due under the policy. In other words, indemnity insurance monies were considered to be damages and not, as one might expect, a debt due under the contract. This fiction, coupled with the legal principle that there can be no payment of damages for the late payment of damages, meant that, other than a potential liability to pay simple interest under the Senior Courts Act 1981, insurers could delay paying a claim with impunity (The Italia Express (No 3)). An insured who suffered foreseeable loss as a result of the delay would not be compensated.
An insurer dragging its feet over payment without reason could have catastrophic consequences for some insureds, especially small and medium businesses. The notorious case of Mr Sprung in Sprung v Royal Insurance (UK) Ltd, is a powerful example. In that case, the insurers’ four year delay in paying the insurance monies caused Mr Sprung to suffer substantial further losses and to eventually go out of business. However, the Court of Appeal held, albeit reluctantly, that he could not be compensated for his extensive and foreseeable losses.
This “blot in English common law” (see M. Clarke, Late Payment of Insurance Money, Erasmus Law Review, Vol. 5, 2012) led to calls for reform, culminating in the report of the English and Scottish Law Commissions recommending a statutory duty no to delay payment. This recommendation was enacted by the Enterprise Act 2016.
A new implied duty
A term is now implied into every insurance policy taken out, varied or renewed from 4 May 2017 that insurers must pay insurance claims within a reasonable time (see sections 28 to 30 of the Enterprise Act 2016 Act, and section 13A of the Insurance Act 2015). If they do not, they may have to pay damages to the insured. This new right to claim damages for late payment is in addition to the insured’s right to interest (under the contract or statutory) on those sums.
The key points to note are:
- A reasonable time will always include time to investigate and assess the claim.
- What is reasonable in a given case is not defined, but it is an objective test and will depend on all the relevant circumstances, including the type of insurance, size and complexity of the claim, compliance with relevant statutory and regulatory rules or guidance, and factors outside the insurer’s control.
- An insurer has a defence: it will not be in breach of the implied term where it fails to pay the entire or part of a claim and has reasonable grounds for doing so. However, the manner in which the claim is handled may be a relevant factor in deciding whether the term was breached.
- The new duty simply changes the default regime and parties to non-consumer insurance remain free to contract out of section 13A, provided the breach of the implied term is not deliberate or reckless and the insurer has made clear to the insured that it is contracting out (sections 16A and 17, Insurance Act 2015).
- Insureds have one year from the date the insurer made full payment of, or otherwise settled, the claim to bring a claim for late payment.