Norton Rose publishes latest edition of Insurance focus
In this edition of Insurance focus, we take stock of the latest development in the long-running West Tankers saga. Philip Roche, Michael Mendelowitz and Camilla de Moraes from our disputes team consider the implications of a recent High Court decision on anti-suit injunctions and propose some practical measures parties might consider where unwelcome overseas proceedings are on the cards.
The Italian insurance market has been subject to a plethora of recent reform measures. One such reform is the prohibition of “interlocking” directorates. Andrea Zulli and Nicolò Juvara focus on the prohibition and its impact on the market. In Australia two new Bills have been proposed that could have unwelcome consequences for directors of failed companies. Insurers underwriting D&O cover in Australia should be aware of the proposals which are considered by Marnie McConnell and Jodie Odell in Sydney.
In our case notes section we report on the recent decision of the UK Supreme Court which has brought welcome clarity to Employers’ Liability “trigger” litigation. We also consider a recent decision which considered whether commission payments paid for the provision of information was subject to value added tax (Royal Bank of Scotland v HMRC  EWHC 9 (CH)).
In our regular feature, International focus, we include updates from the People’s Republic of China, Germany, Italy, South Africa, Canada and the UK.
For further information: Insurance focus - June 2012
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European Commission to present IMD2 legislative proposal
The European Commission has announced that it will present a proposal to revise the Insurance Mediation Directive (2002/92/EC), known as IMD2, on 3 July 2012. In a press release, published on 22 June 2012, the Commission comments that, when necessary, the sale of insurance products should be accompanied by honest and professional advice, information about the status of the insurance product seller and the remuneration received by the seller. Furthermore, this level of protection should apply whether consumers buy insurance directly from an insurer or indirectly from an intermediary. Finally, the Commission states that, with respect to sales of insurance investment products, enhanced standards should apply including the assessment of suitability and appropriateness of the product for the consumer.
The revision of IMD forms part of a three-part legislative package, which also includes proposals for a regulation on transparency in packaged retail investment products and an amendment to the Undertakings for Collective Investment in Transferable Securities Directive. The legislative package is dedicated to rebuilding consumer trust in the financial markets. The Commission notes that there is a wide range of investment and insurance products available for purchase in the EU. Due to the complexity of some products and the varying standards on transparency and distribution across Member States, consumers often struggle to understand the risks associated when purchasing such products. This factor, the Commission believes, has contributed to the current lack of trust in the financial sector.
For further information: European Commission’s legislative proposal
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Law Commission publish join consultation paper on the business insured’s duty of disclosure and the law of warranties
On 26 June 2012, the Law Commission and the Scottish Law Commission (the Law Commissions) published their third consultation paper in their review of insurance contract law in the UK. The consultation considers proposals to change business insureds’ duty to give pre-contractual information to their insurers and the law of warranties in insurance contracts.
The Law Commissions previously consulted on the impact of pre-contractual information given by insureds in 2007. The outcome of the earlier consultation for consumers was an Act of Parliament which is expected to come into force next spring which will alter consumers’ obligations to disclose information before contracting. The Consumer Insurance (Disclosure and Representations) Act 2012 was passed without much controversy as there had been widespread consensus that change was required to ensure that the law was more closely aligned to commercial and regulatory practice. For business insurance, there was much less agreement as to the extent to which the current disclosure requirements and law on warranties should be altered. As a result, the Law Commissions have decided to consult again with revised proposals for reform.
Why is reform being proposed?
The UK has one of the largest and most competitive insurance markets in the world. Insurance is sought in London for risks located all over the world. So to what extent does the current law provide a barrier to the insurance market? In truth there is little evidence that our current law has any negative impact on London’s appeal as a market for insurance. So why is change needed?
Essentially, the Law Commissions argue that in too many instances, the underwriting of insurance contracts is taking place at the claims stage. In other words, the principles of the law can allow the insurer to deny coverage on the basis of information learned when a claim comes in rather than when cover is proposed. The Law Commissions also argue that many insureds do not understand their legal obligations or the impact of the law as written in the Marine Insurance Act 1906 (the MIA). The MIA has ossified nineteenth century practices and has required the courts to develop the law extensively beyond that contained in statute in order that contemporary market practice and expectations might be reflected in decisions.
What are the Law Commissions now proposing?
Disclosure and misrepresentation
The Law Commissions have considered sections 17, 18, 19 and 20 of the MIA. Section 17 of the MIA imposes upon both parties a duty of utmost good faith. Should a material fact fail to be disclosed to underwriters or be misrepresented, the effect of sections 18 and 20 is that the insurer may avoid the policy ab initio (the only remedy provided in section 17 for breach of the duty of good faith). Section 19 provides that the agent to insure (i.e. the placing broker) is under a similar duty to disclose information to insurers, even if such information is not known by the insured himself (for example market knowledge of which the placing broker has become aware).
The above duties on the insured and his agent are not matched by a duty on the underwriter to ask questions about the risk. This has caused an imbalance in the rights of the parties. In the case of Carter v Boehm in 1766 Lord Mansfield (considered to be the originator of the duty of good faith in insurance law) considered the role the underwriter plays before contracting and mentions facts which the underwriter “by fair inquiry and due diligence, may learn from ordinary sources of information”. In contrast, by the twentieth century, Scrutton LJ, saw the position of the underwriter more akin to the proverbial three wise monkeys - under no obligation whatsoever to ask for information from the insured. In his words: “I have always understood the proper line that an underwriter should take, except in matters that he is bound to know, is absolutely to abstain from asking any questions”. Is the modern underwriter to have a completely passive role or should the law require more of him when a commercial risk is being placed?
The Law Commissions have stepped back from some of the more radical proposals first mooted in 2007. For example, gone is the suggestion that material facts should be those which a “reasonable insured” rather than prudent insurer would deem relevant to disclose. Instead the following is proposed.
The essential elements of section 18 should be retained but the concepts of the materiality of the facts to be disclosed and the knowledge of the insured require statutory clarification. In particular, legislation should specify that a material circumstance is one required to provide a “fair presentation of the risk”. A fair presentation should include disclosure of any unusual circumstances which might increase the risk; any particular concerns about the risk which led the policyholder to seek the insurance; and standard information which is generally understood should be disclosed by market participants. Where the underwriter receives information which would prompt a reasonably careful underwriter to make further enquiries, failure to ask further questions will mean that the underwriter concerned will not have any remedy for non-disclosure of a fact which would have been revealed on enquiry.
In order to update legislation to come into line with the Pan Atlantic v Pine Top Insurance decision in 1995, the Law Commissions propose to include a requirement that an underwriter be induced to enter into the contract by any non-disclosure or misrepresentation.
The Law Commissions also propose clarifying what is meant by the knowledge of the insured. This is a simple question in the consumer realm but far more complicated where large commercial organisations are buying insurance. Exactly what knowledge is deemed to be known by the insured and who knows what? It is proposed that where an insured is a corporate entity, “knowledge” should include information known to the directing mind and will of the organisation (i.e. the board) and to those persons who arrange the insurance (usually the risk manager). For these purposes, knowledge will include both actual knowledge and “blind eye” knowledge.
Furthermore, it is proposed that business insureds should disclose information that would be discovered by reasonable enquires proportionate to the type of business, its size, nature and complexity. In short, insureds will be expected to pay much closer attention to the kinds of information being presented to their insurers to ensure that they are in fact giving a fair presentation of the risk being insured.
In relation to section 20 which requires the insured not to make a misrepresentation, the Law Commissions propose that knowledge should be aligned with the requirements in section 18 of the MIA. As a result, they propose replacing the distinction between matters of fact and matters of expectation or belief with a reference to those matters which the policyholder knows or ought to know. Where a representation is one which the policyholder ought to have known about, it must be true. Where a representation is not one which the policyholder knew or ought to know about, it must be made in good faith.
As regards section 19 of the MIA, the Law Commissions propose that the requirement for brokers to disclose information should be extended beyond the placing broker to the producing and intermediate brokers in the chain between insured and underwriter. In addition, the information which the broker is required to disclose should be limited to information received or held in his capacity as agent for the particular insured on whose behalf he is disclosing that information to the underwriter.
Perhaps most significantly, the Law Commissions look at the impact of section 17 which provides only one remedy for a breach of the duty of good faith: avoidance of the contract in its entirety. Instead, the Law Commissions propose that there should be a range of remedies proportionate to the breach. Where an insured is deliberate or reckless (in other words dishonest) about a non-disclosure or misrepresentation the insurer, will (as is currently the position) be able to avoid the contract. However, in the absence of dishonesty there should be a proportionate remedy with the following effects. Where the insurer would have not written the risk at all had it known the true facts, the insurer may avoid the policy. Where the insurer would have written the policy on different terms (excluding, for theses purposes, the premium) the contract is to be treated as if it included those terms. Where the insurer would have charged a higher premium had the true facts been made available to it, the indemnity payable will be reduced in inverse proportion to the additional premium that the insurer would have charged.
The Law Commissions propose that parties should be free to contract out of the proportionate remedies where any such provision is written in clear and unambiguous language.
Insurance warranties are rather hard to describe but are easily recognised in an insurance contract. They serve to redress the balance between the insurer - who traditionally had no knowledge about the risk and wanted to impose limitations in the contract, and the insured - who could alter the degree of risk once cover was provided. In order that insurers may control the risk during the period of cover, warranties must be strictly complied with, regardless of whether or not the breach is remedied or has any connection to a loss. Furthermore, section 33(3) of the MIA states that insurers are discharged from all liability under the contract on the occurrence of the breach - termination of the contract occurs by operation of law rather than by election. Warranties can be harsh on insureds. Once broken, a warranty cannot be remedied. As a result, the courts have used elaborate devices to describe contract terms as anything but strict warranties.
Essentially the Law Commissions propose three changes to the law.
Basis of the contract clauses should be abolished. Basis clauses are terms in the proposal form which state that the proposer for insurance warrants the accuracy of the responses or states that the answers given form the “basis of the contract”.
Warranties should be suspensive; the insurer’s liability being restored as soon as the breach is remedied. Furthermore, the insurer’s right to cancel should be contractual rather than statutory.
Where a term is designed to reduce a particular risk, for example theft, a breach of that term would suspend liability in respect of that loss only. The same should apply where a term is designed to reduce the risk of loss at a particular time or in a particular location. For example, failure to appoint a night watchman should not affect a theft during office hours.
The Law Commissions emphasise that their proposals will not necessarily introduce a causal link between the loss and the broken warranty but in some cases it would appear that the proposals do just that. For example, the Commissions give an example of a policy covering a yacht containing various warranties. One warranty requires the hatch of the yacht to be secured with a particular type of lock. Should this warranty be broken it would not impact losses not connected to theft such as storm damage - clearly the cause of the loss will be relevant to the breach of warranty. In such cases, the cause of the loss must be within a type which the particular warranty seeks to control and this would certainly bring causation into the capacity to terminate the contract for breach - likely to be unpopular with insurers who will want to ensure that certain warranties will be complied with, regardless of the cause of loss.
These provisions would be the default regime for business insureds: parties will remain free to contract out as they wish. For consumers, the proposals would be mandatory.
The Law Commissions have decided not to provide additional protection to small businesses. They will be subject to the general regime for commercial insureds, but in many instances will have the protection of the Financial Ombudsman Service.
What is the significance of the proposals?
The Law Commissions’ proposals - if brought into law - will have a significant impact on both insurers and commercial insureds. Although certainly less radical than the original proposals made in 2007, the changes suggested would limit the power of insurers to avoid policies on discovery of a non-disclosure of information. In practice, however, insurers currently apply proportionate remedies where it is in their commercial interest to do so.
For insureds, the proposals will mean that organisations should pay closer attention to the quality of information given to their insurers in order to be certain that a fair presentation is made. It is likely that risk managers will be required to bring the insurance programme to the attention of the board, whose members will need to be comfortable that they understand the information being given to underwriters.
The consultation period will run until 26 September 2012. The Law Commission are proposing to publish a final report and draft Bill on both this latest consultation and the consultation on post-contractual duties by the end of 2013.
For further information about the proposals please contact:
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FSA letter on monitoring ongoing appropriateness of Solvency II internal models
On 18 June 2012, the Financial Services Authority (FSA) published a letter from Julian Adams, FSA Director of Insurance. The letter was sent to firms involved in the FSA’s internal model approval process (IMAP) under the Solvency II Directive. The letter focuses on how the FSA intends to monitor the ongoing appropriateness of a firm’s internal model after approval.
The FSA is concerned that, whilst significant effort is put into the approval process, firms are not giving adequate attention to ongoing appropriateness. Following approval, firms must ensure that the internal model is monitored and updated on a regular basis so it continues to meet the tests and standards and reflects the firm’s risk profile. The FSA needs to be confident that the controls put in place are adequate and effective at all times, including in stressed market conditions, to ensure that solvency standards do not deteriorate.
With this is mind, the FSA is developing a number of early warning indicators to ensure that, after approval, internal models and the solvency capital requirement (SCR) calculation remain appropriate. The information provided by firms in their Solvency II regulatory reporting will be used to assess their position in relation to these indicators. The FSA stresses that it must be notified immediately by a firm if their position falls outside pre-determined ranges, at which point, in all but exceptional cases, the FSA will take immediate supervisory action. Such action may include revision of the parameters and/or imposing a capital add-on with the aim of bringing the SCR back above the indicator level. The indicators will be specifically tailored to sectors of the insurance market and will be reviewed periodically.
One indicator the FSA is currently developing is a ratio between the pre-corridor minimum capital requirement (pMCR) and the modelled SCR. This ratio would only apply to UK solo entities since there is no MCR for groups. The FSA’s preliminary analysis indicates that the pMCR indicator could range between 175-200% for life business and general insurance business. The FSA intends to issue a template and instructions to UK firms in September 2012 in order to gather information to refine the calibration. Also in September 2012, the FSA plans to provide an update on the other early warning indicators it is currently considering to prompt supervisory intervention, including the use of stress tests and scenarios for economy-wide variables for with-profits business and groups.
For further information: Solvency II: monitoring the ongoing appropriateness of internal models
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The following case summaries have been written by Professor Rob Merkin who is a consultant to the insurance and reinsurance and international arbitration teams.
Links have been provided to copies of the judgments on Bailii wherever possible.
Coles v Hetherton  EWHC 1599 (Comm)
Motor insurance – Cost of repairs – Measure of damages
Royal & Sun Alliance Insurance Plc (RSAI) issued motor policies covering both first and third party losses. In the event of damage to an insured vehicle which could be repaired for less than the market value of the vehicle, the policy provided that the assured could choose a repairer or elect to use RSAI system. Under that system RSAI would engage Motor Repair Network Management (MRNM), a member of the RSA Group, to undertake repairs. Those repairs would be effected at one of MRNM’s six regional repair centres (QRCs) or contracted out to independent garages. MRNM and repairers in its Priority Repair Network (PRN repairers) were required to maintain minimum service standards, including a delivery and collection service and a courtesy car. The amounts charged by MRNM allowed it to make a profit over and above the charges paid by it to PRN repairers. The defendants’ insurers contended the arrangements increased costs and amounted to a failure to mitigate loss. Two preliminary issues were resolved by Cooke J:
- The measure of damages for a damaged vehicle was the diminution in its value, normally assessed by reference to repair costs. It did not matter whether or not repairs were effected by the claimant: he was entitled to recover that sum because that was what he had lost. It followed from the principles that damages were due at the date of the loss, and that damages were to be assessed on that date, that questions of mitigation could not arise. The only issue for the court was the assessment of that figure. The measure of loss could be established by evidence of the actual repair cost, estimates of repair costs or expert evidence as to repair costs. However, it was not the case that only the actual costs incurred could be recovered.
- In assessing the amount of damages recoverable, the intervention of the insurers is to be disregarded. The fact that insurers could have obtained (or has obtained) a cheaper price for the repairs than that achievable by the assured was not relevant. The matter had to be looked at from the point of view of the assured.
For further information: Coles v Hetherton  EWHC 1599 (Comm)
Stych v Dibble  EWHC 1606 (QB)
Motor insurance – Excluded liability
S was a passenger in a Range Rover being driven by D. The vehicle belonged to a customer (B) at a garage where D worked part-time, and it was being used without B’s knowledge or consent. D was uninsured. An accident occurred in which S was severely and permanently injured. S obtained judgment in default against D, and the question was whether B’s motor liability insurers were required to satisfy the judgment against D. Under section 151(2)(b) of the Road Traffic Act 1988 insurers are liable to meet a judgment obtained against any person other than the assured, but that does not apply to an “excluded liability”. That term is defined by section 151(4) as one suffered by a person who was allowing himself to be carried in or upon the vehicle and knew or had reason to believe that the vehicle had been stolen or unlawfully taken. The Court held, refusing to follow McMinn v McMinn  EWHC 827 (QB), that the provision had to be construed consistently with the Second Motor Insurance Directive, Council Directive 84/85/EC, which referred only to a passenger who “knew” that the vehicle was stolen, so that the words “or ought to have known” bore no additional meaning. The Court did not deal with the question whether the words “unlawfully taken” were consistent with the Directive, as it had been conceded that a taking short of theft would bring the exception into play. On the facts, the insurers had failed to prove that S had known that the vehicle had been taken without permission, and so he was able to recover.
Ma Kim Ying v Manulife (International) Ltd  HKCFI 941
Life insurance – Fraudulent non-disclosure – Breach of warranty
Mr Wong Shiu Tong applied for a life policy on 12 July 2004, and a policy was issued backdated to 1 July 2004 with Mr Wong as policyholder and his wife as sole beneficiary. The policy contained an incontestability clause which stated: “The Owner’s or the life insured’s failure to disclose any fact or their misrepresentation of any fact within their knowledge that is material to the insurance (and it is not disclosed by the other party) will not, in the absence of fraud, render this policy voidable by the company after it has been in force during the life insured’s lifetime for 2 years from its date of issue or date of reinstatement …”. Mr Wong died on 14 May 2007 from a condition which he had not disclosed to the insurers. The Court held that the non-disclosure had been fraudulent, that the facts withheld were material, that the underwriter had been induced to write the policy when it would otherwise have not been written and that the incontestability clause did not provide a defence. In addition, the assured was in breach of a warranty stating that the answers had been given to the best of his knowledge and belief.
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