By Sindri Bergsson, Senior Associate

On 6 February 2020, the Australian Government passed the Financial Sector Reform (Hayne Royal Commission Response – Protecting Consumers (2019 Measures)) Bill 2019 (Bill) which, amongst other things, extended the unfair contract term (UCT) regime to certain insurance contracts.

The changes will apply to certain insurance contracts that are issued (including those that are renewed) from 5 April 2021.

This regime has already been the subject of extensive coverage (pardon the insurance pun) in various legal articles, but it is worthwhile to now take a closer look at some uncertainties in the application of the new regime.

To recap, the reforms will make the term of an insurance contract unfair if each of the below criteria are met:

1. the term forms part of a standard form contract;
2. the insured is a consumer or small business;
3. the term would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
4. the term is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
5. it would cause financial or other detriment to a party if it were to be applied or relied on.

In other words, if one of the above criteria are not met then the term will not be an ‘unfair contract term’.

Legitimate Interests

In the event that a consumer complains of an unfair contract term, we anticipate that insurers will seek to rely most heavily on the fourth criteria (above) by contending that the term is reasonably necessary in order to protect the legitimate interests of the insurer and is therefore not an unfair contract term. There is likely to be a significant amount of grey area in determining what is a legitimate business interest of the insurer.

It seems likely that one term might be seen to protect a legitimate business interest for one insurer but not another, leading to an inconsistency of application of the legislative regime across differing policies and differing insurers.

By way of example, let’s assume that Insurer A and Insurer B both provide cover for property damage to consumers. Insurer A might choose to exclude cover for terrorism for which it can’t obtain re-insurance. Insurer B might choose to exclude cover for terrorism due to its underwriting guidelines and/or risk appetite. However, it would be conceivable that Insurer A might be able to successfully argue that the exclusion is reasonably necessary to protect its legitimate business interests, whereas Insurer B might have a tougher argument.

This could lead to an inconsistent application of the UCT protections to consumers, simply because of the business interests of the insurer who providers cover.

But what it will come down to is a subjective assessment of what is a legitimate business interest for the insurer, which is not something that a consumer (or anybody) is likely to be in a position to assess without detailed information of the commercial operations of the insurer.

Application of the UCT Regime

The UCT legislation will apply to all standard form insurance contracts that are either consumer contracts or small business contracts. This is a substantial expansion of the existing laws. However, there remains uncertainty over whether the new regime will apply to strata insurance as a strata scheme is unlikely to fall within the definition of a consumer or a small business.

A consumer contract is defined to be one where at least one of the parties is an individual whose acquisition of what is supplied under the contract is wholly or predominantly an acquisition for personal, domestic or household use or consumption.

A small business contract is defined to be one where at least one party is a business that employs fewer than 20 persons and either the upfront contract price is less than $300,000 or the contract has a duration of more than 12 months and a contract price of less than $1 million.

As such, the strata insurance market is one which appears to be unlikely to be protected by the new legislative regime, despite being a reasonably significant and vulnerable insurance customer.

It will be interesting to see whether any further guidance is issued ahead of the legislative changes taking effect on 5 April 2021.