To:Christina Sparks,

Law Commission,

Steel House,

11 Tothill Street,

London SW1H 9LJ

6 October 2010

Dear Christina,

AFM Response toIssues Paper 7, Insured’s Post-contract duty of good faith

  1. I am writing in response to this consultation paper, on behalf of the Association of Financial Mutuals. The objectives we seek from our response are to:
  • Provide our general support for the proposals in the paper, and commenton issues that may have greatest impact;
  • Highlight the importance of aligning the law, industry practice and the FOS approach to fraudulent claims.
  1. The Association of Financial Mutuals (AFM) was established on 1 January 2010, as a result of a merger between the Association of Mutual Insurers and the Association of Friendly Societies. Financial Mutuals are member-owned organisations, and the nature of their ownership, and the consequently lower prices, higher returns or better service that typically result, make mutuals accessible and attractive to consumers.
  1. AFM currently has 57 members and represents mutual insurers and friendly societies in the UK. Between them, these organisations manage the savings, protection and healthcare needs of 20 million people, and have total funds under management of over £80 billion.
  1. As a sector, we believe the primary role of an insurance provider is to pay legitimate claims as quickly as practical. There are a significant number of AFM members that are providers of income protection- and their commitment to paying claims is clear and best demonstrated by the number who publish claims statistics. Very few non-mutual providers follow suit, and we consider that this is because they see their primary role as to maximise shareholder value.
  1. A mutual insurer and its members are bound by the rules of the organisation. These rules are made with clear reference to the law and prevailing legislation, and may therefore determine the recourse open to the insurer in the event of fraud. AFM members would risk finding themselves operating ultra vires if they acted beyond their rules.
  1. The issues paper focuses on fraudulent claims, and explores alternatives to the insurer avoiding the contract from the start. Much is made of the information asymmetry that exists between financial services providers and their customers and how this works in favour of the provider, but fraud is clearly an exception to this. The doubling in the value of fraud in general insurance over the past five years is a great concern.
  1. But it is also a reminder that insurers have legitimate powers to verify the validity of claims, and in particular for mutual organisations, a growing responsibility on behalf of policyholders as a whole, to ensure they have the skills to identify fraud and the proper legal recourse to remedying fraud. In this respect we accept that the burden of proof for fraud is with the insurer and that the threshold is set high- but we are concerned that in some cases referred to the Financial Ombudsman Service, continued evidence of a consumer deliberately misleading an insurer or healthcare professionals is dismissed simply because the customer denies it.
  1. So the evidence presented in the paper that highlights the possible contradictions between common law and legislation is useful. On the whole we consider that insurers navigate between these contradictions affectively, but in our experience the Financial Ombudsman Service has produced decisions that draw us into conflict with the law and with the rules, and as stated above the risk of acting ultra vires is a significant risk to a mutual.
  1. We therefore accept that it may be helpful to introduce legislation to clarify the insurer’s remedy for a fraudulent claim. With that in mind, we agree with the proposals that for claims received following the date of enactment:
  1. The insured should forfeit the whole claim to which the fraud relates.
  2. A fraudulent claim should not affect previous, valid claims, whether or not they have been paid.
  3. A fraudulent claim should give the insurer the right to terminate the contract, but should not affect a valid claim arising between the fraud and the termination.
  4. The insurer should be entitled to recover reasonable and foreseeable costs relating to a fraudulent claim which would not otherwise be compensated.
  1. We consider that the inconsistencies between the legislation, the binding rules of insurers, common law and the FOS’ approach as sufficient until the date of enactment to indicate that the issues in paragraph 9 above do not constitute recognised good practice now, nor that they should be retrospectively applied to claims rejected in the past. We would value your thoughts on this.
  1. We agree with the proposal that there should be a non-excludable duty of good faith on both insurer and insured, and that the legislation should state that there is a duty on the insured not to make a fraudulent claim. We also agree that where an insurer seeks greater remedy than forfeiture of the claim, for example to avoid the contract altogether, that this must be stated unambiguously, presumably in policyholder documents and contractual terms.
  1. We broadly agree with other aspects of the consultation, in summary:
  1. We would be content to act in accordance with any statutory reform in relation to co-insurance;
  2. We agree that the current approach to increases in the risk are appropriate and that adopting the Principles of European Insurance Contract Law have little value;
  3. The insured’s general duty of good faith should continue to have general, unspecified effect.
  1. We would also point out that many fraudulent claims are preceded by fraudulent applications, so that if the principle is adopted that the remedy for fraud is centred on the point of time at which it occurs, then where a fraudulent claim was preceded by a fraudulent application, the insurer should be able to avoid the contract from the start. For the most part, this is covered in the pre-contract disclosure requirements, but (fraudulent or intentional) non-disclosure at outset may only become apparent, or be compounded by a fraudulent claim.
  1. Wewould be pleased to discuss further any of the items raised by our response.

Yours sincerely,

Martin Shaw

Chief Executive

Association of Financial Mutuals

AFM Response to Law Commission Issues Paper 71 of 3

October 2010