Exclusion and cancellation clauses

Exclusion clauses

Exclusion clauses seek to limit the cover otherwise provided by a policy. The policy document will state the risks that are covered and set out – often in a parallel column – any exclusions that apply. For example, a household buildings policy may cover subsidence, but exclude damage caused by coastal or river erosion.

The FOS recommends in ON4 that exclusions are printed next to the statement of cover which they modify:

In many policies the exclusions are printed on different pages from the paragraphs they modify. This can mean policyholders are unaware of relevant exclusions until their claims are rejected. In our experience, many complaints would be avoided if, for example, exclusions from theft cover were printed next to the paragraph setting out what the insurer will pay for.

The FOS has made it clear in ON1 that the proper use of exclusion clauses is entirely acceptable:

Where exclusions are clearly expressed and of general application, they are an entirely appropriate part of the insurance contract and the ombudsman will uphold them.

However, the FOS has drawn attention to two problem areas:

  • exclusion clauses that dramatically reduce the extent of cover which would otherwise be provided;
  • exclusion clauses that require a policyholder to exercise an unusual degree of care over their possessions or wellbeing.

The common requirement imposed by the FOS is that such exclusion clauses must be clearly brought to the attention of the policyholder at the point a policy is sold if they are later to be relied upon in rejecting a claim.

Exclusion clauses that dramatically reduce the extent of cover have been the subject of particular comment by the FOS in connection with private medical insurance policies, in which it is usual to cover conditions that are “acute” and exclude those that are “chronic”. For more on this see the section on private medical insurance. The FOS has indicated that it is unlikely to allow insurers to rely on the interpretation of such an exclusion in rejecting a claim, unless the exclusion was “fully explained” when the policy was sold (ON1).

Exclusion clauses that require a policyholder to exercise an unusual degree of care over their possessions or wellbeing have also been regularly considered by the FOS. There have, for example, been a series of cases where the FOS has had to consider terms in motor policies aimed at excluding theft cover where a policyholder leaves car keys in or on an unattended vehicle. These cases are considered in the motor insurance section.

Unless such exclusions are “very clearly” brought to the attention of the policyholder at the time the policy is sold, the FOS will not consider them to be reasonable.

For the future, insurers should take particular note of a warning given by the FOS. There is a tendency for insurers to encourage the view that insurance can be bought swiftly, without too much thought. If these trends continue, the FOS has indicated that it is likely to take less notice of exclusion clauses, and more notice of the environment in which a policy was sold.

Cancellation clauses

Most annual insurance policies contain a cancellation clause. Typically, this will give both policyholder and insurer the right to cancel the policy on a given period of notice. When a policy is cancelled, the question arises as to what part, if any, of the premium should be refunded. If the insurer exercises its cancellation rights, a refund is likely to be made on a pro rata basis - that is, the policyholder receives a refund proportionate to the unexpired period of cover. However, if the cancellation is requested by the policyholder, insurers will frequently refund a lesser amount.

The justification for this difference of approach is that there are fixed costs for the insurer associated with the policy - regardless of the period for which it is in force. Additionally, there will be some costs involved in processing the cancellation. In ON54, the FOS accepts that these factors might entitle an insurer to offer less than a pro rata refund when a policy is cancelled by a policyholder. However, it indicates that it will require the insurer both to have fair reasons for the refund scheme used and to have given a clear explanation of that scheme to the policyholder. The FOS relies on the Unfair Terms in Consumer Contracts Regulations 1999 (and guidance issued by the FSA on those regulations) in suggesting that any policy term which seeks to impose a penalty on cancellation may be unenforceable in law.

The FOS gives the following case study in ON54. Mr A took out an annual motor policy, but after five months sold the car. The policy conditions provided that no refund would be payable on cancellation by the policyholder more than four months after inception. In answer to an enquiry from the FOS, the insurer confirmed that this provision had a double purpose - to recover the costs involved, and to discourage cancellations. The insurer was unable to provide evidence that its actual costs warranted such a large deduction, and the use of penalties to discourage cancellation was regarded by the FOS as unfair under the regulations. It therefore required the insurer to make a pro-rata refund after the deduction of "a reasonable administration fee".

The FOS recognises that a different approach may be appropriate in some circumstances – for example where a claim has been made, where the cover is seasonal or the risk is otherwise spread unevenly over the term.