Jan Heuvels, Ince & Co
HARD TIMES IN SOFT MARKETS
2007/2008 has seen a softening insurance market globally, and the UK is no exception. And soft markets can mean hard times. Firms face difficult decisions as to whether to diversify through acquisition or concentrate on what they know best. One strategy for adding value in a soft market is improved claims handling and the Association of Insurance and Risk Managers is at the forefront of initiatives to achieve that. Most controversial is its proposal to impose a 90-day restriction on the use of "reservation of rights" clauses. Under English law there is no requirement for a general reservation of rights to be issued in order to protect underwriters' interests.
Unless and until underwriters have knowledge of specific facts that give rise to a legal right of which they know or appear to know (what will suffice to create the appearance of having knowledge will need to be judicially determined), they arguably run no risk of waiving any such right. However, the use of a general reservation of rights has become commonplace and can cause significant problems for the assured, for example, in connection with its reporting requirements. Will the proposal work? It is said that AIRMIC's partner insurers are supportive, but it is less certain whether the market as a whole will be favourably inclined.
SUBPRIME: A SLOW BURNER?
Debate continues over the potential impact of the subprime crisis and credit crunch. Borrower class actions against subprime lenders and securities-related claims have grown in the US; and D&O, E&O and claims against rating agencies are likely to rise accordingly. Some predict meltdown for the entire financial guarantee sector. However, there is also support for the view that sub-prime is a ‘slow burner' in the UK, such that the market will be able to make adjustments to cope with the fall-out. Whichever proves correct, reinsurers should remain alert to the legal issues, most obviously the early notification of potential claims leading to difficulties in setting reserves.
A RISE IN BUSINESS INTERRUPTION CLAIMS
2008 has seen an exceptionally high number of catastrophic and single-event losses. In addition to heavy mining losses triggered by weather events, a number of energy and industrial plants have been hit by fire and explosions. One likely result is that the courts will see increasing numbers of claims for business interruption losses, hitherto rarely subject to judicial scrutiny.
This development was foreshadowed by the judgment in Coromin v AXA RE. Coromin was the captive insurer of Anglo American plc, one of the world's largest diversified mining and natural resources groups. The claim, settled by Coromin and then pursued against its reinsurers, was for business interruption losses suffered at a Chilean mining site.
In a nutshell, the policy was placed in June 2004 for 12 months and the incident giving rise to the claim occurred in March 2005, triggering a 24-month indemnity period for business interruption (BI) losses. When the policy was placed, when the incident occurred, and even when the original 12-month period expired, a key piece of machinery, the molybdenum plant, was not in place. But it did come on stream during the indemnity period sufficiently for the disruption caused by the March 2005 incident to lead to a loss of income specifically referable to it. Could Anglo recover from Coromin, and Coromin from reinsurers, a loss caused by interrupting "a business" that had, to that extent, not been in existence either when the incident happened or during the policy period? The trial judge concluded that they could.
The policy provided for insurance for "loss resulting from the interruption of or interference with the business". "Business" was to be given its ordinary meaning and was defined to include "all operations and activities of the Insured" without qualification or temporal limitation. The wording did not require the business which had been interrupted to be business which existed at the time of the placement or incident; the only requirement was that the interruption was caused by the insured event and fell within the indemnity period. Cooke J refused to imply any term which sought to restrict the word "business" to business being carried on during the initial policy period.
This is a sensible decision, but it ought not to be taken out of context. The coverage secured for Anglo was undoubtedly broad. Moreover, a finding that post-placement expansion of a business will bind BI insurers carries with it an exposure. If the insured business does not make clear at placement what its settled future expansion plans are (or if insurers do not waive disclosure of such details) then insurers may look askance at losses that, because of the introduction of new and unheralded plant, accumulate at a faster-than-anticipated rate.
TRANSPARENCY IN THE MARKET
Regulators continue to have a significant impact on the industry. Publication of the European Commission's report into competition in the business insurance market has borne out fears that it would fail to understand the unique nature of the London market and its business practices. The Commission remains concerned about ‘anti-competitive' practices, such as the leading insurer's premium being disclosed to the following market, potentially leading to price fixing.
However, its attempts to impose limits on such disclosure may well create problems for a market in which complex insurance programmes are underwritten using a subscription market. Second, at present the Commission sees no compelling reason for renewing the Block Exemption Regulation (which grants an exemption from the general prohibition on anti-competitive agreements for certain forms of (re)insurance cooperation agreement). This overlooks the benefits for insurers in not having to justify each arrangement individually. However, the most controversial part of the report covers conflicts of interest, in particular broker remuneration which the Commission suggests is often structured to favour the broker's own interests over those of his client(s).
The report led the FSA to publish its own discussion paper on transparency in the commercial insurance market proposing, amongst other things, mandatory disclosure of details concerning broker remuneration, services and status. The closing date for comments was 25 June 2008 and, at the time of writing, feedback has yet to be published. Whatever the outcome, insurance intermediaries should prepare themselves for a more robust disclosure regime.
At least contract certainty is off the FSA's agenda, the Market Reform Office having reported a 90 per cent compliance rate as at December 2007. Unfortunately, certainty does not guarantee clarity. The case of Standard Life v Oak Dedicated illustrates the fact that, despite wordings being issued, courts still resort to slips to aid construction. At issue here was the effect of conflicting excess provisions in the contractual documents. The policy schedule and slip contained the words "excess: £25million each and every claim and/or claimant". The policy wording itself did not. Tomlinson J held that the slip should be used as an aid to construction of the policy because the words "and/or claimant" were likely to have been regarded by the parties as of relevance to the extent of the substantive obligations undertaken by underwriters. They had been carried through to the schedule with the result that they had to be given a function and not considered as merely a summary.
REINSURERS IN THE LIMELIGHT
Reinsurers have seen their fair share of significant judgments over the past year. The Court of Appeal had previously held, in RSA v Dornoch, that notification to reinsurers of a loss that was required by a liability reinsurance claims cooperation clause could be deferred by an insurer until the liability of the original insured had been established in the original action. However, the issue arose again in AIG v Faraday. AIG's brokers had placed a reinsurance of AIG covering its D&O account. The policy contained a claims cooperation clause obliging the reinsured to give notice of "any loss or losses which may give rise to a claim".
In November 2002, AIG's insured, Smartforce, announced that it intended to restate its accounts for various reasons and promptly suffered a severe stock market fall of the type which usually precedes a shareholder action. AIG had been given notice of that but had not told its reinsurers. It was many months later that liability for the underlying claim was established. AIG then gave its reinsurers notice within the 30 days required. Faraday disputed that this was timely and the Court of Appeal, perhaps surprisingly, agreed that notice should have been given back in late 2002. The view taken was that the expression "any loss or losses which may give rise to a claim", was not confined to losses which, in due course, did constitute the claim. If the original shareholders suffered "a loss" in the sense of the company's share price falling, that was sufficient of a loss to trigger the notification requirement (assuming the insurer hears about the fall in share price).
But these were the facts of the Dornoch case, so why the different approach? In Dornoch, the share price fall could, the Court thought, be a normal market fluctuation - there was no event to explain it. In Faraday, Smartforce's NYSE announcement that it intended to restate its accounts, which came just the day before its stock collapse, meant the fall could only be attributable to that "event".
Of even more significance to reinsurers was the Court of Appeal judgment in Wasa v Lexington, arising from Lexington's appeal against the Commercial Court decision that it was not entitled to recover from reinsurers in full its settlement with its insured, Alcoa. Lexington had settled with Alcoa after being found jointly and severally liable by the Supreme Court of Washington for Alcoa's clean-up costs for pollution damage, irrespective of when the damage had been sustained. At first instance it was held that reinsurers were only obliged to indemnify Lexington in respect of the costs incurred during the three-year period of the reinsurance. The Court of Appeal unanimously overruled this finding. Rather than ask whether the reinsurance was intended to be back-to-back or to apply only to loss and damage occurring within the policy period, the appropriate question was whether the parties intended that, to the extent they used the same or equivalent wording in the reinsurance as in the underlying insurance, the wording was to have the same meaning in both contracts. The contracts provided cover for property damage for the same period. As such, it was natural to infer that the parties intended the wording to have the same meaning in each contract. This is a pro-cedent decision that will trigger further debate over back-to-back interpretation.
GOING FOR BROKERS
Brokers have not been immune from scrutiny. A further issue in Standard Life was whether Aon had been negligent in placing the cover. It is well established that a broker owes a duty to obtain, as far as possible, insurance coverage which clearly meets the client's requirements. Standard Life clearly required cover that provided for the aggregation of related claims brought by many individual claimants. In concluding that Aon was in breach of duty, the judge took account of factual evidence that appropriate cover could readily have been procured and, in light of market conditions at the time, could probably have been placed without any other alteration in its terms and at the same premium.
And it seems that brokers are not safe even after placement. In a postscript to the infamous film finance litigation, the Court of Appeal in HIH v JLT held that JLT had a duty, post-placement, to alert HIH to the implications of developments on the risk they had written (in this case a reduction in the number of films warranted to be made). Indeed, one of the Lords Justice suggested that a post-placement ‘watch and warn' duty would be uncontroversial wherever the broker's lay client was not a specialist. This raises serious questions as to whether brokers in the ordinary line of commercial business are remunerated to perform such a monitoring service and staffed and organised to do so.
A LOOK AHEAD
Looking forward, the Lloyd's emerging risks team has identified three issues as a potential threat to the market for the remainder of 2008 and beyond. Of those, climate change is perceived to be the key risk facing the industry, with implications not only for the property market but for liability insurers. Nanotechnology is also seen as a potential source of liability claims. Finally, GPS system failure is, to excuse the pun, on the radar. Lloyd's is assessing the worrying risk of a sudden loss of GPS for all ships at sea.
Insurance contract law reform remains on the agenda, the Law Commission having published a consultation paper setting out proposals for reform to the law on misrepresentation, non-disclosure and warranties. Detailed discussion of these must wait for another day. Suffice it to say that while consumer insurance faces significant, and mandatory, changes, for business insurance there would be a default regime, with some freedom for the parties to contract out through bespoke wordings. At the time of writing, the Commission is yet to publish a summary of the responses to its proposals for business insurance. We await the reaction with interest.