Reform of U.K. insurance contract law ‘some way off’, says Hertzell

But any changes to the Marine Insurance Act that determines how such claims are governed remain ‘some way off’, said the man with overall responsibility for U.K. insurance law during a recent AIRMIC live debate.

Fellow speaker Paul Maynard, Broker Director for Willis U.K. and Ireland, and John Hurrell, Chief Executive of AIRMIC, who hosted the debate, agreed that the current law is unbalanced and called for reforms to address buyers’ concerns.

The issue of disclosure is a hot topic for AIRMIC and insurance buyers in the U.K. currently.

Debate over claims is predicted to rise in the coming months because insurers’ margins are likely to come under pressure as the soft market conditions combine with an expected rise in claims and relatively poor investment returns and volume growth.

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AIRMIC’s ‘The Perils of Non-Disclosure’ debate was a live panel discussion about the recently published Mactavish Research Report. This report warned that, whilst rapid changes have occurred within organisations because of the financial turmoil, these increased risks faced by business have not been analysed adequately.

As such these changes have not been reported to insurers and future disclosure problems may occur, said Bruce Hepburn, Chief Executive at specialist research firm Mactavish.

According to Mr. Hepburn, buyers’ submissions standards are deteriorating because of the current financial turbulence. And, certain buyers appear unaware of their obligations on disclosure. Insurers in the U.K., that have been paying more in claims than they are legally required to do, will likely cut back on claims payment, he added.

The current law, which governs the disclosure of information from buyers to insurers when placing insurance is the Marine Insurance Act 1906. Over 100 years old, it was originally designed for shipowners that insured large vessels rather than modern-day commercial policyholders.

The Act requires the buyer of insurance to inform its insurer of all material facts that may have an effect on the mind of a ‘prudent insurer’ when it assesses risk and decides what premium to charge, said Mr. Hertzell.

“That is a difficult obligation for the purchaser of insurance to satisfy. In effect the purchaser is being asked to peer into the mind of the underwriter and, if the purchaser makes a mistake and fails to disclose information or chooses incorrect information, however reasonable, then the insurer is entitled to void that policy from the outset, refuse to pay the claim in question and indeed they can seek reimbursement of any claim already paid,” he explained.

“[This] Avoidance favours the insurer and doesn’t really fit with the kind of mutual obligation and goodwill that underpins the whole concept of insurance,” added Mr. Hertzell.

For large commercial buyers there are two options for change, Mr. Hertzell said.

The first option would be to reconsider how the duty of disclosure and the obligations on the purchaser in terms of the information that they have to provide are defined.

Reform in this context, which reflects both the interests of insurers and policyholders, would be worthwhile, but, it may have a relatively modest effect in practice, he added.

The second option would be to look at the remedies for disclosure, he said.

“The current remedies are that the polices are voided, treated as if they never existed. We do have a concern that such a one-size-fits-all remedy is inappropriate. The insurer, after all, may have had a range of responses had it known the correct information from doing absolutely nothing to refusing to take the risk in the first place,” Mr. Hertzell explained.

“And we are minded at some point to consider whether there should be compensatory remedies for the insurer. So, what you look at is what would the insurer actually have done had it known the true information and compensated for the loss it has suffered as a result of that. That may in fact change market practice because all parties would then have some kind of risk that they retained in the transaction and both would have an incentive to get it right, which at the moment they don’t,” he continued.

But, reform of the commercial side of the insurance act remains ‘some way off’, said Mr. Hertzell.

“I think it is going to be a long wait…if you (the politicians) are proposing a full review of the FSA [the U.K. financial regulator] then that is likely to soak up quite a lot of resources so I wouldn’t bank on this change happening very quickly,” he added.

Reform of the Marine Insurance Act for individual consumers, which would significantly reduce the burden of disclosure on policyholders, is underway with recent Law Commissions’ proposals to reform insurance contract law submitted.

However as reported in Commercial Risk Europe last month, there remain severe doubts about whether that reform is likely to be extended to the large corporate insurance market.

This would be a concern to AIRMIC.

During the debate John Hurrell noted that the Law Commissioner’s comments ‘tend to point towards an imbalance between the position of the contracting parties on commercial insurance contracts. I think the point that I take away is that, at the moment, the punishment (for non-disclosure) does not fit the crime and that is something that I think we need to work towards.’

Mr. Hurrell pointed towards an AIRMIC poll of its members, published last month, that suggests that disclosure is a big issue for buyers in the U.K. One third of those questioned said that they had potential non-disclosure raised in connection with a claim over the last five years.

And the claim was resolved satisfactorily in only half of those cases, explained Mr. Hurrell.

Paul Maynard of Willis described the law as a ‘Victorian relic that makes no sense on modern commercial contract.’ The law as it stands in the U.K., in comparison with European and the U.S. markets, is the ‘harshest’, he added.

“Outside of the U.K. legal system there is much more proportionality in terms of the onus placed on the insurer to make enquiries,” said Mr. Maynard. “One of the key issues with material fact law here (in the U.K.) is the all or nothing nature of it. The insurer often feels that, at the end of the long process…they have no choice but to go for the jugular,” he added.

“Obviously there is compromise sought beforehand, but, after that you are off the cliff aren’t you. Whereas generally the approach outside of the U.K. legal system is much more balanced with more opportunity for discussion and compromise,” he continued.

Mr. Maynard said he fully supports AIRMIC’s initiatives on disclosure and believes a change in the law is needed because the law, as it stands, is unbalanced.

The broker said he was concerned by the findings of the Mactavish report that suggested that buyers’ submission standards are falling and that some buyers are failing to understand their disclosure obligations.

According to Mactavish’s Mr. Hepburn, 65% of customers interviewed in their research either didn’t have a copy of their broker submission or had a copy but had not read it.

“It is expected that smaller buyers may not be [aware of] the legal obligations of material fact. But, it is quite concerning that larger businesses are also saying that when it is laid out before them they do not understand the obligations placed upon them,” explained Mr. Maynard.

“Clearly we need to do more with our clients, encouraging sensible discussions with underwriters has got to be good,” he said. “Where I think brokers need to improve is by being able to work with clients to get them to give richer information…and we have just got to be better at encouraging that,” he added.

Mr. Hurrell argued that most clients would be prepared to disclose more, but called for clarification from brokers and insurers on exactly what buyers need to disclose and what may drive risk pricing and the material information upon which insurers rely.

Transparency and particularly pricing transparency is something that we encourage, said Mark Platten, Chief Underwriting Officer for Zurich Global Corporate in the U.K.

“We would encourage any customer to sit down with their insurers and understand what assumptions the underwriter has made in order to reach his pricing conclusion or indeed setting the other terms and conditions. And, it is surprising how much comes out during these sessions. It is certainly something that we have been actively encouraging and I would encourage any customer to talk to any insurer about it,” he said.