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          What happens when an insurer has reasons not to pay out on a policy?

          Date: 30 January 2017

          Date: 30/01/2017

          Insurance expert, Richard Birks, looks at a case where a landlords claim was rejected by insurers and a subsequent bill for damages was passed to tenants. 

          In virtually all forms of leasehold property, the landlord will affect the insurance of the building structure, walls and roof, with an obligation to apply insurance proceeds in reinstatement. This is all well and good but what happens in circumstances where the insurer has reasons not to pay out on the policy? This was exactly the situation discussed in a Parliamentary debate which revolving around some retirement housing in Plymouth, Regent Court.

          In a nightmarish scenario the roof of the property was blown off in a 2012 storm, a traumatic event in itself, but worse followed. The residents naturally looked to the landlord to recover the £114,000 costs of the repairs from their insurers. After some discussion between the landlord freeholder and the insurer, the claim was rejected due to the state of the roof before the damage. The landlord then presented a bill to the tenants of around £140,000 for the required works. It is unclear what constituted the increase in the figure from the pure costs of repair but this would certainly have added insult to injury.

          This dispute continues and has come to the attention of Westminster, being debated just before the Christmas break in the Commons. The residents cause has been taken up by the All People's Parliamentary Group for leasehold and commonhold (APPG) and looks likely to run and run. The detachment between the parties affected, i.e. the residents, and the contract of insurance in place between freeholder and insurer, leaves the tenants in the invidious position of having very few rights to investigate and/or challenge the rejection of the claim on the policy.

          The circumstances highlight the dangers in passively allowing the freeholder to take sole charge of insurance arrangements. In commercial leases, obligations are often included to consult tenants on insurance terms and note occupational interests on the policy. Tenants should consider bolstering these provisions to increase visibility of the arrangements. In a residential context, tenants might want to investigate how to join together to take over the management of the relevant building, so they are less reliant on a third party landlord. This is easier said than done, the right to manage routes being costly and complex. The more situations like this that arise though, the louder the clamour for a direct line of sight from tenant to insurer,  an attachment which, while burdensome, could provide a fairer position all round.      

          Practices involved in the sale of, acceptance of rights under, and claims covering, insurance for leasehold properties raise a number of insurance regulatory issues.  

          For example (while it is not apparently a feature of the above case), from time to time the insurance, real estate or legal media pick up on questions of commissions being received by various entities with commercial interests in leasehold arrangements (eg: landlords; property management companies; insurance underwriting agents, such as 'managing general agents' or 'MGAs, and other 'coverholders'; and insurance brokers).

          These commissions can be controversial because they can be high proportions of the premiums paid as consideration for the insurance – and such premiums may ultimately be funded directly or indirectly by leaseholders – or high proportions of the profits that the insurer makes by the value of premiums exceeding the value of claims ("profit share").  

          Profit share has the potential to be especially controversial because it is possible that in the event of damage giving rise to an insurance claim a landlord (for instance) could have an economic 'upside' in the claim being rejected by insurers (in that the landlord then shares in the insurer's profit that results from not paying the claim) while having no 'downside', in that the landlord can seek an indemnity from leaseholders for the damage. 

          Insurance arrangements that involve high levels of commission and low claims levels have long been of concern to UK regulators – such arrangements were key features of the 'PPI' market.

          The Financial Conduct Authority ("FCA") has also expressed concerns over profit share arrangements that could give a party a conflict of interest as to the payment of claims (see the FCA's report on 'Outsourcing in the general insurance market' from 2015).

          More fundamentally, some property businesses may be operating so as to bring themselves within the 'perimeter' of regulated insurance activities.  For instance, property managers could be deemed to be engaged in arrangements for the buying or selling of insurance, and doing so 'by way of business' and 'for remuneration'.  The FCA has stated that it regards 'remuneration' as including the receipt of 'indirect economic benefit'.  Businesses falling within this perimeter need to be authorised or exempt under the Financial Services and Markets Act 2000 ("FSMA") or they risk committing a criminal offence.

          Further, businesses that are already authorised need to think carefully about the regulatory 'conduct' duties – not just legal duties – that they could owe to leaseholders, since the latter could, depending on the matrix of contractual arrangements involved in the lease and insurance, fall within the definition of 'consumer' (even if they are not 'policyholders') under FSMA.  The FCA has statutory duties of protection to consumers.

          While there has been no action with a public profile by UK regulators in respect of insurance practices in the leasehold sector, as the discussions in Parliament show, these issues remain liable to become controversial.

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