In December 2016, the Financial Conduct Authority (‘FCA’) published its report on the “thematic project” on a 'Review of general insurance intermediaries’ professional indemnity insurance”. Such professional indemnity insurance (‘PII’) is required by the FCA’s ‘Prudential Sourcebook for Mortgage and Home Finance Firms, and Insurance Intermediaries’ (“MIPRU”).
The review was of a sample of 186 different firms:
“Lloyd’s brokers, intermediaries acting as MGAs, trade/professional bodies that provide insurance to their members, and insurers where they were carrying out intermediation”.
The FCA’s findings are a microcosm of wider failures across the commercial insurance markets to:
- invest in effective coverage advice, and
- appreciate the resultant legal risk.
The FCA raised a number of concerns about the suitability and effectiveness of the PII underwritten direct by some 40 insurers and 16 managing general agents (‘MGAs’) acting on behalf of various of those and other insurers. The principal concerns were:
“Policies contained exclusion clauses which gave us significant concerns as their effect could be to reduce the scope of the cover below that required by MIPRU”
“Many policies had inadvertent gaps in coverage or inaccuracies indicating that they had not been subject to appropriate review by firms themselves, the intermediaries they used to place their cover, or by the insurers and MGAs that provide products. This extended to:
- exclusion clauses intended to exclude investment-related activities but so widely drafted that they excluded [the intermediaries’ general insurance (“GI”) intermediation activities];
- a lack of clarity about whether policies provided cover for [the full range of firms’ agents and potential forms of liability]; and
- out-of-date language [and issues, including] one provider’s policies [that contained] a Y2K Compliance clause.”
The Causes Of The Failures
One might dismiss the issues raised by the FCA as being incidents confined to a particular market sector and set of circumstances, or regard those intermediaries with sub-standard PII cover as bearing out the adage as to ‘the cobbler’s children’, in that the intermediaries would be expected to manage insurance purchases correctly for their clients. Such expectation could flow from awareness that:
- the UK regulator (as was) announced a decade ago that it was “absolutely committed to finding an end to the practice that has come to be known as "deal now, detail later" in the insurance market” (see David Strachan’s speech, 10.01.06) and
- the market and regulator have worked in parallel – although not necessarily in tandem – to establish processes to provide “contract certainty” so as to ensure that:
“policyholders will know exactly what protection they have bought; brokers will reduce the legal, fiduciary and operational risks which they are running; and underwriters will have a clearer view of their underwriting exposure …”
And yet the FCA has now identified a statistically significant occurrence of “inaccuracies, errors or exclusions that serve to create gaps or omissions in the required cover” within a substantial and important market segment that represents a cross-section of the insurance industry.
Identifying inconsistencies in policy wordings, especially those that could render cover nugatory, is of course ‘meat and drink’ to insurers’ claims managers, and often result in the denial of claims and disputes over coverage. Preventing or resolving such disputes requires the ascertainment of the meaning of the words in any part of an insurance policy by reference to (at the very least) the rest of the policy, and vice versa: “a first impression and a simple answer [may not] be the best … The words must be set in the landscape of the instrument as a whole” (Charter Re -v- Fagan  AC 313). Moreover, as set out in Investors Compensation Scheme LTD. v West Bromwich Building Society  1 WLR 896:
“[Contractual] interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract …
… it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man … [excluding] the previous negotiations of the parties and their declarations of subjective intent …”
All too often, ascertaining the meaning of a policy’s terms has been left to legal proceedings following a coverage dispute. Certainly there is an increasing trend for insurers and intermediaries to seek legal advice on coverage when developing the templates or general wordings for new insurance products. However, it is still relatively rare for legal advice to be sought in relation to the purchase of insurance by a specific party in specific circumstances, even when the insurance is a regulatory requirement or otherwise fundamental to the operating model of a business, as in the case of a PII policy for an insurance intermediary.
As the FCA’s review shows, if the parties to insurance contracts, and their advisers or underwriting agents, do not undertake careful assessment of the coverage in its ‘real-world’ context, being the risks against which the insured actual wants protection, those parties and agents are taking on ‘legal risk’ by virtue of:
- the uncertainty of the effects of the insurance, and
- the possibility of an adverse outcome from a dispute as to such effects.
Insureds that do not undertake such assessment might also be failing to manage fully their operational risks. In the case of PII, the FCA found that:
“…insurer insolvency exclusions [were] in 140 … policies … [Most] referred to the insolvency of insurers [and] extended to the insolvency of the range of financial institutions with which a firm has had dealings, including building societies, banks, investment managers …
… [PII] insurers … explained that … they do not want to underwrite the credit risk of the insurers with which the intermediary places policies …
However, we found that the breadth of the exclusion clause varied widely – specifically how closely linked the claim needs to be to the insolvency of the insurer or other financial institution to be excluded. In many cases, we were concerned that the exclusion clause would not provide intermediaries with the necessary cover under the policy for claims for which they may be liable … [such as] negligence on the part of the intermediary in the selection of an insurer that subsequently became insolvent.
… It is not clear to us how insurer insolvency exclusion clauses, formulated in a broad fashion, would operate effectively to ensure that the required cover under MIPRU remains in place.”
The FCA’s review also identified some factors that illustrate the softness of the PII, and possibly other, markets:
- the FCA found there were twice as many PII insurers than correspondents identified;
- in the apparently short time between the FCA’s selection of intermediaries and its request for copies of their PII policies and claims data, 7% of the sample “ceased business” – with the implication that these intermediaries were operating without the requisite PII.
Intermediaries operating without requisite resources have an unfair cost-base advantage, and present ‘conduct risk’ in being unable to satisfy liabilities to customers. Conduct risk will also arise if:
“… insurers and MGAs … provide PII [products that] are [not] consistent with the needs of those intermediaries to whom they are providing cover...”This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.