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In this edition of Insurance focus, we consider the regulatory review of claims handling practices taking place in the UK. With claims related complaints on the rise, how insurance firms handle claims is firmly on the Financial Conduct Authority’s agenda. Laura Hodgson and Zara Evans outline how firms can review their claims handling practice to satisfy regulatory requirements and ensure good consumer outcomes.
Against a backdrop of increasing disputes in China’s insurance market, Wenhao Han considers recent guidance from China’s highest court on how certain possible ambiguities of insurance law should be interpreted. From Johannesburg, Christopher MacRoberts and John Neaves take a look at the meaning of “direct financial loss” in the bond market and offer advice on how to avoid policy drafting that allows for competing interpretations.
Zein El Hassan and Michele Levine from our Sydney office discuss the accidental provision of insurance and suggest ways in which parties to commercial contracts can avoid carrying out insurance activities without the necessary licensing and regulatory authority.
We also consider some significant cases from our colleagues in the United States and Australia. In our international focus section, we take stock of the latest insurance developments across our global practice including the UK, Germany, China, South Africa and the Netherlands.
Insurance related complaints by consumers have reached unprecedented levels and while the overwhelming majority relate to mis-sold payment protection insurance, there has been a sharp rise in complaints about how firms handle claims. Insurers face greater challenges from consumers arguing that their claims have been unfairly rejected. Consumers are increasingly willing to complain about an unsuccessful claim and, given the current regulatory climate in which the fair treatment of customers is paramount, now is the time for firms to ensure their claims handling culture is fit for purpose.
The claims process is the latest target of the UK’s new Financial Conduct Authority (FCA) as it continues to investigate potential failings across the insurance sector and, as recent well-publicised fines prove, firms need to take claims handling duties seriously. In this article, Laura Hodgson and Zara Evans consider the key issues and steps that firms can take to address the regulator’s concerns.
In June, the FCA launched a thematic review into the claims process of direct insurers and intermediaries amid concern that:
The investigation will cover the general insurance market with a particular focus on travel and household products. The claims thematic project was prompted by an earlier FCA investigation into mobile phone insurance (MPI) products. The regulator identified significant failings in how firms deal with claims, specifically, that claims handling was often slow and the outcomes for consumers unfair.
The MPI review found examples of a two-stage claims process, whereby claims that were initially rejected were accepted on appeal. Findings revealed that some firms initially rejected high volumes of claims (70 per cent in one example), sometimes with no legitimate reason, and only paid out when the customer complained. Such practices favour those customers who are more persistent and confident in complaining, leaving more vulnerable or timid customers out of pocket. The potential for consumer detriment has given the FCA sufficient cause for concern to carry out a full investigation of the claims process.
Common failings revealed in recent enforcement action against insurance firms highlight persistent breaches of the FCA’s high-level Principles for Businesses. Some of these principles are directly applicable to claims handling practices. In particular, insurance firms are required to meet regulatory duties to treat customers fairly (Principle 6), provide information that is clear, fair and not misleading (Principle 7) and operate effective systems and controls (Principle 3).
The FCA Handbook contains general provisions on how insurers should deal with claims, which can be found in the Insurance Conduct of Business sourcebook (ICOBS). Insurers are obliged to meet the following duties under ICOBS 8.1.1 R.
No guidance is provided on what the FCA deems to be ‘prompt’ and ‘fair’ handling of claims; however, this is likely to mean without any unnecessary or unreasonable delay. Delaying the progress of a claim without valid, justifiable reasons will not meet the regulator’s expectations of good conduct.
Information on how the claims process works must be adequate and clearly communicate any steps to be taken by the policyholder. Examples of customers having to ‘chase’ their insurer for an update on their claim are common. Claimants should be kept well informed of the status of their claim and firms should review their literature to ensure it satisfies customers’ information requirements. Firms should consider setting claims handling benchmarks with performance standards being reported in management information.
Claims processes should be monitored to identify any failings and ensure that claims are not being rejected unreasonably. ICOBS 8.1.2 R prescribes that, without evidence of fraud, it is unreasonable for an insurer to reject a claim for breach of a policy condition or warranty that is not connected to the loss suffered.
For example, an insurer will be in breach of ICOBS if it refuses a claim for flood damage on the grounds that the policyholder has failed to maintain a burglar alarm as warranted in the terms of the policy. The insured’s failure to maintain the burglar alarm has no connection to the loss that has occurred and, therefore, is not a reasonable ground for declining the claim. Similarly, refusal based on the policyholder’s failure to report a claim within the contractual time limit has been deemed unreasonable by the FCA where the delay in reporting has had no impact on the insurer’s ability to mitigate loss or asses the genuineness of a claim.
Rejecting a claim on the grounds of misrepresentation by a customer (except where the misrepresentation is deliberate, reckless or careless) will also be unreasonable under ICOBS 8.1.2 R.
It is essential that firms get this right and have a clear understanding of the grounds on which claims can be rejected. Insurers who avoid paying claims by relying on breaches of policy terms that are unconnected to the nature of the loss, or a policyholder’s innocent misrepresentation, will risk regulatory action.
Again, there is no regulatory guidance on what constitutes ‘prompt’ settlement of a claim. As a general principle, insurers should ensure that payment is not unnecessarily delayed. Outcome six of the treating customers fairly (TCF) principle is that consumers do not face unreasonable post-sale barriers imposed by firms; the claims process is specifically mentioned. Firms should consider measuring their claims handling performance against TCF outcomes.
A comprehensive claims process review should take into account the following considerations:
Firms that outsource their claims handling function to a third party must have sufficient oversight of how claims are dealt with and maintain effective systems and controls to monitor processes. Rules on outsourcing are found in the Senior Management Arrangements, Systems and Controls (SYSC) sourcebook.
Firms remain fully responsible for critical operational functions that are outsourced. Failure to comply with SYSC requirements to identify, manage, monitor and report risks has led to regulatory action. Regular reviews of claims issues and the firm’s regulatory obligations should be considered at board level.
Outsourcing of claims management also raises concerns about incentivisation. Firms should be prepared to show how they manage and mitigate conflicts between keeping costs down and delivering fair outcomes to consumers.
The results of the thematic review are expected by the end of the year and may lead to FCA rule changes and enforcement action. Some other developments in the claims arena that have been gaining momentum recently may also come to the fore. FCA scrutiny has so far been largely focused on retail insurance, but the suggestion of weaknesses in commercial claims handling may prompt regulatory comment.
Despite strong opposition from the industry, the FCA is also exploring whether firms should be required to disclose their claims data publicly. The regulator argues that this could improve consumer choice and drive greater competition, with negative publicity for firms whose data shows up poorly, providing an incentive for better behaviour. Whether such information is beneficial to consumers is debatable. Favourable claims data does not necessarily indicate better quality products, and producing a simple and accurate comparison from across the sector is a challenging task.
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It has been nearly four years since the People’s Republic of China (the PRC) revised the legislation governing the insurance sector, known as Insurance Law 2009. With the fast development of the insurance market in China, the number of insurance disputes is increasing at a phenomenal pace. In 2012, the Chinese courts heard 76,430 first instance insurance cases. In order to address ambiguities and to provide clarity on some gaps in the law, the Supreme People’s Court of the PRC (the Court) recently issued guidance on Insurance Law 2009 in its second set of interpretations which came into effect on 8 June 2013.
The Court’s guidance consists of 21 articles focused mainly on insurable interest, duty of disclosure, exclusion clauses and subrogation. Although far from comprehensive, the Court’s interpretation provides some useful guidance on how to understand certain key articles of Insurance Law 2009 and aims to resolve the legislative ambiguities. In this article, Wenhao Han considers whether the Court’s guidance addresses the grey areas of Chinese insurance law.
The principle of insurable interest is recognised in Chinese law. Article 12 of Insurance Law 2009 defines insurable interest as interest legally recognised in the subject matter insured. In terms of property insurance, the assured must have insurable interest at the time of the loss. For life insurance the proposer must have an insurable interest at the time the policy is taken out. Without an insurable interest, the policy is void.
Previously it was unclear whether, for property insurance, different proposers could have separate insurable interests in the same subject matter. The Court’s interpretation has clarified this position; prospective insureds can have different interests and are entitled to be indemnified for loss to the extent of their respective interests in the subject matter.
For life insurance, in practice, most products are sold by insurance agents who do not check whether the beneficiary under the life policy has an insurable interest in the life assured. It is not uncommon for insurers to deny liability for lack of insurable interest when a claim is made. The Court’s interpretation has helpfully clarified that if an insurer avoids a life insurance policy for lack of insurable interest, the policyholder is entitled to request a refund of the premium paid, after deduction of any relevant administration fees.
Under Chinese law, the duty of disclosure differs between marine and non-marine insurance. In non-marine insurance, the proposer has a duty to disclose only the information relevant to specific enquiries made by the insurer. By contrast, marine insurance (governed by the Maritime Code of the PRC), requires the proposer to disclose all material information to the insurer, regardless of whether or not the insurer has asked for it.
The Court has clarified that only information or circumstances known to the proposer about the risk being insured will fall within the scope of the duty of disclosure. In addition, the insurer bears the burden of proving that proper enquiries were made in terms of the scope and content of disclosure. Insurers seeking to terminate a policy based on the insured’s breach of disclosure duty must now demonstrate that the scope of disclosure was made clear. The insurer cannot rely on answers to any ‘catch-all’ questions to prove that specific enquiries were made.
Furthermore, the Court has confirmed that where an insurer intends to deny liability on the basis of the insured’s failure to disclose information relevant to the risk, it is a pre-condition that the insurer must terminate the policy first, unless the parties have reached an agreement regarding claims settlement and/or the existence of an insurance contract. Finally, an insurer will not be able to terminate a policy where the payment of premium has been accepted but the insurer knew, or ought to have known, that the proposer had not complied with duty of disclosure.
It is common practice in China for most policies to be based on the insurers’ standard terms and conditions. Article 17 of Insurance Law 2009 requires insurers to provide proposers with a copy of their standard clauses and explain the contents of the policy. Specifically, the insurer must give sufficient warning of any exclusions under the policy and explain to the proposer, either orally or in writing, the meaning of these clauses. Failure to satisfy this obligation will render such clauses void.
This of course prompts the question: what constitutes an exclusion clause? One view is that an exclusion clause should be given the widest possible interpretation to include any policy clauses which purport to limit or exclude the insurer’s liability (such as deductibles and warranties), regardless of whether the clause is listed in the exclusions section or found elsewhere in the policy. The Court has offered some clarifications in this area:
The right of subrogation is statutory and takes place by operation of law. Once the insured has been indemnified, the insurer automatically acquires the insured’s rights and remedies to the extent of the indemnity paid. For marine insurance, the insurer must bring subrogation proceedings in its own name in accordance with articles 94 and 95 of the Maritime Special Procedure Code of the PRC.
In accordance with the Court’s interpretation, this position now also applies to non-marine insurance.
In terms of limitation periods for subrogated claims, there was both confusion and criticism as to whether an insurer is bound by the same time limit that applies to the insured’s claim against third parties. Far more helpful for insurer’s protecting subrogated claims is the Court’s interpretation that the time limit for bringing such a claim will start from the day the insurer pays the indemnity to the insured.
There are however some outstanding subrogation issues that were not addressed by the Court. For example, it remains unclear whether the jurisdiction and choice of law clause in the underlying contract between the insured and a third party is binding on the insurer. In practice, although Chinese law accepts that the insurer is stepping into the shoes of the insured, most courts hold the view that an insurer does not agree an arbitration clause because it is not a party to the underlying contract. Therefore, unless an insurer subsequently accepts the arbitration clause, it will not be bound by it. Insurers would however benefit from the Court’s future clarification on this point.
Although not a common law jurisdiction, with a doctrine of judicial precedent, the lower courts in China are likely to follow the Supreme People’s Court interpretation of Insurance Law 2009. Whilst offering greater clarity, it is perhaps inevitable that this interpretation will be applied differently by the lower courts in due course. Nevertheless, the Supreme People’s Court has provided a useful guide to the application of Insurance Law 2009 with more certainty. It is reasonable to expect that China’s highest court will issue further guidance as required by the market.
This latest clarification of insurance contract law in China follows a number of measures being undertaken by other national insurance or supra-national markets to modernise insurance law, as can be seen in the Law Commissions’ efforts in the UK and through the development of European insurance law principles (embodied in the Principles of European Insurance Contract Law).
This article was first published in the Journal of British Insurance Law Association July 2013 issue.
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The debate between insurers and insureds concerning the term “direct financial loss” and similar expressions in financial institution bonds is not new. However, recent experience and an interesting decision of the New York appellate court highlight that the term should be cautiously approached by insurers. Competing interpretations by insurer and insured in a recent instruction as to whether loss is “direct” showed that an ill-conceived interpretation of policy wording has a significant, far-reaching and potentially damaging impact on the admissibility of a claim under a particular section. In addition, clear definitions and the consistent use of terms throughout a policy are important to minimise interpretation disputes. In this article, Christopher MacRoberts and John Neaves reflect on the latest developments in this area.
A third-party sued a bank for the contractual enforcement of payment guarantees which were ostensibly signed by two of the bank’s branch managers. The bank denied that it issued the guarantees and denied that its implicated managers were authorised to issue the guarantees. The bank maintained that because at least one of the managers’ signatures on the documents was a forgery, the guarantees were a nullity and could not be enforced. The bank notified a claim on its financial institution bond in the event that it was obliged to pay the guarantees.
The insurers contended that the bank’s loss was not “direct financial loss” caused by employee dishonesty. It was a liability towards a third-party in consequence of employee dishonesty. The insurer maintained that it could be considered a civil liability to a third-party falling under the professional indemnity section of the policy, but the policy contained an exclusion relating to guarantees.
The policy was a conventional three-sided financial institution bond. Section I was the crime bond.
Section II covered professional liability to third parties caused by negligence, error or omission. Section III provided directors’ and officers’ and company reimbursement liability cover.
The insuring clause of Section I provided an indemnity for “direct loss sustained by the Insured at any time where discovery occurs during the policy period, and which direct loss resulted by reason of and solely and directly caused by dishonest, fraudulent, malicious or deliberate criminal acts of any employee, committed with the intent to cause the insured to sustain a loss or to obtain an improper financial gain for themselves or for any other person”.
There was no doubt that the loss suffered by the bank was predominantly and effectively caused by the dishonest and fraudulent actions of its manager.
“Direct loss” was circuitously defined to mean “a direct financial loss sustained by the insured”. Given its ordinary grammatical meaning, the word “direct” in the phrase “direct financial loss” qualified “loss” and did not give rise to a proximate cause debate in this context.
The policy excluded indirect or consequential loss of any nature, except defence costs, costs & expenses, mitigation costs or to the extent covered by the basis of valuation clause.
“Direct financial loss” is often confined to loss of the insured’s own property (first-party loss) but Section I of this policy did not impose such limitations. Loss covered under Section I could also arise out of the insured’s possession of, and responsibility for, third party property and the insured’s liability therefor.
As with most complex policies, the wording had evolved and been supplemented over time. In places this meant that the terms “direct loss” and “loss resulting solely and directly from” appeared inconsistently in other sections of the policy. Elsewhere in the policy “direct financial loss” had been assigned a fairly broad meaning and contemplated a number of circumstances including liabilities to third-parties.
The effect of the words “direct financial loss” is that the insurer undertakes to indemnify the bank for the direct diminution or impairment of its financial position as a result of the fraud or dishonesty of its employee.
An insured would generally look to Section I where there has been a dishonest, fraudulent, malicious or deliberate criminal act on the part of an employee. Absent such an act and in the event of a negligent act, error or omission causing loss or damage to a third party, an insured would look to Section II. The policy excluded indirect or consequential loss. This excluded loss would include loss of revenue or loss of opportunity.
The only viable interpretation of “direct” in the phrase “direct financial loss” is that it covers all pecuniary loss suffered by the bank which is not indirect or consequential. The addition or use of the word “direct” in the phrase only affected the onus on the insured to show “direct financial loss” as against “indirect or consequential loss”.
Given that a specific exclusion for indirect or consequential loss existed and that causation was not at issue, the use of the word “direct” as a qualifier to “financial loss” was redundant and could have been omitted. This meant that a loss flowing from an award in terms of the unauthorised payment guarantees would constitute a direct financial loss for purposes of Section I.
In other developments, the recent decision of the New York Appellate Division in New Hampshire Insurance Co. v MF Global, Inc., 2013 NY Slip Op 05291 (N.Y. App. Div. July 16, 2013) gives renewed impetus to the “direct loss” debate in the United States.
MF Global’s employee, Dooley, traded overnight commodities futures on the Chicago Mercantile Exchange (CME) beyond his available margin credit, ultimately causing losses to MF Global of some $141 million. MF Global immediately settled the debt with the CME and lodged a claim under its fidelity bond.
The insurers denied coverage on the basis that MF Global did not suffer a “direct financial loss” and that Dooley was not an “employee” for purposes of the policy. The motion court concluded that Dooley was an “employee” as defined and granted summary judgment in favour of MF Global for its loss.
On appeal, the New York Appellate Division upheld the motion court’s decision and ruled that “Dooley’s conduct in making unauthorised trades beyond his margin was the direct and proximate cause of MF Global’s loss. Dooley’s trading activity resulted in a near instantaneous shortfall for which MF Global… was automatically and directly responsible.”
The appeal court distinguished its earlier decision in the oft-cited case of Aetna Casualty & Surety Co. v Kidder, Peabody & Co. Inc., 246 A.D.2d 202 (N.Y. App. Div. 1998) in which it was determined that there was no coverage for settlement amounts relating to the misconduct of an employee in providing confidential information relating to corporate takeovers and mergers to an arbitrageur.
The case was distinguishable on the basis that the events in the Kidder, Peabody & Co. Inc decision were “an attenuated chain” and the loss-causing payments in that case were made years after the employee’s misconduct. The payment made by MF Global to CME was not made simply in satisfaction of a contractual liability, nor was it a third-party loss – it was a direct loss to MF Global under its fidelity bond.
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While many companies are in the business of issuing and distributing insurance products, some may be unintentionally issuing insurance products because of the terms of their supply contracts or product warranties. Firms conducting insurance business in Australia are licensed by the Australian Securities and Investments Commission (ASIC) and authorised by the Australian Prudential Regulation Authority (APRA).
However, some parties to commercial contracts can unintentionally find themselves carrying out general insurance activities. Such ‘accidental’ insurers need to take care as insurance is a highly regulated industry and there are significant penalties for non-compliance with insurance and financial services laws. In this article, Zein El Hassan and Michele Levine review the legal and regulatory framework for firms carrying out insurance activities in Australia and offer some suggestions as to how firms can avoid unintentional insurance provisions in commercial contracts.
Under the Corporations Act 2001 (the Act), an issuer of a general insurance product in Australia is required to hold an Australian financial services licence (AFSL) granted by ASIC. So could product warranties, supply contracts and transportation contracts involve insurance and therefore require an AFSL?
The Act contains a very broad definition of general insurance products and is deemed to include:
So, it is possible to have an insurance product even if the contract does not look and feel like a conventional insurance policy with the usual terms of cover and exclusions, excess payments and duties of disclosure. It is sufficient for a contract to only include one clause that involves the provision of insurance. This is explored below.
The carrying on of a general insurance business is also regulated by the Insurance Act 1973 and requires authorisation by APRA. For this purpose, an insurance business means undertaking liability, by way of insurance, in respect of any loss or damage (including liability to pay damages or compensation) contingent upon the happening of a specified event, including any incidental business. There are penalties for conducting insurance business without APRA authorisation.
In our view, ‘accidental’ insurers are unlikely to be a major concern for APRA and ASIC. Where it is clear that a firm has not intended to carry out insurance business, the main issue is unintentionally triggering the application of insurance and financial services laws. Given the potential penalties for non-compliance, the provision of insurance in commercial contracts can become a real headache in M&A deals.
Due diligence reviews of the vendor’s customer or supply contracts that reveal the provision of insurance can present considerable problems for both parties. It is crucial, therefore, that parties to commercial contracts understand what is involved in the provision of insurance in its simplest terms.
There is no statutory definition of insurance. In the absence of a definition, the general law meaning of “insurance” applies. While there is no settled definition of “insurance” under the general law, the courts have provided useful guidance as to the key characteristics of “insurance”.
A common law definition (based on the principles established by Prudential Insurance Co v Commissioner of Inland Revenue) treats as insurance any enforceable contract under which a provider undertakes:
Essentially, the purpose of a contract of insurance is to transfer the risk of loss that arises from the insured’s interest in the subject matter of the contract to the insurer. This is often referred to as the “transfer of risk” or “assumption of risk”. It is the provider’s obligation to respond to an uncertain event (normally, by providing a benefit) under an enforceable contract that is the “transfer of risk”.
In its simplest form, insurance involves one party (insurer) promising to compensate the other party (insured) for loss caused by an event outside the control of the insurer.
It is worth considering whether your commercial contracts include any provisions that may satisfy the definition of insurance. We have seen many indemnities to that effect in commercial contracts that were not intended to be insurance. Some common examples are considered below but any form of indemnity could possibly involve insurance depending on its scope.
Extended warranties come in all shapes and sizes but the basic principle is that an extended warranty is a contract which extends the manufacturer’s statutory warranty on goods.
ASIC has provided guidance in QFS 35 on the regulation of extended warranties as financial products. Whilst the guidance is directed to extended motor vehicle warranties, it is nevertheless useful in understanding the regulation of extended warranties more broadly.
QFS 35 provides that an extended warranty is generally a financial product if it is a general insurance product or a facility through which customers manage financial risk (miscellaneous financial product). QFS 35 does not provide any instructive guidance on what types of extended warranties will be regulated as insurance or miscellaneous financial products. The guidance is more focused on the operation of the incidental product exception (which is not available for insurance products).
In our experience, an extended warranty is unlikely to be insurance if:
Some examples include an extended warranty given by a manufacturer or retailer:
As these examples demonstrate, care needs to be taken in reviewing the terms of extended warranties to determine whether the warranty falls within the insurance definition.
Indemnities are a standard feature of most commercial transactions, however, certain contractual indemnities may be insurance.
An indemnity is likely to be insurance if a contracting party has indemnified the other party for loss that is caused by events outside of their control. For example:
In many cases, the parties will not intend to be providing insurance or even appreciate that the contract terms could involve insurance. In order to avoid breaching insurance and financial services laws, these contractual terms need to be carefully considered and possibly redrafted to ensure that they do not involve the provision of insurance.
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On 23 September 2013, the Texas Supreme Court issued its opinion in Lennar Corp. v Markel American Insurance Co. A dispute arose as to whether an insurer was liable to cover the insured for repairs to homes damaged by use of exterior insulation and finish systems (EIFS). The Court held that the insured could recoup some $6 million in voluntary payments.
After the NBC television show Dateline revealed that EIFS trap water inside, causing rot, structural damage, mildew, mould, and termite infestations, Lennar proactively contacted the owners of homes it had built, removed the EIFS, and replaced it with conventional stucco. Although Lennar carried out this work on all the homes it had constructed using EIFS, it only sought cover for the homes that had actually suffered damage.
Lennar’s insurer, Markel American Insurance Company, refused to cover Lennar because:
The Court disagreed. First, the Court reiterated its precedent that an insurer cannot deny coverage under an occurrence-based policy for payments made voluntarily, unless the insurer can show that it was prejudiced by the voluntary payment (upholding Hernandez v Gulf Grp. Lloyds). The Court upheld the jury’s verdict that Markel was not prejudiced, stating that “the jury was entitled to credit evidence that, had Lennar not proceeded as it did, the damages would have worsened and the remediation costs increased.” As Markel could not show prejudice, the voluntary settlements established Lennar’s loss under the policy.
Next, the Court considered whether Markel was liable to pay for the total damages incurred by Lennar incurred locating the damage. The question was whether Markel was liable for the cost of locating the damage in addition to the cost of repairing. The policy obliged Markel to pay the total amount of Lennar’s loss “because of” property damage during the policy period. The Court held that all of Lennar’s damages were “because of” property damage and the policy covered total remediation costs on the basis that Lennar could not have located all of the damage without removing all of the EIFS.
The insurer’s argument that the policy did not cover damage occurring outside the policy period was also rejected. Relying on American Physicians Insurance Exchange v Garcia, the Court stated that “for damage that occurs during the policy period, coverage extends to the “total amount” of loss suffered as a result, not just the loss incurred during the policy period”. Lennar’s policy provided coverage for a “continuous exposure” to the same harmful conditions, as long as some damage was caused in the policy period. Consequently, the policy covered Lennar’s total remediation costs.
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The High Court of England and Wales recently handed down its decision in McManus and Others v European Risk Insurance Co  EWHC 18, which considered whether a professional indemnity insurer was correct to reject a “blanket” notification of claims under a claims-made policy.
McManus Seddon was a firm of high street solicitors which took over another firm (Runhams) resulting in the combined firm of McManus Seddon Runhams (MSR). Prior to the take-over, Runhams had acquired a conveyancing practice called Sekhon Firth.
MSR took out a professional indemnity policy with the defendant for the 2011/2012 policy year. That policy was a claims-made policy requiring notification when the insured first became aware of circumstances (defined in the policy as “an incident, occurrence, fact, matter, act or omission which may give rise to a claim” against the insured).
Following inception of the policy, MSR received a claim from a former lender client of Sekhon Firth alleging breaches of contract and tort arising out of a mortgage transaction. MSR notified the claim to its insurers and the notification was accepted as being valid. Subsequently, another 17 claims relating to work conducted by Sekhon Firth in respect of the same borrower were received by MSR. These were also notified to the insurer and accepted as valid.
Given the high number of claims, MSR proceeded to conduct a review of the 17 files as well as another 110 files from Sekhon Firth involving the same borrower and some further Sekhon Firth files selected at random. A third party risk consultant reviewed 32 of those files which were all found to show a consistent pattern of breach of duty by Sekhon Firth. Ex-employees of Sekhon Firth also confirmed mismanagement issues at their former firm. MSR concluded that there was a risk of negligence claims for mismanagement being brought in respect of a number of Sekhon Firth files.
MSR made a “blanket” notification to its insurers under cover of a letter headed “Blanket notification of circumstances which may give rise to claims”. The letter referenced the 17 claims already notified, the similarities between them and the 32 consultant reviewed files and the comments from the ex-employees of Sekhon Firth. MSR also estimated that there were potentially 5,000 other matters which contained these breaches and that “each and every file…should properly be notified to you as individually containing shortcomings on which claimants will rely for the purpose of bringing claims”.
With the exception of the notifications already made in respect of the 17 files and the 32 consultant reviewed files, insurers rejected the notifications on the basis that the notifications were not valid as MSR did not identify “the specific incident, occurrence, matter, act or omission” which could give rise to a claim on an individual file.
MSR sought a declaration that the “blanket” notification was valid and argued that the rejection of the notification had an adverse impact on it in that it had been unable to buy renewal insurance and had been forced to enter the Assigned Risks Pool thereby doubling its premium. The case is unusual in that MSR sought to clarify the issue of the validity of the notification before a claim arising from it had been made.
Applying the principles laid down in the other English decisions on notifications of J Rothschild Assurance Plc & Ors v Collyear & Ors  CLC 1697 and HLB Kidsons v Lloyd’s Underwriters  EWCA Civ 1206, the Court held that notwithstanding that the “blanket” notification letter did not identify any particular clients or transactions that might be affected by the breaches at Sekhon Firth, the letter constituted a valid notification and insurers were wrong to reject it. This was because there had been a “substratum of underlying external facts, over and above [the insured’s] mere concerns”.
The Court did not however grant the declaration even though the notification was deemed valid. Instead, on the balance of justice, it was held that it would be unfair effectively to bind the insurer to accept all claims in respect of the circumstances covered in the notification letter and that it would be better to see what claims materialised and consider them on a case by case basis.
This case highlights the difficulty in rejecting a notification purely on the basis that it notifies a large number of potential claims without identifying the precise circumstances that may give rise to the claim.
The decision reinforces the English law position that in the context of professional indemnity claims-made policies, “blanket” notifications of circumstances may be construed in favour of the policyholder making the notification. Although this is a first instance decision, it follows HLB Kidsons which was a Court of Appeal decision.
For Australian insurers and insureds, as the decision may influence the position here, it serves as a reminder to insurers to look very carefully at notifications and ensure that they are not automatically rejected when it appears that an insured has failed to identify the specific basis on which a future claim may be brought.
The most prudent way to handle “blanket” notifications may be to request further information from the insured whilst reserving rights in relation to indemnity until such time as a claim is actually made and its link to the notification of circumstances can be fully considered.
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Black & Veitch (BV) was insured against professional indemnity liabilities above a self-insured retention of $US10 million. The primary layer of US$5 million was with Lexington. Above that layer was the “PI Tower”, consisting of three excess layers insured by Teal, the captive insurer within the BV Group. The layers were, in respect of any one claim, for US$5 million, US$30 million and US$20 million respectively. Finally, there was a top layer, consisting of a “top and drop” policy of US$10 million. The primary and excess layers provided worldwide cover, but the top and drop policy excluded any claims emanating from the US and Canada. The PI Tower was reinsured with various reinsurers, and the top and drop policy was reinsured with Berkley and Aspen each for 50 per cent. The reinsurance followed the underlying cover issued by Teal.
Four claims were brought against BV:
Claims 3 and 4 fell outside the reinsurance coverage provided by the top and drop policy, but all four claims were within the other policies. Teal claimed that the AEP claims exhausted the PI Tower, so that the Ajman and PPGP claims fell within the top and drop policy and thus the reinsurance, so that Teal had two claims of up to £10 million.
The reinsurers asserted that the Ajman and PPGP claims were covered by the PI Tower, and that the only claims falling within the top and drop were the two AEP claims, both of which were excluded from the reinsurance.
At first instance, Andrew Smith J, on a trial of preliminary issues, held as follows:
The Court of Appeal upheld the judgment of Andrew Smith J. It ruled that any construction of the policies which allowed Teal to determine how to allocate the losses was uncommercial, and that it made more sense for the cover to be exhausted in an orderly manner depending upon when liability was established against BV.
The Supreme Court upheld the judgment of the Court of Appeal. The ascertainment, by agreement, judgment or award, of the assured’s liability gave rise to the claim under the insurance, and to that extent exhausted the coverage. It was not the case that cover was eroded by the actual payment of the claim by the insurers. A claim against the assured which was not notified to the insurers did not go towards exhausting the cover, but once a claim was notified then its priority would be determined by reference to the date on which the assured’s liability was established and quantified. The terms of the policies in the present case were consistent with that principle in that they defined the amount of liability but not its timing. The result was commercially sensible in that it prevented adjustment of liabilities to maximise reinsurance coverage.
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Equity incentives are a key part of the remuneration arrangements for executives and other senior employees of insurance businesses, whether they be large insurers or brokers/other intermediaries. These take many and varied forms, from approved share schemes to bespoke arrangements for privately funded boutique brokerages. Such arrangements have the potential to incentivise performance, particularly long-term performance, and they often attract favourable tax treatment.
Typically, the principal tax objectives of any equity incentive arrangement are to ensure that there is no upfront income tax/national insurance charge on the grant of the equity, and to secure capital gains treatment on any subsequent sale of the shares. If the equity qualifies for entrepreneurs’ relief, so much the better as this allows certain individuals whose equity stake is at least 5 per cent to pay capital gains tax (CGT) at the rate of 10 per cent, rather than at the standard rates of up to 28 per cent.
There is increasing interest in another CGT relief, which came into force on 1 September 2013, either as part of a stand-alone arrangement for individuals who would otherwise pay the 28 per cent rate of CGT or as part of a ‘package’ (including entrepreneurs’ relief) for managers with larger equity stakes. This is the ‘Employee Shareholder’ exemption which George Osborne announced last year, and which was included in the current Finance Act.
The key feature of this relief is that one or more employees give up certain (but not all) of their statutory employment rights in return for at least £2,000 of ‘free’ shares in their employer. The employee is not allowed to pay anything for the shares, other than giving up these employment rights. Although this exemption received a mixed reception in the press, it can be appropriate in certain situations particularly as:
Inevitably, there are some conditions to be satisfied and the proverbial ‘traps for the unwary’ to be avoided when implementing such an arrangement. In this respect, two points are particularly noteworthy:
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The Prudential Regulation Authority (PRA) has published two consultation papers which will be of considerable interest to the London run-off sector, and of no little concern. The consultations, published earlier this month, invite comments on the PRA’s proposals in relation to the availability of solvent schemes of arrangement as a run-off exit solution, and regarding the ability of firms to extract capital in the course of a run-off.
Regarding solvent schemes, the PRA’s proposes that where a scheme is contemplated, the regulator will expect the firm to provide it with details of the scheme before any application to the Court is made. The PRA envisages that it will “in all cases” inform the Court whether it has any objection to the proposed scheme. Perhaps more ominously for the future availability of solvent schemes as an effective runoff exit solution, the paper indicates that “for insurance firms which meet regulatory capital requirements, the PRA’s starting point will be that the use of a scheme is unlikely to be compatible with its statutory objectives”.
Just as the PRA seems sceptical that a solvent scheme can be in the interests of the firm in question’s policyholders, so it perceives that “capital extractions through the life of a run-off inevitably weaken the level of protection available for remaining policyholders”. Among its proposals, the PRA states it will expect the applicant firm to have performed an up-to-date Individual Capital Assessment, which also takes into account the expected future run-off of the business. As part of the suggested new procedure, the regulator will also reserve the right to require the firm to commission an independent review of the analysis undertaken.
The deadline for comments on both consultation papers is 26 October 2013. While a strong reaction from the run-off community is expected, it remains to be seen whether the PRA will moderate its proposals.
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On 14 September 2013, the consultation document for the Dutch Financial Markets Amendment Act 2015 (the Amendment Act) was published. The Amendment Act is currently pending in the Dutch Lower House, but it is intended that it will enter into force on 1 January 2015.
The Amendment Act contains a number of changes to Dutch regulatory legislation, amongst others the modernisation of the right to collect premium payments by insurance intermediaries and the funding of the supervision of the financial sector. A more important change, however, is the extension of the scope of suitability and integrity testing.
The suitability and integrity requirements contained in the Dutch Act on Financial Supervision currently only apply to inter alia the managing directors and supervisory directors (known as (co-)policymakers and internal supervisors) of a licensed financial undertaking. The relevant regulator, the Netherlands Authority for the Financial Markets (AFM) or the Dutch Central Bank (DNB), determines whether such persons employed by a financial undertaking meet the suitability and integrity requirements. ‘Suitable’ means that the persons concerned have sufficient knowledge, skills and professional conduct for the tasks they perform. ‘Integrity’ means that the persons concerned have not committed criminal, financial, fiscal, administrative or regulatory offences.
As a result of the Amendment Act, other persons working at a bank or an insurer will also be subject to the suitability and integrity testing performed by DNB. This concerns persons working at a bank or insurer who are responsible for transactions which involve (large) financial risks, and, consequently, are in a position to affect substantially the risk-profile of the bank or insurer in question. Not all persons involved in the execution of such transactions will meet these criteria, but only the limited category of persons who are (in the end) responsible for the execution of such transactions, for example a head of the department of asset management.
Another consequence of the Amendment Act is that the obligation to take an oath or make a promise will be extended to the aforementioned persons, but also to other employees of financial undertakings whose activities directly relate to offering financial services.
In terms of integrity, it should be noted that in deviation from the integrity testing of (co-)policymakers and internal supervisors, which is performed by DNB, the explanatory notes to the consultation document provide that the bank or insurer will, primarily, be responsible for performing integrity tests. Furthermore, the DNB will not perform a full suitability test before such a person may be appointed. DNB will perform risk-based supervision and may incidentally conduct a minimal suitability and integrity test, for example by checking whether the right training certificates are in place and/or conducting a limited criminal investigation.
In extending the scope of the suitability and integrity testing to include directors at a bank or insurer, the Dutch legislator hopes to prevent risks that may further endanger the stability of the financial services sector.
As part of the Dutch Ministry of Finance’s objective for the financial services sector to give client-centred advice, the Dutch legislator has introduced a number of measures to remove the remuneration incentives that apply to advisers, intermediaries and authorised agents in respect of certain financial products.
From 1 January 2012, an ‘open norm’ was introduced which provides that insurers and (sub-)authorised (insurance) agents are not permitted to receive any commission, either directly or indirectly, which is not necessary for the provision of the financial service. This rule does not apply in a case where providing or receiving commission would not prejudice the obligation of the insurer and authorised agent to act in the best interests of its clients.
It follows from the explanatory notes that an authorised agent may be ‘appropriately’ rewarded in ‘reasonable’ proportion to the services it provides. What this means exactly has not been clarified, but the Dutch Minister of Finance has prohibited remuneration structures that incentivise insurers and/or authorised agents not to comply with their duty of care towards clients. As such, the Dutch Minister of Finance has stated that profit share related remunerations, bonus schemes and commissions based on sales (commissions associated with obtaining a certain turnover or production) are not permitted.
Furthermore, the AFM has issued its interpretation of this ‘open norm’. The AFM states that there should be a balanced relationship between the level of remuneration and the services provided (and related costs) by the authorised agent to eliminate any disincentive. According to the AFM, commissions based on production or sales/turnover are no longer permitted, nor is profit related remuneration. The AFM states that commissions based on a percentage of the premium are only permissible if very strict safeguards are in place to ensure the appropriateness of the remuneration.
Despite these developments, there is currently still considerable uncertainty as to what commission structures are allowed in the Netherlands, largely due to the open nature of the norm regulating the remuneration of authorised agents. Furthermore, recent research has shown that a large number of authorised agents and insurers have not yet reached agreement on a new remuneration model.
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On 15 March 2013, CIRC issued the Administrative Measures for the Market Access of Branch Offices of Insurance Companies, which took effect on 1 April 2013.
The Measures stipulate some new requirements for insurers opening multiple branches. For example, an insurance firm with existing registered capital of RMB 200 million needs to increase its registered capital by no less than RMB 20 million for each provincial branch office to be opened outside of its registered province. Firms with registered capital above RMB 500 million, however, are not required to increase their registered capital when opening a new branch office outside of their registered province.
Although not restricted by regulation, in practice a foreign-invested insurance firm will only be approved by CIRC to open one branch in each application. This implied restriction largely hinders the expansion of a foreign-invested firm in China. The Measures have been interpreted within the market as a signal that CIRC is likely to approve the opening of multiple branches by foreign-invested firms in a single application, but this remains to be tested in practice.
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German Insurance Association (GDV) has issued the 2013 Code of Conduct for insurance distribution (the Code), with insurance firms able to adopt the new code since 1 July 2013. The purpose of the Code, first introduced in 2010, is to ensure consistent, high quality distribution of insurance products. Insurance firms will now need to decide whether or not they intend to adopt the more stringent 2013 Code.
The Code is binding on those firms that adopt it and consists of ten guidelines, as well as some additional requirements. Firms that adopt the Code must satisfy a new requirement that their compliance with the Code is certified by an accounting firm or a certified accountant. An implementation report will have to be submitted to GDV, initially after a full business year and thereafter every two years. The report can be based on the implementation of the provisions of the Code into the firm’s own governance and may, in addition, be based on the effectiveness of implementation.
The names of the insurance firms that have adopted the Code will be published on the GDV website. Firms subject to the Code will agree to work only with insurance mediators who recognise the principles in the Code as minimum standards and practice accordingly.
In addition, the 2013 Code introduces a new compliance provision. By adopting the new Code, insurance firms undertake to provide their employees and insurance intermediaries with compliance provisions relating to, among other things, gifts and hospitality. Finally, the Code reiterates that the customer is “at the centre” of the consultation and mediation of insurance products and emphasises the importance of ongoing training of insurance intermediaries.
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The outsourcing directive, Directive 159.A.i for both long-term and shortterm insurers, came into force on 12 April 2012. Outsource services are any aspect of a firm’s insurance business, supervised under any law or not, which is a function or activity which would otherwise be performed by the insurer itself, but not intermediary services.
Outsourcing must be given to someone competent to do it, must not adversely affect policyholders or materially increase the risk of the insurers, and must be overseen by the insurer. Suboutsourcing is possible.
The remuneration must be reasonable and commensurate with the actual function or activity outsourced, must not duplicate commission or binder fees, must not be structured so that the risk of unfair treatment of policyholders is increased, and must not be linked to the monetary value of claims rejected.
The insurer must have an outsourcing policy approved by its board of directors. Outsourcing must be in a written contract with at least the 20 requirements set out in the Directive. If control, management or material functions are outsourced, the Registrar has to be notified.
Outsourcing contracts were to be in place by no later than 1 January 2013.
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The latest briefing in our Ten things to know series considers the most important features of the UK insolvency regime applicable to insurance companies.
The insolvency of an insurance company is a fairly rare event. This is due in part to the prudential regulatory regime applicable to insurers, particularly large life insurers, which imposes substantial regulatory capital requirements in excess of an “accounting” insolvency.
Notwithstanding the regulatory safeguards, if an insurer were to fail, the procedures that apply to all insolvent companies will be relevant. There are, however, significant modifications relating to insurers, which are designed to ensure the protection of policyholders.
Our aim is to help our clients understand the potential opportunities and challenges that COP25 may have on their business.
IMO 2020 is almost upon us. Readers are well aware of the impending switch to 0.5 percent fuel mandated by Annex VI of MARPOL which will cause an anticipated drop in HSFO demand, the potential hazards of new untested LSFO blends, the concerns around scrubber operations, the debate over open loop versus closed loop, and the myriad of other risks associated with the impending regulatory change.