The London insurance market, responding to the challenge presented by the Financial Services Authority (FSA), is looking for a market-driven solution to the issue of contract certainty. This issue came to the fore following the 9/11 attacks on the New York World Trade Center, which led to a coverage dispute as to whether the destruction of the twin towers was a single event or two separate events.
The archaic practices of the insurance industry, including the use of handwritten notes for temporary cover and long delays in the production of policy wordings, were partly to blame for the dispute. The publicity which followed highlighted the issue of contract certainty, or rather the lack of it, and was part of the driving force behind the current initiative. But what is contract certainty and what does it mean for policyholders?
The idea is that contract certainty will be achieved by the 'complete and final agreement of all terms (including signed down lines) between the insured and insurers before inception'. The concept of all policy terms being agreed before inception may come as something of a surprise to some policyholders. The general practice for many years has been 'deal now, detail later,' with the agreement of precise policy terms and the production of policy wordings, being delayed sometimes for weeks or even months after the policy has gone on risk. It is not unknown for the production of the wording to be prompted only by the fact that a claim has been notified. In the meantime, unless the policy had been renewed on the same terms as an expiring policy, the insured could be completely in the dark as to the precise terms and conditions of the policy, or at best have only the limited information set out in the policy slip or confirmation of cover provided by the brokers.
The contract certainty initiative should lead to fundamental changes in the way in which the insurance market operates. The idea is that the full policy terms wording should be agreed up front before the inception date. It will no longer be acceptable for terms to be left open for months after the policy has gone on risk. The full wording may be a combination of wordings or clauses; either referenced or full text; bespoke or model material. The insurer must be satisfied that the contract certainty requirements have been met before committing to the contract. It is then up to the broker to notify the policyholder of all policy terms and obtain its client's agreement prior to inception.
A number of the practices employed which led to uncertainty will be phased out. This includes the use of the abbreviation 'TBA' (to be agreed), to indicate clauses where the precise wording has yet to be determined. The use of such terms as 'as expiring' or 'as original', where a wording is dependent on another wording, is still acceptable, but the wording must either be attached or clearly identified. Similarly, the term 'subjectivities' can still be used to indicate issues which remain outstanding at inception, for example the provision of an outstanding survey, but they must be clearly stated as conditions of the contract, with responsibilities and timescales for resolution and the consequences of failure clearly specified.
Policyholders need to act
These represent promising developments, in so far as the aim is to achieve clarity and to ensure that policyholders are aware of the policy terms from the date of inception. But do they go far enough to address the needs of policyholders?
The focus at present is on the agreement of terms prior to inception and not on the actual provision to the insured of the complete policy wording. The idea is that contract certainty should be achieved when the policy goes on risk, with the policy wording being provided shortly thereafter. The concern is that the use of 'referenced' terms will mean that policyholders will not have the full text available to them when asked to consent to the policy terms. Moreover, the danger is that policyholders will be pressed into agreeing policy terms in order to meet the contract certainty requirements without fully understanding the meaning or implications of what they are agreeing to, and without being given adequate opportunity to negotiate improvements.
The point is that, while contract certainty may reduce the scope for argument over what the policy says, there may still be disagreement over what the wording actually means, particularly where policyholders have not had the policy terms fully explained to them. The insurer may regard the policy terms as clear and unambiguous, but the increased use of standard wordings means that the insurer may well have drafted the proposed policy wording in the first place. Some brokers do make considerable efforts to explain significant policy terms to their clients, but the practice is not widespread and brokers do not always have the resources available to ensure that they are fully up to speed on the legal implications.
From the point of view of policyholders, there are two key issues which will assist in achieving contract certainty.
- Timing: In order to ensure that they are properly consulted, it is essential that the placement or renewal process is started much earlier than used to be the case. This is the only way to ensure that policyholders have sufficient opportunity, not only to agree the policy terms, but to ask questions about them and seek clarification or improvements where required. For some classes of risk, policy wordings vary enormously, and comparing quotes can be difficult without proper explanation regarding the key differences and the potential impact on the policy cover. The danger is that there will not be sufficient time available before the renewal deadline to go through this process, and policyholders will be pressed into agreeing whatever is on offer. Policyholders can avoid this by taking the initiative and insisting that their brokers begin the renewal process much earlier.
n Negotiation: The increasing use by insurers (and some brokers) of standard policy wordings means that policyholders are often presented with policy wordings as something of a fait accompli. The problem with standard wordings is that they are not designed to meet the requirements of the individual insured and may not take account of the specific risks faced by a particular line of business. Most standard wordings are drafted by insurers with the assistance of their lawyers and are designed to take account of the insurers' interests, often to the detriment of the insured. There may be policy conditions which are unduly onerous, and where non-compliance will lead to the rejection of claims which would otherwise be covered. There may be policy exclusions which seek to exclude from cover precisely the type of risks which the business needs protection against. Such issues can, and should, be addressed by policyholders before policy inception.
The fact that wordings are described as 'standard' does not mean that they are not negotiable. An insurance contract is a commercial contract like any other, and there is no reason in principle why policyholders (particularly those paying significant premiums) should not negotiate improved policy terms to ensure that their interests are properly protected
The FSA has given the insurance market until December 2006 to achieve contract certainty. Failure to achieve the given targets will result in regulatory intervention. The insurance market therefore has little choice but to comply, and the stock-take conducted by the FSA at the end of last year suggests that real progress has already been made. There are of course advantages to insurers in achieving contract certainty, not least because it enables them to maintain greater control over the cost of the underwriting process and over their risk profiles. It has also been suggested that it may make the London insurance market more competitive internationally, because overseas buyers will be attracted by the opportunity to have the policy wording agreed at inception. It is, however, likely to mean that insurers will make greater use of standard policy wordings, and policyholders will need to be active in requesting changes, if they want to ensure that their requirements are met.
The focus of the contract certainty initiative is on the agreement of all policy terms, but certainty can only really be achieved if policyholders fully understand what they have agreed to and are satisfied that their interests are properly protected. There is no advantage to policyholders in tolerating unfavourable or ambiguous policy terms. Policyholders should be looking to negotiate improvements to the wording, and ideally risk managers, brokers and insurance coverage lawyers should be involved in this process. This may sound expensive, but it should be seen as a damage limitation exercise - pay now by taking steps to ensure that the wording reflects the needs of your business, or suffer later when an insurance claim leads to a dispute over the precise meaning of the policy exclusions. Such disputes, for example, the notification and presentation of insurance claims under public liability and directors' and officers' liability policies, can be costly and protracted and can have disastrous effects on the business.
It is not essential that the detailed review and negotiation process is re-conducted at each and every renewal. Policyholders who remain with the same insurers should be able to stick with their existing wording, subject to any necessary changes being agreed each year. Similarly, policyholders able to negotiate their own bespoke policy wordings may be able to use them as their own 'standard' wordings, in much the same way as insurers.
The contract certainty initiative offers a real opportunity for policyholders. In the words of the FSA 'this is the buyers' golden opportunity to force change'. The full benefits of contract certainty are, however, only likely to be fully achieved by those policyholders willing to take an active approach to their insurance coverage.
Jane Harte-Lovelace is a partner and Sarah Turpin is a solicitor in the litigation and dispute resolution practice of Kirkpatrick & Lockhard Nicholson Graham: www.klng.com LONDON MARKET BEATS FIRST TARGET
It was reported last month that the London market has exceeded the first industry target for achieving contract certainty. Figures show that 65% of all contracts agreed during December were certain, compared to the industry-set target of 30%.
Dane Douetil, chairman of the Market Reform Group (MRG), the leadership group responsible for modernising the market, welcomed the figures, but warned against complacency, stressing that much work still needed to be done.
Douetil said: "Today's figures, based on our first formal measurement of data provided by the market, are a good start and show the level of commitment that exists towards achieving contract certainty. But I cannot stress enough that this is our first and easiest target, and we cannot be complacent about the challenge that still lies ahead. Much like running a marathon, it's easy to get into your stride but the last few miles are by far the hardest."
"We recognise that the energy being shown by many firms needs to spread to every corner of the market if the end of year target of 85% is to be achieved. MRG will continue to sponsor and drive a number of initiatives to ensure that happens."