Insurance focus

Publication | March 2014

Introduction

In this edition of Insurance focus, Stephen Pate and James Hartle from our Houston office consider some of the most important cases throughout the Gulf Coast that deal with disputes following storms in the region.

The cyber insurance market continues to evolve in light of increasing data privacy and security concerns. Ffion Flockhart and Steven Hadwin, in our London office, discuss changes to the data protection landscape and potential growth opportunities for insurers writing cyber risk. From our tax practice, Dominic Stuttaford and Uwe Eppler explore the impact on co-insurance arrangements of a German court decision that lead commission paid to a lead insurer is subject to VAT.

Our regular case notes feature includes a selection of recent decisions from across our global practice. Cases cover environmental policies in the US, punitive damages in Canada, prescription clauses in South Africa, and a landmark decision in the UK resolving uncertainty over whether a complainant can accept a FOS award and then launch a subsequent court action for further redress.

Finally, in our international focus section we report on the progress of IMD2, as well as regulatory updates from China, South Africa and the UK.

Gulf Coast Insurance law update

Recent state court decisions throughout the Gulf Coast help clarify the law of insurance. Many of these cases deal with disputes arising in the aftermath of storms from the first decade of the 21st century—most notably Hurricanes Katrina and Ike. In this update, Stephen Pate and James Hartle from our Houston office summarise some of the most important cases from the past year in the hope that insurance lawyers, insurers, and insureds can better understand and account for risk before devastating storms bear down on the region once again.

Appraisal

A pair of recent cases demonstrate Texas courts’ strong preference for enforcing appraisal provisions in insurance contracts. In the case of In re Public Service Mutual Insurance Company1, an insurer invoked an appraisal provision in the insurance contract six months after the insured brought suit for wrongful denial of its claim. The trial court stayed the proceedings and ordered a mediated appraisal. The insured then sought mandamus relief from the Austin Court of Appeals.

On appeal, the Court first reiterated Texas courts’ preference for enforcing appraisal provisions absent illegality or waiver before rejecting the insured’s argument that a dispute between the parties over coverage made the appraisal provision unenforceable. The Court explained that the process of appraisal inherently involves determinations of causation for coverage purposes, and that to hold that a coverage dispute makes the appraisal provision inapplicable would invalidate all appraisal provisions. The Court then turned to the insured’s two waiver arguments. The Court rejected the insured’s waiver-by-futility argument on the ground that the parties were still negotiating, and rejected the waiver-by-delay argument on the grounds that a six month delay was not unreasonable and that the insured was not prejudiced by the delay. Finally, the Court, in a fairly terse manner, rejected the insured’s various common law contract unenforceability arguments.  

In a similar case, In re Texas Windstorm Insurance Association2, much like in the case above, the 14th Court of Appeals upheld the enforcement of an appraisal provision. The Court reinforced the proposition that disputing coverage does not take an insurance dispute out of the scope of a standard appraisal provision. The Court also rejected several waiver arguments, including the claim that the insurer waived appraisal by compelling it seven days after receiving the insured’s notice of intent to sue.

Bad faith

Two recent cases help clarify the bad faith tort in Florida and Alabama. In Hunt v. State Farm Florida Insurance Company3, a home owner obtained an appraisal award against his insurer. The homeowner then sued the insurer for bad faith for denying his initial claim. The insurer sought to dismiss the suit on the ground that an appraisal award is not a “favourable resolution” for the insured, which is a necessary element for maintaining a bad faith claim in Florida. The trial court agreed and the homeowner appealed. On appeal, the 2nd District Court of Appeals of Florida reversed the trial court decision citing prior cases to show that an arbitration award constitutes a “favourable resolution,” and extended that precedent in holding that an appraisal award does as well.

The Alabama case, State Farm Fire and Casualty Co. v. Brechbill4, arose out of a dispute between a homeowner (Brechbill) and his insurer, State Farm. After State Farm denied Brechbill’s claim, Brechbill sued on two theories: (1) “normal” bad faith refusal-to-pay; and (2) “abnormal” bad faith failure-to-investigate. At trial, Brechbill did not oppose State Farm’s motion for summary judgment on the refusal-to-pay claim, but he did oppose the motion with respect to the failure-to-investigate claim. The trial court granted the unopposed part of the motion, but let the case proceed to the jury on the failure-to-investigate claim. Brechbill won at trial, and State Farm appealed.  

On appeal to the Alabama Supreme Court, State Farm asserted that the bad faith tort was a single tort, and that the trial court’s grant of State Farm’s motion for summary judgment on bad faith refusal-to-pay precluded Brechbill’s recovery on the bad faith failure-to-investigate claim. Brechbill countered by citing Jones v. Alfa Mutual Insurance Company, 1 So.3d 23 (Ala. 2008), for the proposition that his two theories constitute two separate torts, and that the dismissal of a bad faith refusal-to-pay claim does not preclude an award for bad faith refusal-to-investigate.

The Alabama Supreme Court first clarified the law by holding that the bad faith tort constitutes a single tort that can be proved in two different ways. A plaintiff seeking to establish the tort on the bad faith refusal-to-pay theory must establish: (1) breach of insurance contract; (2) refusal to pay on the claim; (3) absence of legitimate reason for refusal; and (4) insurer knowledge of such absence. Alternatively, a plaintiff can establish the tort on the bad faith failure-to-investigate theory by demonstrating that the insurer intentionally failed to determine whether there was a legitimate or arguable reason to refuse to pay on the claim. Under either theory, the tort requires proof of absence of a legitimate reason to deny the claim.

The Court went on to distinguish this case from Jones by noting that, in Jones, evidence for the insurer’s denial was gathered after the denial was made. In contrast, here, because State Farm investigated the claim before denying it, and because State Farm had arguable grounds for the denial, the trial court erred by letting the jury hear Brechbill’s claim for bad faith failure-to-investigate. The Court thus reversed and remanded the action to the trial court.

Causation analysis

Florida law on the proper causation analysis in first-party insurance disputes where there is no concurrent-cause exclusion in the policy has been clarified by American Home Assurance Co. v. Sebo5. In this case, Florida’s 2nd District Court of Appeals noted that the trial court’s application of concurrent-cause theory would effectively nullify all exclusions in an all-risk policy because “a covered peril can usually be found somewhere in the chain of causation.” The Court, unwilling to abide by that rule, remanded the action for a new trial where the trial court would analyse causation under the efficient proximate cause theory.

Coverage

Over the course of the past year, US courts have handed down a number of decisions determining coverage under complex insurance policies. JAW the Pointe6, a recent Texas case, has garnered significant publicity for its application of a concurrent-cause exclusion.

In JAW the Pointe, the 14th District Court of Appeals of Texas overturned an award against an insurer because of a concurrent-cause exclusion. Lexington insured the Pointe, a Galveston apartment complex, against losses due to wind and for rebuilding costs caused by operation of ordinance or other law. The policy-at-issue also contained flood and concurrent-cause exclusions. After Hurricane Ike swept over the Texas coast and severely damaged the Pointe, the City of Galveston ordered the Pointe to rebuild to certain specifications. In its letter ordering rebuilding, the City noted that the Pointe had sustained enough damage for an ordinance to require rebuilding of the complex, but the City did not differentiate between flood and wind damage in its damage assessment. After Lexington denied the Pointe’s claim, the Pointe sued for bad faith and won. The Court of Appeals overturned the verdict, holding, amongst other things, that the Pointe failed to prove that the ordinance would have come into effect to cause the loss absent the non-covered flooding that undoubtedly contributed to the damage, a showing necessary to avoid the concurrent-cause exclusion in the policy.

While JAW the Pointe may have some insureds concerned, insurers have their own cases to worry about. In American National Property & Casualty Co. v. Fredrich 2 Partners, Ltd.7, the Court of Appeals of El Paso reinforced the importance of sound policy drafting lest the policy be interpreted against the insurer. Fredrich owned and leased out commercial properties insured by American National. The policy expressly excluded damage caused by frozen plumbing unless Fredrich did its “best to maintain heat in the building or structure” or “drain[ed] the equipment and shut off the supply if the heat [was] not maintained.” During a cold spell, the pipes above an unoccupied, unheated unit within one of Fredrich’s buildings froze and broke, causing water damage to the building. After American National denied its claim, Fredrich sued, arguing that it did “its best to maintain heat” because a tenant in a different unit in the same building had done so. Fredrich was successful at trial. On appeal, the Court upheld the verdict ruling that heat had been maintained “in the building”, and that Fredrich, by giving its tenant the electricity and gas with which to keep one unit heated, had lived up to its obligations under the policy.

Another case, this one from Mississippi, should also have insurers’ full attention. In Coastal Hardware & Rental Co. v. Certain Underwriters at Lloyd’s of London8, the Court of Appeals of Mississippi upheld the trial court’s determination that the Underwriters had agreed to cover wind damage in an insurance binder. Coastal had worked through its agent to obtain an all-risk quote from the Underwriters. The quote binder expressly excluded mould damage, but did not expressly exclude wind damage. However, in several places where deductibles were discussed, the binder did state that wind was either “excluded” or “not required.” Concerned about whether wind was or was not a covered cause of loss, Coastal called the Underwriters’ American agent, who refused to express an opinion. Coastal accepted the quote and paid the premium anyway. It had no independent wind carrier, and before the formal policy arrived, Hurricane Katrina struck, destroying Coastal’s retail operation.

In the ensuing litigation, the trial court granted partial summary judgment in Coastal’s favour, finding that the Underwriters had agreed to cover wind damage under the terms of the binder. On appeal, the Court of Appeals of Mississippi upheld that ruling, stating that: (1) the binder served as the insurance policy until the formal policy was received; (2) the circumstances did not make the parties’ intent clear; (3) the binder’s terms were ambiguous; and (4) the trial court properly construed the terms to cover wind damage. The Court placed a particular emphasis on the fact that the binder-at-issue contemplated an “all-risk” policy and lacked an unambiguous wind exclusion.

A final coverage case of note for insurers is In Cheetham v. Southern Oak Insurance Co.9 The Florida courts tangled with the issue of how to interpret an exclusion for loss caused by water or water-borne material backing up through sewers or drains. The 3rd District Court of Appeals of Florida held that a loss resulting from the deterioration of the piping inside a home that caused debris to build up causing a leak in said home was covered. The Court, reading the “back-up” exclusion in conjunction with provisions covering on-premises leaks and excluding off-premises discharges or overflows, held that the exclusion contemplated backup resulting from off-premises water leaks, not on-premises leaks.

Coverage limitation

A Louisiana case demonstrates the importance for insureds of adhering to limitations provisions in that state, and the danger of not doing so. In Orleans Parish School Board v. Lexington Insurance Company10, the Orleans Parish School Board (OPSB) sought to have its excess insurers cover the increased costs of repairing numerous public schools in the New Orleans area that were severely damaged by Hurricane Katrina. The insurers, citing a two-year limitation provision in the relevant policy, refused to pay. The trial court granted summary judgment to the insurers based on the limitation provision.

On appeal, OPSB argued, amongst other things, that the provision contemplated an impossible and therefore unenforceable condition under Civil Code Art. 1769. OPSB asserted that the process of gaining approval for reconstruction, doing due diligence on the contracts, and making the actual repairs was not possible within two years of the loss. The 4th Circuit Court of Appeals of Louisiana was not persuaded, stating that Art. 1769 concerns itself with “absolute impossibility,” not impossibility under the facts of a given case.

For more information contact:

Stephen P. Pate

James B. Hartle

1 In re Public Service Mutual Insurance Company, 03-13-00003-CV, 2013 WL 692441 (Tex. App.—Austin February 21, 2013)

2 In re Texas Windstorm Insurance Association, 14-13-00632-CV, 2013 WL 4806996 (Tex. App.—Houston [14th Dist.] September 10, 2013)

3 Hunt v. State Farm Florida Insurance Company, 112 So.3d 547, 549 (Fla. 2nd DCA April 5, 2013)

State Farm Fire and Casualty Co. v. Brechbill, 1111117, 2013 WL 5394444 (Ala. September 27, 2013)

5 American Home Assurance Co. v. Sebo, 2D11-4063, 2013 WL 5225271 (Fla. 2nd DCA September 18, 2013)

6 Lexington Insurance Co. v. JAW the Pointe, LLC, 14-11-00881-CV, 2013 WL 3968445 (Tex. App.—Houston [14th Dist.] August 1, 2013, pet. filed)

American National Property & Casualty Co., 08-12-00133-CV, 2013 WL 3939931 (Tex. App.—El Paso July 31, 2013)

8 Coastal Hardware & Rental Co. v. Certain Underwriters at Lloyd’s of London, 120 So.3d 1017, 1020 (Miss. Ct. App. March 26, 2013)

9 Cheetham v. Southern Oak Insurance Co., 114 So.3d 257, 258–61 (Fla. 3rd DCA March 27, 2013)

10 Orleans Parish School Board v. Lexington Insurance Company, 118 So.3d 1203, 1207 (La. App. 4 Cir. 6/5/13)

The General Data Protection Regulation and the evolution of cyber insurance

Recent decades have seen the emergence of a number of policy forms which respond to increased legal and regulatory burdens imposed on companies and individuals by English and EU law. For example, directors' and officers' (D&O) insurance has evolved to cover many of the increased risks which directors and executives face in today’s regulatory climate. Diverse other policy forms, from employment practices liability to pollution liability, have developed in response to greater legal and regulatory burdens being placed on insureds. Perhaps the most recent significant development is in the field of cyber insurance, given the increased focus of governments and legislatures on data privacy and security. In this article, Ffion Flockhart and Steven Hadwin consider the impact of proposed EU legislation and the potential growth opportunities in the cyber market.

The General Data Protection Regulation (the Regulation) is a proposed EU regulation which would impose a robust, harmonised data protection law across the EU. The Regulation will replace the existing Data Protection Directive (95/46) and will be directly applicable in all EU member states.  

While the final text of the Regulation is yet to be agreed, some of the most significant proposals which impose greater burdens on companies are as follows:

  • Companies based in the EU, as well as non-EU companies that carry out certain types of business in the EU, will need to report all personal data breaches to the appropriate data protection authority without undue delay, and where feasible within 24 hours.
  • Persons affected by the data breach will be able to claim compensation from the company affected, if the company is in breach of the Regulation.
  • Companies that breach their obligations under the Regulation could be fined as much as €1 million or 2 per cent of their global annual turnover, whichever is higher.

The Regulation would represent a significant increase in the data protection obligations imposed on companies in England & Wales.

At present, the final terms of the Regulation, including the details of the obligations to be placed on organisations, the sanctions for non-compliance and the likely timeframe for implementation, are only propositions and remain to be finally determined. Plans to agree the form and content of the Regulation before the European Parliamentary elections in May 2014 now appear unrealistic and 2017 is effectively the earliest year in which the Regulation could come into in force.

The timetable for implementation could slip further given that a number of Member States are still expressing reservations about the Regulation’s content – with UK Home Secretary Theresa May recently commenting that the Regulation’s proposals “do not reflect the realities of the modern, interconnected world” and the UK Information Commissioner’s Office having commented that the potential penalties imposed on companies may be too harsh.

Whatever the final form of the Regulation, it appears likely that it will act as a catalyst for growth of the cyber insurance industry. The implementation of more stringent data protection laws in the United States, many of which contain compulsory notification regimes and mechanisms by which affected individuals can bring claims against the organisations which process their personal data, has seen the US cyber insurance industry develop into a $1 billion industry, with around 30 insurers competing for business. The potential for growth in Europe is therefore clear.

Insurers will need to act quickly to ensure their cyber product offerings match market demand following the implementation of the Regulation. Equally, insureds will need to ensure that any cyber cover which they obtain matches the risk landscape they face.

Particular developments in policy form which are likely when the Regulation comes into force include the following:

  • There will be a general shift away from the current focus in European cyber insurance policy wordings on first-party losses. At present, insureds tend to be more concerned about cover for first-party risks such as loss arising from business interruption following a cyber attack than potential third-party liabilities. The implementation of the Regulation looks set to change this, as insureds will need to consider the much larger potential liabilities for non-compliance with their legal obligations and the potential third-party claims in relation to non-compliance.
  • The shift towards greater emphasis on cover for third-party liabilities will lead to some elements of existing cyber insurance policies becoming obsolete. Time deductibles, for example, will not be a suitable mechanism in a policy which is primarily designed to cover liabilities to third parties rather than first-party loss.
  • Insureds will most likely be required to give a wider range of pre-contractual warranties that they have taken steps to comply with data protection laws including the Regulation, given the potential consequences of breach. Insurers are also likely to carry out more stringent due diligence on potential insureds for this reason.
  • Ancillary services provided under a cyber insurance policy, such as legal and forensic support in the event of a data breach, will also grow in significance as responding swiftly to breaches will become a crucial step avoiding or minimising liability under the Regulation. Appropriate legal support will, for example, optimise the possibility that timely and accurate notifications are made to all relevant data protection authorities.

Each of these issues will require careful consideration from a policy drafting and negotiation perspective.

There are also a number of legal considerations which may affect the scope of cover provided by cyber insurance policies following the implementation of the Regulation. For example, while it will most likely be legally possible to insure liabilities arising out of claims brought by individuals who have been affected by a data breach, the legal position remains unclear on the insurability of fines issued by data protection authorities pursuant to the Regulation.   

At present, penetration of cyber insurance products in Europe remains low, with only around 1 per cent of potential insureds taking out cyber cover. Market research has shown that this reluctance to purchase cyber cover often arises out of a perception that many of the benefits provided by a cyber policy are offered under more conventional covers such as property damage and business interruption or general liability policies. However, the increased risk of third party liability pursuant to the Regulation looks set to change this perception.

For insurers, this represents a valuable opportunity to grow their cyber business. Insurers should act now to ensure that the products they offer accurately reflect the risks which their customers face, including under the Regulation.

Equally, insureds should begin to consider how the Regulation will affect the risks and potential liabilities they face and should also consider whether any cyber products they have obtained to date would cover these risks appropriately.

For further information contact:

Ffion Flockhart

Steven Hadwin

German VAT decision could have significant impact on co-insurance arrangements in Europe

A German court decision has determined that lead commission paid to a lead insurer on a co-insurance arrangement is subject to VAT in Germany. If this decision were followed throughout the EU, it will potentially have a significant impact on all co-insurance arrangements. In this article, Dominic Stuttaford and Uwe Eppler from our tax practice take a look at the decision and consider the implications for insurers and insureds.

The facts of the case are relatively straight-forward. The lead insurer was paid an enhanced share of the premium on a co-insurance programme; it undertook to carry on the task of arranging the co-insurance and provided various “administrative” services. The conclusion reached by the German Fiscal Court was that contrary to the expectations of the parties when the insurance was entered into, these services were subject to VAT. They were provided to the co-insurers. The consideration was the additional premium received by the lead insurer, over and above that part of the aggregate premium proportionate to its risk.

This decision has potentially major consequences; if a VAT-able service is provided to other insurers, any VAT is likely to be a cost of the programme, as the insurers are likely to be largely exempt entities. The VAT could be suffered either because the lead insurer is obliged to charge VAT (if the other insurers are in the same jurisdiction) or if there is a reverse charge cost where the recipient of the service has to charge itself VAT. The one exception to this would be if the recipient of the services (in this case the other insurers) were underwriting the policy from outside the EU. In this case, the place of supply by the lead insurer would be likely to be outside the EU.

It is arguable that this decision should not prevail more generally within the EU. The decision is not binding on, say, an English court, which it would be, were this a decision of the Court of Justice of the European Union.

In seeking to analyse other similar arrangements such as co-insurance arrangements for multinational insurance programmes, the first issue is to consider if there is a service, to whom is it provided? The service could be seen as being provided to the insured (and not the other insurers). The insured is the recipient of the insurance and benefits from the fact that the co-insurance arrangement has been put in place. If this is the aim, two possible treatments could apply. First, if there is a separate VAT-able supply to the insured of administrative services, most insureds would be expected to recover any VAT charged (to the extent that they were in the EU). The one exception would be if the insured were in the financial sector and therefore generally unable to recover its VAT generally. Secondly, and this may often be the case – there could be one composite supply under the insurance contract to the insured – of insurance. Any supply of administrative services would not therefore be a separate supply; rather, it would be ancillary to the main supply. The main supply would then be exempt from VAT and in most cases, subject to insurance premium tax (IPT). Indeed, one of the unfortunate consequences of this decision is that in theory, there could be a double charge to indirect tax, IPT on the premium charged to the insured and VAT paid on a supply of administrative services.

Assuming that there is not a supply to the insured and therefore a service is being provided to the co-insurers, it could be argued that a more natural interpretation is that the service being supplied is essentially one of insurance brokerage (and therefore exempt). The lead insurer’s composite supply for which it is receiving an enhanced share of the premium is the arranging of the insurance and putting together the panel of insurers, who will together underwrite the risk.

Where does this leave insurers and insureds?

The decision is of the German Fiscal Court and therefore binding in Germany. In this specific case, the German court did not accept that the co-insurance arrangements were drafted in a form for there to be a service to the insured. Rather the German court concluded the contractual arrangements indicated that the services were provided to the co-insurers. Also, the German Fiscal Court rejected the argument that there was an (exempt) brokerage service provided to the co-insured.

The case means that insurers should look carefully at the wording of their co-insurance arrangements and see if there is room for the relevant tax authority to take a similar view to the German court. In some cases, this may not matter, if the co-insurers are based outside the EU. Much will depend upon the drafting; this is not conclusive but making it clear who supplies what to whom is likely to be key. In each particular case, thought should be given before the policy is concluded as to what the intended contractual arrangements should be and what impact this has for VAT and IPT purposes. Once it has been concluded and any co-insurance arrangements put in place, it is likely to be very difficult, if not impossible, to alter the conclusion.

For more information contact:

Dominic Stuttaford

Uwe Eppler

Case notes

United States

Pollution Exclusion: “Sudden and Accidental” applied to legacy clean-up sites

This update was authored by Barclay Nicholson in the Houston office summarising the evolution of the “sudden and accidental” discharge exception to the pollution exclusion provision in environmental insurance policies.

The “sudden and accidental” discharge exception to the pollution exclusion provision of most environmental insurance policies has been the subject of hundreds of environmental coverage decisions throughout the years, mainly because “sudden and accidental” is not defined in the policy. Recent decisions concerning “sudden and accidental” relate to pollution incidents that occurred many years ago, with some courts applying the exception while others do not.

Travelers Indemnity v Northrop Grumman1

Northrop Grumman Corporation (NGC) sought insurance coverage from Travelers Indemnity Company (Travelers) and another carrier for the clean-up of its Bethpage, New York plant where it manufactured and tested airplanes, weapons and satellites beginning in the 1930s. In its operations, NGC used and stored volatile organic compounds such as trichloroethylene (TCE), which was used as a cleaning solvent for metal parts. TCE and other contaminants were found in the groundwater in the 1970s.  

The New York State Department of Environmental Conservation (NYSDEC) inspected and tested the site, eventually providing a 1980 report in which the plant was designated a hazardous waste site. On December 6, 1983, the NYSDEC initiated a formal adversarial proceeding against NGC who in turn allegedly notified its insurance carriers in January 1984. Travelers has no record of ever receiving this notice.  

In October 1990, NGC entered into a consent order with the NYSDEC to investigate and study the Bethpage facilities. In 1995 and 2001, the NYSDEC issued Records of Decisions (RODs) which set out remedial measures that NGC was required to implement. Travelers was not notified of the consent order or the RODs.  

In 2012, NGC sent a letter to Travelers stating that it had spent $40,600,000 to date to remediate the property. After denying coverage, Travelers brought a lawsuit to determine whether it must cover the clean-up and remediation costs.

The court decided that the pollution exclusions in the policies applied because NGC intended to use the TCE in its operations. The policies that were in effect from 1972 to 1983 excluded coverage from liabilities “arising out of pollution or contamination caused by the discharge, dispersal, release or escape of any pollutants, irritants or contaminants into or upon land, the atmosphere or any water course or body of water unless such discharge, dispersal, release or escape is sudden and accidental.” Here it clearly was not. According to the court, the lawfulness of NGC’s acts in discharging or disposing of its wastes was not at issue. Rather the relevant question was whether the act of discharge or disposal was intended, and it was.

The 1983 to 1985 policies did “not apply to bodily injury or property damage arising out of any emission, discharge, seepage, release or escape of any liquid, solid, gaseous or thermal waste or pollutant if such emission, discharge, seepage, release or escape is either expected or intended from the standpoint of any insured or any person or organisation for whose acts or omissions any insured is liable.” The court stated that NGC knew what it was doing by intentionally using TCE in its operations.

At oral argument, NGC urged that at least the initial release of TCE-contaminated water was “sudden” within the meaning of the exception. The court found no cognisable factual basis for this assertion. Every release has some instant of commencement. To read the word “sudden” to incorporate the initiation of every release would be to render that word meaningless.

It should be noted that the court also denied coverage because NGC had failed to provide timely notice under the terms of the policy and it had voluntarily assumed payments without Travelers’ consent.

Narragansett Electric Company v American Home Assurance2

Narragansett Electric Company’s (NEC) predecessor released hazardous wastes in the 1930s and 1940s in Massachusetts. In 1987, the state brought a lawsuit against NEC to clean-up that location. NEC asked for coverage from American Home Assurance Company (American Home). American Home denied coverage, stating that this was not a “sudden and accidental discharge” that would be covered.

The court decided that there was a duty to defend. Applying Massachusetts law, the court ruled that “releases occurring over extended periods of time as part of the insured’s regular business activities are not sudden and accidental, absent additional facts” but the compliant was reasonably susceptible to the interpretation that [a co-defendant’s subsequent] residential excavation caused a separate, abrupt and unintentional release by exposing the waste products to the elements, which triggered a duty to defend.

Ross Development v PCS Nitrogen3 

Beginning in 1906, Ross Development Corporation operated a phosphate fertiliser manufacturing facility near Charleston, South Carolina, which generated a slag byproduct containing high concentrations of arsenic and lead. In 1963, a fire destroyed a large portion of the plant. After constructing a new plant building, Ross sold the property and its equipment in 1966.  

Years after selling the site Ross purchased insurance policies to provide basic liability coverage for unexpected and unintentional damages to third-party property. Several of the policies contained a qualified pollution exclusion barring coverage for the discharge of pollutants onto land unless sudden and accidental. A second group of policies contained an absolute pollution exclusion, but would allow coverage if the discharge was “caused by heat, smoke, or fumes from a hostile fire.” The court ruled that, because there was no dispute Ross intentionally used materials that created the harmful byproducts, the “sudden and accidental” exception did not apply. Also Ross failed to offer any evidence that the fire actually caused any third-party property damage.  

United Nuclear v Allstate Insurance4

United Nuclear Corporation (UNC) operated several uranium mines in New Mexico from the 1960s through the early 1980s. Among other environmental incidents through those years, in July 1979, about 94 million gallons of radioactive liquid escaped from a tailings pond and poured into the nearby Rio Grande. UNC’s insurance policies provided coverage if the pollutant discharge was “both sudden and accidental.”

The New Mexico Supreme Court reasoned that since the policies lacked a definition of the term “sudden” and there was no consensus concerning its meaning among other state courts, it could take notice of dictionary definitions and look to the insurance industry’s drafting history of the qualified pollution exclusion. Reviewing these sources, the Court held as a matter of law that the term “sudden” in the pollution exclusion clause meant “unexpected,” rather than indicating a temporal limitation on the occurrence. The Court remanded the case to allow UNC the opportunity to prove that its operations led to discharges that were in fact “sudden and accidental.”

Conclusion

These decisions demonstrate that the “sudden and accidental” exception to the pollution exclusion provision contained in environmental insurance policies will continue to be a topic of much legal concern and analysis in the years to come.  

For more information contact:

Barclay Nicholson

1 Travelers Indemnity Co. v. Northrop Grumman Corp., Case No. 1:12-cv-03040 (S.D.N.Y., February 25, 2014)  

2 Narragansett Electric Company v. American Home Assurance Company, et al., Case No. 1:11-cv-08299 (S.D.N.Y., February 1, 2013) 

3 Ross Development Corporation v PCS Nitrogen Incorporated, Case No. 12-2059, 12-2454 (4th Cir. June 6, 2013)

4 United Nuclear Corporation v. Allstate Ins. Co., 285 P.3d 644 (New Mexico, August 23, 2012)

Canada

Never having to say you’re sorry: are Canadian punitive damage awards on the rise?

Punitive damage awards in Canada appear to be on the rise, with a number of significant punitive damage amounts awarded of late.

The following cases suggest a trend towards rising punitive damage awards:

  • Branco v American Home Assurance Co.1 Disability insurance case — $4.5 million in punitive damages awarded at the Saskatchewan Queen’s Bench level (currently subject to appeal).
  • Fernandes v Penncorp Life Insurance Co.2 Disability insurance case — $200,000 in punitive damages awarded at the Ontario Superior Court level.
  • Cinar Corporation v Robinson.3 Copyright infringement case — $500,000 in punitive damages awarded by the Supreme Court of Canada.

Pate Estate

The recent Ontario Court of Appeal decision in Pate Estate v Galway-Cavendish and Harvey (Township)4 appears to further substantiate this trend.    

P was the township’s chief building official for almost 10 years when he was fired because of discrepancies with respect to building fees. The township turned some, but not all, information over to the police who reluctantly laid charges against P, but only after pressure from the township. At the criminal trial, P was acquitted of all charges.

Following his acquittal, P sued the township for wrongful dismissal, malicious prosecution and reputational injuries, and also sought punitive damages. The claim for wrongful dismissal succeeded and P received punitive damages of $25,000 based on the township’s conduct, which the trial judge described as “reprehensible.”

In 2011, P successfully appealed the claim for malicious prosecution and the quantum of the punitive damage award. The Ontario Court of Appeal referred the matter back to the Superior Court, which increased the punitive damage award to $550,000 and found the township liable for malicious prosecution. The township appealed to the Court of Appeal in 2013.

The Ontario Court of Appeal upheld the finding of malicious prosecution, and substituted a punitive damage award of $450,000, noting that it was a sum sufficient to satisfy the purpose of punitive damages (i.e. retribution, deterrence and denunciation). Although this punitive damage award constituted a reduction from the Superior Court amount, the decision is notable for its high punitive damage award rendered by an appellate court. It is also noteworthy that Lauwers J.A., writing for the dissent, would have maintained the higher $550,000 award.

The decision in Pate Estate is appellate court confirmation of what appears to be a trend towards increased punitive damage awards.

Take-away

Courts have wide discretion when imposing punitive damage awards. The modest punitive damage awards originally envisioned by the Supreme Court of Canada appear to be trending upward. Employers, insurers, and defendants generally should take note and be cognisant of this apparent trend in their dealings with opposing parties, both before and during litigation.

For more information contact:

Tate McLeod

1 2013 SKQB 98

2 2013 ONSC 1637

3 Cinar Corporation v Robinson, 2013 SCC 73 [Cinar]

4 2013 ONCA 669 [Pate Estate]. This decision is not being appealed to the Supreme Court of Canada

South Africa

Contractual prescription clauses: South African insurers not alone

South African insurers can take heart from the Hong Kong High Court’s judgment to uphold an insurers’ reliance both on a time limit clause and a forfeiture clause in a commercial insurance policy.

The time limit clause provided that the insurer was not liable for any loss or damage after the expiration of twelve months from the happening of the loss or damage, unless the claim was the subject of pending action or arbitration.

The forfeiture clause provided that all benefit under the policy is forfeited if any claim is made and rejected, and no action is sued within three months of a rejection, or within three months after the arbitrator’s award.

Arbitration had been commenced within three months of the date of the rejection notice, but the arbitration notice was invalid because it did not engage the matters agreed by the parties for determination by the arbitrators.

Because the insurer rejected the claim in whole, no dispute had arisen as to the amount to be paid under the policy. In the circumstances, no arbitration was possible and the insurers were entitled to rely on the forfeiture clause.

The insured should have instituted court action in twelve months both to interrupt the time limit provision and to stall the operation of the forfeiture clause. There was no reason why the insured could not have done so.

The suggestion that the insurer had acted deviously in delaying dealing with the claim, and that there was an implied term that the claim should have been rejected or accepted within a reasonable time period was rejected by the court.

Both parties were commercial parties and the policy contained no markedly unusual or obscure language or conditions. The insured was legally represented from fairly early on in the claim and the insured could easily have acted to protect itself.

Time-bar and forfeiture clauses have been upheld by South African courts. But in the case of personal lines policies a more consumer-based approach will be adopted if the policyholder has limited means to protect their rights.

For more information contact:

Donald Dinnie

United Kingdom

Claimants have but one bite of the cherry

Clark and another v In Focus Asset Management & Tax Solutions Ltd1

The Court of Appeal of England and Wales has held that a complainant cannot accept an award from the Financial Ombudsman Service (the FOS) and subsequently bring a civil action in court for additional redress in respect of the same complaint. This landmark decision resolves the uncertainty that had arisen from two previous conflicting High Court judgments. Yet, while it provides some welcome clarification of the law, it remains to be seen how much comfort it will give professional indemnity insurers and their insureds.

The facts

In November 2008, Mr and Mrs Clark made a complaint to the FOS alleging losses of £500,000 as a result of investment advice given by their financial adviser, In Focus, to invest the sale proceeds from a family business in a geared traded endowment plan. Upholding their complaint, the FOS awarded the Clarks £100,000 (the then statutory maximum award, which is now £150,000) and recommended that In Focus pay the balance of the Clarks’ alleged loss. The Clarks accepted the FOS award inserting the words “we reserve the right to pursue the matter further through the Civil Court” in the acceptance form. In Focus paid the Clarks £100,000 only, following which the Clarks issued court proceedings against In Focus for the balance of their loss.

At first instance, In Focus sought to strike out the claim on the basis of the High Court decision in Andrews v SBJ Benefit Consultants2, which held that a complainant accepting a FOS award cannot subsequently litigate to recover the balance of any loss. The High Court3 declined to follow Andrews holding that the FOS award did not extinguish the Clarks’ cause of action.

The Court of Appeal Judgment

Allowing the appeal, Lady Justice Arden confirmed that, in accordance with the doctrine of res judicata (which essentially operates to prevent the same matter being litigated twice), acceptance of a FOS award precludes a complainant from starting legal proceedings to pursue complaints already submitted to, and decided by, the FOS.

In brief, a complainant will be barred from pursuing further litigation, and any subsequent claim will be struck out, if the following two requirements are met:

  • the defendant establishes that the complainant relied in a complaint to the FOS on a set of facts which are in substance the same as those forming the basis of the claim being litigated; and
  • the complainant accepted the FOS award in relation to the complaint.

Arden LJ considered the statutory construction of section 228(5) of the Financial Services and Markets Act 2000 (FSMA), which provides that acceptance of a FOS decision is “binding on the respondent and complainant and final”, and acknowledged that this section does not expressly address whether or not an award precludes further legal proceedings. Equally, she found that there is nothing in FSMA to exclude the common law doctrine of res judicata. Indeed, to do so would “run counter to the more specific purpose set out in section 225(1) [of FSMA] that disputes should be resolved quickly and with the minimum of formality.”

In her judgment, Arden LJ commented that if Parliament had intended that the complainant should be able to recover loss in excess of the FOS limit, it would not have imposed that limit and would have made it clear that consumers were free to go outside the scheme and start court proceedings. However, when setting up the FOS scheme for resolving disputes “Parliament manifested its intention that consumer protection did not go beyond the scheme.”  

The Court held that the FOS would not be able to circumvent the doctrine of res judicata by formulating its award in a particular way or by simply stating that the doctrine did not apply (this is a matter for the Court).

Implications

The principal effect of the Court of Appeal’s decision is to prevent a complainant from accepting a FOS award and litigating the same matter again, regardless of the size of any monetary award and any recommendations made by the FOS.

This ruling resolves the uncertainty that arose following the conflicting High Court judgments in this case and Andrews and effectively closes the door to repeat claims by complainants who accept FOS awards. Costs appears to have been one motivating factor behind the decision. As recognised by Arden LJ, if the Clarks had been successful in the appeal it could set a precedent for complainants to use a FOS award as a “fighting fund for legal proceedings” and “the development of a claims industry in this field that increases the costs of obtaining financial advice.”

Insurers and financial intermediaries will welcome this clarification of the law and the certainty that should result where the requirements described above are met. In some cases, however, there may be room to argue over whether the first requirement is met. More broadly, uncertainty remains about how this decision will influence the pursuit and defence of claims and the associated costs.

On its face, for complainants whose claims fall well within the FOS limit, or substantially exceed it, deciding whether to go to the FOS or the courts should be fairly straightforward. More difficult may be those cases that are valued closer to the FOS limit. Even then, a complainant may be more inclined to go to the FOS, on the basis that this will more likely result in a favourable decision and be cheaper and quicker than court action. This may not be so where the case is more complex or faces limitation issues.

Assuming that complainants are more likely to go to (and accept an award from) the FOS, this should not only shorten the tail of some claims but also reduce the costs exposure for firms and insurers.  However, there are several reasons why the costs burden for firms and insurers may not necessarily reduce following the Court of Appeal’s decision. First, some complainants with larger claims may be more inclined to go directly to court, which will likely result in more costs being incurred sooner by both sides. However, some complainants may still choose to refer a complaint to the FOS, hoping for a favourable indication which they can then use to support a court action. Brave may be the complainant who receives a significant monetary award from the FOS and chooses not to accept it. But some complainants may still consider it worthwhile to decline a favourable award, in view of the FOS limits. Further, complainants who are unsure of their options, or the merits or value of their claims, may seek legal advice more readily than they might have done previously, which is also only likely to increase costs.  

In short, it remains to be seen what effect the Court of Appeal decision will have in practice on how complainants pursue their claims or how firms and their insurers defend them. What can at least be said is that the decision will not necessarily have the effect of reducing costs overall and may well result in it being more expensive to resolve some cases. Decisions about the defence and settlement of individual claims will likely continue to be made on a case by case basis.  

For more information contact:

Jehan-Philippe Wood

Katie Stephen

Sally Tavares

1 Clark and another v In Focus Asset Management & Tax Solutions Ltd [2014] EWCA 118

2 Andrews v SBJ Benefit Consultants [2010] EWHC 2875

3 Clark and another v In Focus Asset Management & Tax Solutions Ltd [2012] EWHC 3669 

International focus

Europe

IMD2 plenary vote postponed as text goes back to trialogue

The European Parliament voted on various amendments to the draft Insurance Mediation Directive (or “IMD2”) on February 26, but did not vote on the underlying legislation as a whole. The IMD2 procedure file had indicated that the Parliament would vote either to accept or amend the text before the first Council reading. By voting on the amendments, Parliament has reaffirmed its position while leaving open the possibility of negotiating a first-reading agreement.

Trialogue discussion on IMD2 is not expected to resume before the elections for the new Parliament (due to take place in May 2014). The legislative timeline is now uncertain. Commissioner Barnier has indicated that there is still some way to go but expects agreement to be reached by the end of the year at the latest.

The amendments adopted by the Parliament were made to the latest iteration of the IMD2 text produced by the Parliamentary Committee on Economic and Monetary Affairs (ECON) published on February 4. ECON’s draft included a number of ignificant changes to the original proposal following considerable negotiation. Proposed changes that have been adopted by the Parliament include:

  • Scope. The scope of the proposed IMD2 no longer extends to claims managers, loss adjusters or the expert appraisal of claims. Insurers and reinsurers selling directly to customers are brought into scope. IMD2 will not apply to those who undertake insurance mediation as an ancillary activity to another profession so long as they do not take any additional steps to assist the customer in concluding the contract. Price comparison websites remain within the scope of regulation under IMD2.
  • Commission disclosure is not mandatory, but “on request” from the customer. The payment and receipt of commission is allowed but the draft requires greater disclosure about the source of any commission (or other remuneration). This will not affect the ban on commissions under the Retail Distribution Review as Member States are given discretion to impose additional requirements. Where an insurer sells directly they will be required to disclose to the customer whether any variable remuneration is paid to employees for distributing the policy in question. This will have the effect of disclosing the nature of any incentive structures for selling the policy.
  • Increased standards. IMD2 will raise the standard of professional qualifications for intermediaries and requires that at least 200 hours of continuing professional development are undertaken within a five year period (adapted proportionately for those who are not undertaking mediation as their main activity).
  • Intermediaries to act “honourably”. A general principle is introduced to ensure that intermediaries “always act honestly, fairly, trustworthily, honourably and professionally in accordance with the best interests of their customers”.
  • Cross selling. Tying and bundling are allowed although EIOPA is given the power to draft guidelines for the assessment of such practices. The European Parliament adopted a further provision allowing Member States to require national supervisors to adopt or maintain additional measures to address cross selling practices that are detrimental to consumers. Under the Parliament’s amendments, insurance offered as part of a package will be subject to the Unfair Commercial Practices Directive which provides a set of safeguards for customers purchasing tied or bundled products.
  • Alignment with MiFID. For insurance investment products IMD2 requires that conduct of business standards are aligned with those in MiFID with the result that the two regimes are consistent. Adopted amendments provide that the European Parliament will seek to ensure the alignment of IMD2 with MiFID II both during and in its negotiations with the Council.

Points of concern

The purpose of the revision of the original IMD was to ensure that there was greater harmonisation across the EU. The latest IMD2 text, although peppered with references to ensuring a “level playing field” and minimising differences in national regimes, allows for extensive Member State discretion. This would therefore seem to undermine the very point of revising the original directive.

The introduction of an overriding duty to “act in the best interests of customers” particularly extends the liability of intermediaries and insurers selling non-life products.

It is hoped that the opportunity for further trialogue negotiation will provide much needed clarity on the final text.

For further information contact:

Laura Hodgson

China

CIRC broadens reform on use of insurance funds

2014 is expected to be another growth year for China’s insurance asset management sector following its initial boom in 2010. In this article we highlight a number of recent developments and historic changes in the sector.

Proposal to adjust the general rules

On January 8, 2014, the China Insurance Regulatory Commission (CIRC) issued a draft notice (Draft Notice) for public consultation aiming to revise the Interim Measures on Use of Insurance Funds (the Interim Measures), which took effect in late 2010 when CIRC first set about reforming the insurance asset management sector. According to the Draft Notice, CIRC proposes replacing the clause setting out detailed investment ratio requirements on insurance funds with a more general clause stating that CIRC would separately regulate and/or adjust relevant investment ratios of insurance funds.

By way of background, since late 2010, CIRC has taken several steps to liberalise investment restrictions on insurance funds and provide greater flexibility in asset allocation. In addition to the Interim Measures, CIRC has already issued several implementation rules regulating investment ratios of insurance funds investing in various product categories. These regulations show some inconsistency with the Interim Measures. By proposing a more general clause in the Interim Measures CIRC would be able to adjust investment ratio requirements in specific areas and, therefore, avoid any potential conflicts.

Unifications of the investment ratios

Also in January, further to the Draft Notice, CIRC formally issued the Circular for CIRC to Strengthen and Improve the Regulatory Requirements on Ratios of Use of Insurance Funds (the Circular). The Circular aims to unify the investment ratios that were previously regulated in different circulars or notices in one regulatory document which will supersede all previous regulatory requirements on ratios of investments made by insurance funds.

Five categories of assets are identified in the Circular: liquid assets; fixed-income assets; equity assets; property assets; and other financial assets. Regulatory requirements on investment ratios are established on the basis of these five categories of assets. For example:

  • investment in liquid assets or fixed-income assets by insurance funds is no longer capped;
  • investment in equity assets is capped at 30 per cent of total assets in the preceding quarter;
  • investment in property assets is also capped at 30 per cent of total assets in the preceding quarter, while investment in self-use property may reach 50 per cent;
  • investment in other financial assets is capped at 25 per cent of total assets in the preceding quarter;
  • total overseas investment in all five categories of assets shall not exceed 15 per cent of total assets in the preceding quarter;
  • investment in any single asset is capped at 5 per cent of total assets in the preceding quarter unless the investment is made to domestic central government issued bonds, quasi-government bonds, bank deposits, major equity interests, equity interests of insurance companies by using proprietary funds, self-use properties, or insurance asset management products within the group; and
  • investment in rights of credit of or equities in any single legal entity is capped at 20 per cent of total assets in the preceding quarter.

In addition to the requirements on investment ratios, the Circular also requires insurance companies to establish internal control measures to be further disclosed to CIRC. Such internal control measures shall both include an insurer’s investment ratio requirements and risk monitoring and warning measures. Any investments triggering risk monitoring ratio shall be reported to CIRC.

In future, CIRC will require insurance firms to focus more on the overall investment limitation on each category of assets rather than any specific asset. This may help firms to achieve better economic returns while retaining control of risks.

Other potential reforms

The vice chairman of CIRC discussed recently three other strands to facilitate reform that will be implemented this year. These are: 

  • establishing a centralised registration and trading system for insurance asset management products for the ease of investors’ entry and exit;
  • setting up an asset management association administrating the registration matters for insurance asset management products; and
  • reforming the investment scale and scope of insurance funds such as broadening infrastructure investment, refining policies on investment in equities, real estate and overseas investments.

According to an earlier report, CIRC had announced that it would consider allowing insurance companies to invest in the Second Board at the Shenzhen Stock Exchange where the shares of start-up companies are listed, and permitting insurance companies to invest premium received on policies sold at least 15 years ago into blue-chip stocks in a trial programme. CIRC is trying to reduce unnecessary prior administrative approval of insurance funds by strengthening post-risk prevention such as ongoing supervision of disclosure, internal control and solvency maintenance, among others issues.

The evolving insurance asset management landscape

In terms of historic changes CIRC has, in recent years, been dedicated to reforming the insurance asset management sector. In late 2010, CIRC permitted insurance asset managers to act as professional third party asset managers.

In 2012, in view of low investment returns and asset depreciation suffered by insurers, CIRC allowed qualified fund houses and securities firms to manage entrusted insurance funds by investing them domestically in mutual funds, listed bonds and stocks. Further, CIRC issued several new regulations to liberalise investment restrictions on insurance funds and provide greater flexibility in asset allocation, including but not limited to:

  • insurers being allowed to invest in hybrid and convertible bonds;
  • insurers being no longer required to meet annual profit making requirements for equity or real estate investments; and
  • caps on aggregated investment by insurance funds in unlisted equities and equity investment funds being raised to 10 per cent, and in unsecured bonds being raised to 50 per cent.

In the same year, CIRC issued long-awaited implementation rules to:

  • expand the permitted jurisdictions for overseas investments significantly to include 45 countries (including 25 developed markets and 20 emerging markets); and
  • widen the scope of approved assets classes to be invested overseas by domestic insurers to cover money market instruments, fixed-income products, equity products, real estate which is profitable and located in central areas of major cities in a permitted jurisdiction, and qualified overseas funds such as mutual funds and privately placed funds.

For further information contact:

Lynn Yang

Ai Tong

South Africa

Twin Peaks Bill published

On February 1, 2013, the Financial Regulatory Reform Steering Committee published Implementing a twin peaks model of financial regulation in South Africa for public comment. This document sets out the proposed reforms to South Africa’s system of financial regulation. It proposes dividing the regulation of the financial sector into two bodies, the Prudential Authority, located in the South African Reserve Bank (the higher peak) and the Market Conduct Authority, which role will be assumed by the Financial Services Board. In December last year, National Treasury published the draft Financial Sector Regulation Bill for comment. The Bill proposes a two phase implementation process.

Phase one: few changes to regulations

In the first phase of the reform, the two regulators will be established and appropriate powers assigned to them. In phase one very few changes will be made to existing sector legislation (for example the Banks Act and Long-term and Short-term Insurance Acts) other than re-assigning responsibility for implementation of legislation to the two regulators. For example, the formal responsibility for the Banks Act is shifted from the Banking Supervision Department to the Prudential Authority. National Treasury believes that this will minimise disruption during the transition phase.

Mono- and dual-regulated institutions

The Bill also creates the concepts of “mono-regulated” and “dual-regulated” institutions. Mono-regulated entities are those that undertake activities that only give rise to market conduct regulation (for example advisory and intermediary services). Dual-regulated entities are those that undertake activities that give rise to both prudential and market conduct regulation (for example banking and insurance).

Phase two: legislative reform

In the second phase, the existing financial sector legislation will be gradually amended or replaced with laws that align more appropriately with the Twin Peaks framework.
One example proposed is that a comprehensive market conduct framework will be legislated, which will give legal effect to the Treating Customers Fairly initiative currently underway, and will ensure a comprehensive, consistent and complete approach to governing the conduct of financial institutions across the financial sector.

Other objectives

Other stated objectives of the Bill include enhancing coordination and cooperation between regulators, balancing operational independence and accountability of regulators, establishing a crisis management and resolution framework, creating a Financial Services Tribunal and strengthening Ombud Schemes.

For more information contact:

Gareth Weston

UK

Insurance intermediary pays heavy price for poor attitude to compliance

HomeServe, an insurance intermediary which sells home emergency and repairs insurance cover, has received the largest retail fine to date of £30,647,400 (reduced from £42,782,058 for early settlement). The catalogue of compliance and regulatory failings spanned a period of six years, dating as far back as 2005 when the firm was first authorised by the now defunct FSA. Broadly, the investigation found that HomeServe had breached Principles 3 (management and control), 6 (customers’ interests) and 7 (communications with clients) of the Financial Conduct Authority (FCA) Principles for Businesses. This considerable fine clearly demonstrates the regulatory appetite in the UK for enforcement against firms’ poor conduct.

Oversight of sales practices

HomeServe enjoyed rapid growth and, by 2011, had sold approximately 12 million policies to its sizeable retail customer base. The firm’s sales strategy focused on volume at the expensive of quality and customer need. This fine illustrates how ineffective oversight of compliance issues at board level leads to significant failings further down the business. Compliance monitoring reports raised serious concerns relating to treating customers fairly (TCF), poor sales techniques, providing customers with misleading information and mis-selling, however, not all reports were discussed at board level and insufficient attention was paid to those that were.

In the clearest indication of the firm’s lack of regard for compliance issues, the role of ‘legal and compliance director’ ceased to exist in September 2010 leaving no dedicated compliance representation on HomeServe’s board. From that point on, a senior compliance staff member attended board meetings, as an observer, to answer any compliance questions. The governance structure was such that issues discussed at Compliance and Risk Committee meetings, such as agents providing customers with misleading information, were not subsequently raised at full board meetings. HomeServe has acknowledged that the compliance team was not given ‘sufficient weight’ to raise serious issues and ensure their significance was understood.

The most serious mis-selling cases occurred in relation to two very similar products offered by HomeServe. These products, typically sold over the telephone, were complex in nature covering multiple elements and contained numerous exclusions. The FCA’s investigation into the firm’s sales practices found that customers were not given sufficiently clear information about the scope of cover, eligibility to claim, exclusions and cost. In October 2011, a year after concerns were first raised, HomeServe suspended all telephone sales following an independent report that identified serious issues regarding the quality of such sales. The redress bill for mis-selling these products is expected to run to £14.03 million.

Complaints handling

During two particularly busy periods when HomeServe experienced an increase in claims and complaints, a fast track process was implemented for certain complaints which focussed on reducing complaint numbers quickly, as opposed to treating customers fairly. Significantly, senior management rejected a request from the complaints handling team to re-deploy some sales staff to deal with the high volume of complaints, deciding that achieving sales targets was more important.

The final notice cites various inadequacies of the complaints handling process and HomeServe has paid over £1.3 million in redress to those customers that suffered detriment. In particular, the firm failed to comply with DISP rules that require firms to investigate complaints competently, diligently and impartially and offer redress to the customer if it is decided that this is appropriate. Many complaints settled using the fast track process were not investigated at all and were instead resolved simply by negotiating with the customer.

Remuneration

HomeServe’s remuneration schemes and payment structures were complex and varied between each of the sales departments. Sales agents were heavily incentivised and rewarded predominantly on the basis of volume of products sold rather than quality of sales. Examples include a ‘sales per hour’ rate, a ‘£s for closures’ incentive scheme and a ‘quality bonus’. In addition, commission deductions for sales that failed to meet the required quality standard were ineffective to incentivise staff to maintain appropriate standards.  

Regulatory training

Regulatory training provided to senior management was ‘at best, limited, ad hoc and dependent on the individual, but more often on-existent’. Consequently, regulatory risks were not understood at senior level and there was a widespread lack of regulatory knowledge. Senior management attached little importance to the regulatory objectives, as reflected by the firm’s profit driven culture. In terms of training and competence, the message for firms is clear: TCF must be ingrained from the top down; senior management should have adequate knowledge of regulatory risk and possess clear understanding of the controlled function held and corresponding responsibilities; and the implications of being a regulated firm must be considered across all levels of the organisation.

IT systems

The FCA also found fault with the firm’s IT systems. HomeServe failed to maintain adequate IT systems and, consequently, a coding error that led to 34,859 customers being overcharged went undetected for over four years. For a period of six years, IT software intended to prevent overlaps in cover failed to do so leading to some customers being sold multiple insurance policies resulting in duplicate cover.

This is the latest in a string of mis-selling fines for intermediaries but the systemic and widespread failings detailed by the FCA serve to reinforce the emphasis it places on culture, consumer needs, board oversight and regulatory training; and offer a stark reminder of the consequences for failing to take compliance issues seriously.

For more information contact:

Laura Hodgson


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Contacts

Maria Ross

Maria Ross

London
Laura Hodgson

Laura Hodgson

London