Introduction

This edition of Insurance focus includes the second part of our report on the American Law Institute’s project to reform US liability insurance law. This project has taken on greater significance following the change in title to a ‘Restatement of the Law of Liability Insurance’. Stephen Pate from our Houston office considers the effect of this change.

From our Melbourne office, Matt Ellis and Erica Leaman reflect on the shifting regulatory landscape in Australia, with a particular focus on how the Australian regulator’s approach may impact insurers underwriting add-on products.

In Europe, the Insurance Mediation Directive (now called the Insurance Distribution Directive) remains under consideration and has undergone various changes in the last six months. Laura Hodgson highlights ten key features of the proposal as it currently stands.

In our quarterly review of cases, we report on a decision of the UK Supreme Court ordering the liability insurers of a non-party solicitor to pay costs for both parties to a dispute. We also consider three new cases on business interruption insurance that address the difficulties of proving loss and adjustments under trend clauses.

Our regular feature, International focus, includes regulatory updates from France, Italy, China, Indonesia and the UK.

A rose by any other name: the ALI principles of liability insurance project becomes a restatement

In the September edition of Insurance focus, I wrote about the American Law Institute’s (ALI) project to redefine American liability insurance law by preparing a work entitled ‘Principles of the Law of Liability Insurance’. That article explained that ALI’s important new work would redefine American liability insurance law for possibly the next century, and that its statements could become persuasive law for American courts. A ‘Principles’ publication was, according to the ALI, a statement of the ‘best practices’ of the law - what the law should be. This is different from a ‘Restatement’, which is a recitation of what the law actually is. The September article also noted that several provisions in the Principles work were somewhat controversial and adopted minority positions. Yet, after several fits and starts, the work seemed on its way to completion. Three chapters of the work have been drafted, with more on the way.

Just recently, however, in an email to the members of the consultative group, the Director of the American Law Institute announced that the ALI Council had voted to change the title of the project from the ‘Principles of the Law of Liability Insurance’ to the ‘Restatement of the Law of Liability Insurance’. The email stated that ‘this change is consistent with the Council’s view that projects designed to give guidance primarily to the courts and based on primarily positive law should generally take the form of Restatements’.

This is an important development. Simply by its title, a ‘Restatement’ carries much more weight than a ‘Principles’ guideline. If a rose by any other name should smell as sweet, then actually this project now smells sweeter. Courts in all likelihood will be more likely to want to find a ‘Restatement’ persuasive, and to cite to a ‘Restatement’ in their opinions.

Some have wondered about the change. Perhaps the ALI Council realised that the project was taking on important material, and thus was worthy of a new title and heightened status.

There may also be other reasons for the change. As noted above, a Principles project states ‘best practices’. This project’s Reporters (the law professors who actually draft the work) decided some controversial, minority positions were ‘best practices’. Real storms arose over the adoption of several provisions that are actually at odds with positions taken by the majority of American courts and, in fact, had been rejected by many as unduly draconian. 

This was not the only minority position adopted. Randy Maniloff, a Philadelphia attorney who writes a publication entitled Coverage Opinions noted in a recent article1 several minority positions that have been adopted:

  • Waiver of the right to contest coverage if insurer wrongfully breaches the duty to defend.
  • Adoption of a minority position concerning extending coverage to an innocent co-insured.
  • Pre-tendered defence costs. The project adopted a minority position stating that an insured needed to prove substantial prejudice to preclude coverage – a position rejected by most courts who have addressed this issue.

These are only some examples of minority positions adopted. Some lawyers felt that an adoption of these provisions by the ALI would prove persuasive to courts and lead to unsound opinions. Many others felt that rather than being persuasive to courts, the minority positions actually weakened the effect of the Principles project as courts would not take the project seriously given the fact that these provisions were somewhat ‘extreme’.

So what really happened? It can be surmised that the views of many commentators and members of the consultative group (including this one), regarding these controversial minority positions reached the ears of the ALI Council members and concerns were raised as to the project’s more extreme provisions.

What is to be done now? Given the fact that Restatements describe the law as it should be, the project should no longer take minority positions. Moreover, the minority positions that have already been adopted will have to be reviewed. Indeed, the email announcing that the project had been promoted to Restatement status noted that ‘the Reporters will closely examine the existing text to determine what portions will need to be changed’. The email also suggested that the changes would have to be made and approved at the next ALI annual meeting, which will take place in May 2015. A members consultative group meeting will take place in late March, at which, some fireworks may be expected. Once again, the project is likely to be delayed.

This change of status puts the entire project in a state of flux. Still, it is a needed development. One of the greatest controversies arose about the most recent chapter (Chapter 3) and concerned the definition of ‘accident’. All liability insurance is based upon the concept of an accident occurring. Nevertheless, with few exceptions, ‘accident’ has never been defined in policies. Some policies do define occurrence, and then proceed to define occurrence to include accident, but this is as far as it goes. Case law in different states, however, has defined ‘accident’ by various tests and definitions for years. An accident is almost always defined as something being unforeseen or unexpected. There is no doubt that a project such as the Principles of Liability Insurance Law project should define accident, giving courts guidance, and perhaps leading the way to national uniformity. Yet Chapter 3 (adopted on September 5) defined an accident as ‘an action or event that causes a result that the insured does not subjectively expect or intend’ (emphasis added). This is far afield from what most practitioners expected.

What does ‘subjectively’ mean? Does this mean that if someone does what normal society regards as an intentional act, yet claims that he did not mean to do it, then it counts as an unintentional act and, therefore, in fact, an accident? Taken to an extreme, it could mean that a criminal act could be found by a jury to be accidental, if a jury finds that someone ‘didn’t mean to do it’. One is reminded of the old Steve Martin comedy routine in which he said that he could not be found guilty if he stated ‘I forgot that murder was a crime’. Many think this definition is unworkable and, at the very least, increases the length and the complexity of litigation by requiring a determination of ‘intent’.

This ‘accident’ definition is currently the hot button topic in the Principles, now Restatement world. Certainly, the adoption of a ‘subjective’ standard would be a minority position. It is conjectured that this definition must be substantially revised now that the Project has become a Restatement. It will be interesting to see what revisions are made before the May ALI meeting. I will comment on these revisions as they occur. Stay tuned.

Add-on insurance products and a new approach to regulation

Behavioural economics is fast becoming the driving force behind financial services regulation in the UK, and it is an approach that has the potential to bring about significant changes to the regulatory framework in Australia. In this article, Matt Ellis and Erica Leaman explore recent developments in Australia and how a change in regulatory philosophy may impact on insurers underwriting add-on products.

There is real potential for the regulatory landscape in Australia to undergo a significant shift in coming years - from one based on ensuring consumers have sufficient information to make informed investment choices to one aimed at ensuring the consumer environment is one that promotes good investment decisions. While the language may suggest only a subtle change of focus, the reality is a monumental shift in philosophy with disclosure-based regulation giving way to targeted market intervention. That this is the direction we are heading can be gleaned from Australian Securities and Investments Commission’s (ASIC) submissions to the Financial Services Inquiry (FSI) where it has called on government to provide it with a broader regulatory ‘toolkit’ to enable it to intervene in product design and development and address market challenges that disclosure-based regulation, according to ASIC, has proven incapable of remedying.

While any legislative changes resulting from the FSI recommendations may be some time away, recent ASIC publications suggest it has already begun a re-alignment towards this new regulatory philosophy. For the insurance market, this new philosophy appears to be already influencing the approach to add-on insurance products, where ASIC will be deploying some of its resources over the next 12 months.

The influence of ASIC’s UK equivalent, the Financial Conduct Authority (FCA), in this area, cannot be understated. Driven by theories of behavioural economics, and empowered by a suite of temporary product intervention powers, the FCA is lighting a path that ASIC is eagerly following.

ASIC’s approach to add-on insurance products

In a speech to the Insurance Council of Australia (ICA) in February 2014, the Deputy Chairman of ASIC, Peter Kell, announced that ASIC’s focus in the area of general insurance would include add-on insurance products. While not the main products in the market, Mr Kell said ASIC would focus on these areas because the products were a perennial source of complaints from consumers, and importantly, because selling practices appear to be ‘exploiting consumer behavioural bias’.

Add-on insurance products are generally those sold in conjunction with another primary product. The primary product may be a financial services product (such as a mortgage or other type of insurance contract) or it may be another type of product altogether (such as a motor vehicle). Examples of add-on insurance products include consumer credit insurance sold with loans and insurances sold with motor vehicles such as tyre and rim cover.

Mr Kell explained that add-on insurance products are not the consumer’s focus at the time of purchase, the consumer has little or no information about the products and therefore they rely heavily on statements made by sales representatives to inform their decision to buy. Sales practices for add-on products are often aggressive, with a tendency to overstate the risk of loss and the value of the product. Drawing comparisons with recent UK experience with the payment protection insurance (PPI) scandal, Mr Kell noted how badly things can go wrong with add-on products, highlighting that the enormous capital return on PPI products, along with very low claim ratios, suggested a product offering little value to consumers.

Shortly after Mr Kell’s announcement at the ICA meeting, ASIC invited the Chief Executive of the FCA, Martin Wheatley, to talk about behavioural economics. In a speech delivered at ASIC in March this year, Mr Wheatley said that the PPI scandal had brought about a re-think on the approach to financial services regulation in the UK, and evidence now supported a theory that consumer choices did not correlate to the extent of information available to them. That is to say, regardless of adequate disclosure about a product, consumers still made wrong, or sub-optimal decisions. Whether because of product complexity, consumer inertia or poor sales conduct, the historic approach simply has not delivered appropriate results for consumers. Mr Wheatley described behavioural economics as a game changer ‘not just for firms, not just for consumers, but potentially for the shape of regulation for many years to come’.

ASIC clearly agrees. In its submissions to the FSI, ASIC has adopted the same critique of disclosure-based regulation, and called on legislative change to provide it with a regulatory ‘toolkit’ that enables it to achieve results where disclosure has not worked. ASIC has requested that it be empowered in the same manner as the FCA through a broader regulatory ‘toolkit’ of product intervention powers. Borrowing directly from the UK, ASIC has suggested that these powers should include:

  • requiring providers to issue consumer or industry warnings;
  • requiring that certain products are only sold by advisers with additional competence requirements;
  • preventing non-advised sales or marketing of a product to some types of consumer;
  • requiring providers to amend promotional materials;
  • requiring providers to design appropriate charging structures;
  • banning or mandating particular product features; and
  • in rare cases, banning sales of the product altogether.

The approach to product intervention in the UK

The UK market is now well aware of the willingness of the FCA to use these powers, having seen the recent banning of the sale of CoCos (contingent convertible securities) to the mass retail market with effect from October 1. The FCA has also used its powers to require changes to policy terms and conditions and intervened in a raft of areas following a thematic review of mobile phone insurance.

In terms of add-on products, the FCA has yet to take any action. However it is clear that there is an intention to do so. In his speech to ASIC, Mr Wheatley referred expressly to research the FCA had commissioned concerning add-on insurance products, noting that their behavioural studies showed that 65 per cent of consumers did not look for alternative products, 25 per cent were not aware they could get the product elsewhere, 58 per cent made no comparison to alternative products and consumers were six times more likely to make mistakes in respect of their product choice.

He also noted that claim ratios for add-on products had fallen below ‘acceptable’ levels – for Guaranteed Asset Protection insurance at 10 per cent and for personal accident at 9 per cent. These studies are prompting the FCA to look at such things as: a ban on pre-ticked boxes to challenge consumer inertia; publication of claims ratios to reduce information asymmetries; and improvement in the manner in which add-ons are offered through price comparison websites. In many respects, these criticisms were also made by the UK's Competition and Markets Authority in its recent review of the car insurance market.

What to expect in Australia

The release by ASIC of the Strategy Outlook 2014/15 makes it clear that lobbying for product intervention powers and collecting evidence of consumer behaviour will be a key focus for ASIC over the next 12 months. ASIC has identified as one of the four ‘key risks’ in its recent Strategy Outlook, the existence of a gap between the expectations that consumers have of the regulator and the reality that under the existing regulatory framework, ASIC is unable to deliver on those expectations because it does not have an appropriate remedy. If ASIC achieves what it is after, this ‘expectations gap’ will be plugged with product intervention powers similar to those available to the FCA.

Of some concern is the statement in the Strategy Outlook that ASIC is presently unable to ‘ensure compensation for investors who lose money’ – a telling glimpse at the approach ASIC may take to its product intervention powers if it gets them. The statement suggests an assumption that losses incurred by consumers are a result of a poor consumer environment and are therefore compensable, while dismissing the reality that informed investors sometimes make poor investment choices. For a regulator whose role is to ensure market integrity, a tendency towards compensating poor consumer choices may deter new capital, stifle product innovation and reinforce poor consumer behaviour, all of which undermines the market it is regulating. This is the sharp end of the tension between the existing and new regulatory philosophies – drawing a dividing line between poor consumer choices, and choices made in a poor consumer environment.

Market participants should expect behavioural economics to drive ASIC's criticism of products, particularly add-on insurance products and PPI, where much of the work has been done by their UK peers. A big hurdle for ASIC is to convince policy makers that the proposed increase in regulation will be offset by a reduction of regulation elsewhere, given the government’s clear direction to cut red tape and reduce the regulatory burden. To this end ASIC has suggested that the regulation of disclosure may be ’peeled back’, but no real detail has been provided to date.

There is little doubt that if ASIC is given the regulatory ‘toolkit’ it wants, add-on insurance products will be among the first to be put in the vice. Insurers and intermediaries should keep an eye on developments in the UK as an indicator for what may be in store in Australia.

The Insurance Distribution Directive – 10 things to know about the proposals so far

Since May 2014 there have been published six compromise texts of the directive to revise the regulation of insurance mediation – now called the Insurance Distribution Directive (IDD). The directive is expected to be adopted by Spring 2015 with transposition within two years meaning that the revised rules for the distribution of insurance products may be in effect in early 2017. In this article, Laura Hodgson takes a look at the key issues relating to the proposals in the IDD.

  1. Revised scope. The IDD is a minimum harmonisation European Directive that will be applied to intermediaries and also to insurance and reinsurance undertakings who sell direct to their customers. Claims management, loss adjusting and expert claims appraising are not within scope of the draft IDD according to the latest compromise text.
  2. Introducing no longer included. Insurance distribution includes advising on, proposing or carrying out work preparatory to a contract of insurance or assisting in the administration and performance of such contracts, in particular in the event of a claim. Notably, the activity of ‘introducing’ is not within the definition of insurance distribution (as it is under the current Insurance Mediation Directive (IMD)). Accordingly, once in force there will no longer be any need for those merely introducing customers to brokers or insurers (or providing data on policyholders to insurers) to be registered.
  3. Registration of all intermediaries. Intermediaries (i.e. those distributors who are not insurers or reinsurers selling directly) are required to be registered with a competent authority in their Home Member State. Where a distributor is responsible for the activities of an intermediary (for example, an Appointed Representative) they will have responsibility to ensure that the intermediary meets the conditions for registration and for registering that intermediary with the relevant competent authority.
  4. Overriding requirement to act in customers’ ‘best interests’. The IDD requires that all insurance distributors should act ‘honestly, fairly and professionally in accordance with the best interests of its customers’. This requirement imposes a high standard upon all distributors (including direct sellers and those distributing to professional customers) to consider the interests of customers in their business. This could have potentially far reaching consequences as was seen in the application of Treating Customers Fairly by regulators in the UK. Furthermore, distributors are required to ensure that they do not remunerate or assess the performance of their employees in a way that conflicts with the duty to act in the best interests of customers. In a move similar to the recent tack taken by the Financial Conduct Authority (FCA), the draft IDD also requires firms to operate and review a process for the approval of each insurance product they offer and to review any significant adaptations of existing products before they are marketed or distributed to customers. This process requires firms to identify target markets and ensure that risks to the target market are assessed and managed.
  5. Conflict management requirements for investment products. The IDD introduces higher standards of disclosure and conflict management for Insurance-based Investment Products (IBIPs). These are products that offer a maturity or surrender value that is dependent on market fluctuations. Where organisational measures are insufficient to ensure, with reasonable confidence, that risks of damage to the customer cannot be prevented, the distributor is required to disclose the general nature and source of the conflict. The European Commission is given powers under the IDD to introduce delegated acts in order to define the steps that distributors might reasonably take in order to identify, prevent, manage and disclose conflicts and to establish criteria for determining the types of conflicts that may damage the interests of customers or potential customers. The inclusion of the conflicts measures and supporting delegated acts reflects similar requirements in the Markets in Financial Instruments Directive (MiFID). In addition, insurance distributors will be subject to the requirement in the measures being developed for packaged retail investment and insurance-based investment products (PRIIPs) to provide customers with a key information document (or ‘KID’).
  6. Conflict measures expedited into ‘IMD 1.5’ by MiFID II. In order to ensure that MiFID type conflicts measures are introduced for IBIPs in advance of agreement on the IDD, Article 91 of MiFID II introduces a new Chapter IIIA into the IMD in a measure being called ‘IMD 1.5’. Chapter IIIA introduces the requirement for insurance intermediaries and direct sellers to identify conflicts and disclose the existence of conflicts where required. Similar to the current draft of the IDD, IMD 1.5 requires the European Commission to introduce delegated acts to define the steps that distributors might take to identify and manage conflicts and to identify particular types of conflicts. In its consultation, the European Insurance and Occupational Pensions Authority (EIOPA) proposes using very similar wording to that applied in MiFID for both the identification of conflicts and types of conflict scenarios. It is likely that this IMD 1.5 approach will be replicated in the IDD, once finally agreed.
  7. Enhanced professional requirements. Those persons carrying out insurance or reinsurance distribution will be required to meet certain competency requirements and comply with obligations for continuing professional development, taking into account the nature of the products being sold and the type of distributor (i.e. taking into account the variances between tied agents, commercial brokers and IFAs). These include requirements for continuing professional development.
  8. Disclosure and transparency. Before the conclusion of an insurance contract, intermediaries are required to provide details about themselves and must describe to their customer the nature of their remuneration and whether the contract will work on the basis of a fee or commission (or other type of arrangement). The IDD excludes these obligations where the distribution relates to large risks, reinsurance or for professional customers. The European Commission proposal for a revised IMD had originally mandated commission disclosure after a 5 year transitional period for all insurance policies. Insurance undertakings will be required to disclose the nature of the remuneration received by its employees in relation to the contract sold (i.e. bonus payments). The latest European Council compromise text enables Member States to restrict the payment of commission as has been done in the UK under the Retail Distribution Review rules in operation since December 31, 2012.
  9. Online selling and aggregators. The IDD recognises the use of websites in distribution and in particular includes aggregator sites within scope. In addition, the IDD recognises that pre-contractual information can be provided to customers via a website.
  10. Cross-selling disclosures. When a product is offered with another service or as part of a package the distributor must inform the customer whether it is possible to buy the different components separately and if so they must provide an adequate description of the different components as well as separate evidence of costs and charges.

UK

Supreme Court orders non-party’s liability insurers to pay both parties’ costs of a wills dispute

In the recent case of Marley v Rawlings and another [2014] UKSC 51, the Supreme Court held that a non-party solicitor’s liability insurers should bear both parties’ costs of the proceedings, in circumstances where the solicitor was responsible for the error which had prompted the dispute. Natasha Hawkins, an associate in our London office, considers this case and the wider circumstances in which liability insurers might be exposed to a non-party costs order in English litigation.

The Marley v Rawlings case

This case concerned an appeal against the Court of Appeal’s refusal to admit to probate the will of Alfred Rawlings. Mr Rawlings’ solicitor had drafted the wills of both Mr Rawlings and his wife (who predeceased Mr Rawlings), but had mistakenly presented the Rawlings with each other’s wills for signature, meaning that Mr Rawlings had signed his wife’s will, and vice versa. Mr Marley was named as the beneficiary under Mr Rawlings’ will, and therefore would have been entitled to the inheritance if the will had been validly executed. Mr Rawlings’ two sons would have been entitled to the inheritance under intestacy rules if the will had not been validly executed. A dispute arose therefore between Mr Marley and Mr Rawlings’ sons, the respondents, over the validity of the will.

Although the solicitor responsible for the error was not a party to the litigation, the solicitor’s liability insurers agreed to underwrite Mr Marley’s costs of bringing proceedings to have the will upheld as valid, after Mr Marley intimated a claim for professional negligence against the solicitor.

The Supreme Court held that the will had been validly executed, and therefore that Mr Marley was entitled to the inheritance, which amounted to around £70,000. While, in the usual course of hostile litigation, the losing party would be expected to pay the successful party’s costs, the Supreme Court noted that, where the litigation concerns the validity of a will and where both parties pursue a reasonable argument, it would generally be appropriate to order that the costs of the dispute be paid out of the estate. In this case, however, the Supreme Court was concerned that, given the size of the estate and the level of costs incurred, this would deprive the successful party, Mr Marley, of any benefit from the litigation or from the estate.

In light of this, the Supreme Court considered whether to issue a non-party costs order against Mr Rawlings’ solicitor (or its insurers). Insurers raised defences that:

  • the Court should only issue non-party costs orders in exceptional cases;
  • it would be unfair to require the solicitor (or insurers) to pay the respondents’ costs in circumstances where the solicitor owed no duty of care to the respondents; and
  • it was not the solicitor’s (or his insurers’) fault that the respondents had chosen to fight the claim

The Supreme Court was not persuaded by these arguments, finding that:

  • it is not unusual for costs to be awarded against a non-party who funds or is responsible for litigation;
  • the respondents’ decision to fight the litigation was not unreasonable, and it would be unfair if they had to pay substantial costs; and
  • it was foreseeable that the respondents would contest the claim to the Supreme Court, given that they had been successful in the High Court and the Court of Appeal.

The Supreme Court decided that, rather than ordering the parties to recover their costs from the estate (leaving Mr Marley to pursue a claim against his solicitor, and the solicitor to be indemnified by insurers), a practical shortcut would be to order insurers to pay all of the costs of Mr Marley up to and including the Supreme Court, and the costs of the respondents up to and including the Court of Appeal. The respondents’ solicitors and counsel had acted under a conditional fee agreement in respect of the Supreme Court proceedings, and the Supreme Court held that the respondents were entitled to recover also from insurers their solicitors’ disbursement costs in relation to the Supreme Court proceedings, including counsel’s base fees.

This case is a reminder to solicitors and their liability insurers that, even where rectification proceedings are successful, they may be liable for significant adverse costs (particularly where they have agreed at the outset to fund one of the party’s costs of the proceedings).

Wider circumstances in which liability insurers might incur non-party costs orders

The English Court has wide jurisdiction to grant costs orders against parties and non-parties to litigation. Under section 51(3) of the Senior Courts Act 1981, the County Court, High Court and Court of Appeal ‘…have full power to determine by whom and to what extent the costs [of the litigation] are to be paid’. Similarly, under its rules, the Supreme Court is entitled to make any costs orders ‘as it considers just’.

While the starting point when considering potential liability for a non-party costs order is that such orders are ‘exceptional’, the threshold for defining what is ‘exceptional’ has been lowered gradually since the landmark House of Lords decision in Aiden Shipping v Interbulk Limited (The Vimeira) (No 2) [1986] 1 AC 965, and the Court has shown increasing willingness to order non-parties to pay litigation costs. ‘Exceptional’ is now accepted to mean ‘no more than outside the ordinary run of cases where parties litigate for their own benefit and at their own expense’ (see Dymocks Franchise Systems (NSW) Pty Ltd v Todd and others [2004] UKPC 39).

Of course, it is common (and thus not ‘exceptional’) for liability insurers to fund and/or control litigation, and the Court has held that this would not usually render insurers liable for adverse costs where their interests overlap with those of the insured (as they generally would). However, where the interests of insurers and the insured are not aligned, and where the insured has no interest in the dispute and/or no reputation to protect, insurers may be at risk of liability for adverse costs. In the case of Plymouth and South West Co-operative Society Ltd v Architecture, Structure and Management Ltd [2006] EWHC 3252 (TCC), for example, the Court issued a non-party costs order against insurers of the insolvent defendant, in circumstances where insurers had funded the entirety of the defence and where the defendant had wanted to put the company into liquidation and had no desire to defend the claim.

In Marley v Rawlings, the Supreme Court was persuaded by the fact that the solicitor’s insurers had required Mr Marley to bring the proceedings as a step in mitigation (in respect of his potential claim against the solicitor) and had underwritten the costs of doing so.

In summary, liability insurers should be alive to the risk of a non-party costs order where they not only fund litigation, but where:

  • insurers control or are set to benefit from the litigation and where the litigation is pursued against (or in the absence of) the insured’s interests; and/or
  • insurers are responsible for the litigation taking place and/or for a party incurring costs that would not otherwise have been spent.

Three new cases on Business Interruption insurance – proving loss, Trends Clauses and the TOWIE effect

“…the Club was a beautiful place teeming with beautiful people. It was filled with ornate Thai artefacts, velvet drapes and exotic flowers. It was an opulent and extravagant venue with a unique atmosphere created by lavish decoration, elaborate lighting and music. The Club was extremely successful. Every weekend there would be queues of customers down the High Street in Brentwood waiting to get in.”

Unfortunately, the Club burnt down. In common with two other cases decided by the Commercial Court in the final quarter of the year, this incident gave rise to a substantial business interruption (BI) claim which was wholly or partly rejected by the policyholder’s insurers. In two of the cases, Sugar Hut Group Limited & Ors v AJ Insurance [2014] EWHC 3775 (Comm) and Eurokey Recycling Limited v Giles Insurance Brokers Limited[2014] EWHC 2989 (Comm), the policyholder looked to its broker in order to recover its losses. In the other case, Ted Baker Plc & Anor v Axa Insurance UK Plc & Ors [2014] EWHC 3548 (Comm), the judgment marked the culmination of a lengthy action in which the policyholder had previously established that its BI policies responded to employee theft.

Whereas the Eurokey judgment focused on the nature of a BI insurance broker’s duties at the time of placement and following inception, the other two decisions looked at the policyholder’s ability to prove its loss. In this context, the Sugar Hut and Ted Baker cases also concerned the application of a ‘Trends Clause’ – the first occasion that the English Courts have had reason to consider this type of provision since Orient Express Hotels Limited v Assicurazioni Generali S.p.A. [2010] EWHC 1186 (Comm). We therefore pass comment below on the lessons learned from these cases.

The difficulties of proving loss

While the precise wording varies, the basic structure of most BI covers is an indemnity for loss of ‘Gross Profit’ as a consequence of an insured peril calculated by reference to the ‘Standard Turnover’ of the business (i.e. the turnover during the period of 12 months immediately prior to the indemnity period). A mechanism is also often included in the form of a Trends Clause, allowing for an adjustment to the standard formula in order to take account of any overarching trends in the business. When it comes to evidencing loss, Trends Clauses can be a source of particular difficulty (as to which, see below).

However, demonstrating that a loss exceeds the excess is not usually a problem. In the Ted Baker case, the underlying claim was for the fashion retailer’s (TB) BI losses arising from the theft of stock by a rogue employee from the fashion retailer’s warehouse. The unusual difficulty faced by TB was that the multitude of thefts were incremental and took place over a period of five years. Having concluded that the claim failed as a result of TB’s failure to comply with a claims provision which operated as a condition precedent to liability, the Court went on to consider whether TB had proved its loss, accepting TB’s contention in light of recent authority (including Equitas v R&Q [2009] EWHC 2787 (Comm)) that precision as to quantum is not a bar to recovery.

In attempting to ascertain the quantum of TB’s losses, one of the issues for the Court was whether TB could demonstrate on a balance of probability (or to the lower standard envisaged in the authorities) that its numerous losses exceeded the excess of £5,000 each and every loss. Although TB was able to rely on expert evidence derived from a model, the issue for TB was that there was negligible (if any) concrete evidence as to the exact incidence, number and size of the thefts. For this further reason, the Court concluded that TB’s claim would also have failed.

Trends Clauses

A further issue in the Ted Baker case was whether adjustments could be made under the Trends Clause in order to reflect the fact that the lost profit on any given item of stock depended on a range of factors such as the timing of the hypothetical sale (e.g. at the start of a season or in the sales). Although there was also a question as to whether TB’s adjustments were permitted by the other terms of the policies, the limitations of TB’s model were such that it was ultimately unnecessary to decide this point. Because TB could not prove its lost profit above the excess, there was also no need to consider the accuracy of insurers’ model.

In contrast, the application of the Trends Clause was the major issue in dispute in Sugar Hut. In that case, the defendant broker having accepted liability for 65 per cent of the claimant’s losses, the Court was asked to determine if the trajectory of the business was such that the BI losses for a 49-week period amounted to approximately £1.35 million (as the claimant contended) or no more than around £400,000 (on the defendant’s case).

In support of an elevated figure, the claimant argued that the Club had significant ‘momentum’ at the time of the fire. For the purposes of the Trends Clause, this was said to be evidenced by the 11 months of trading immediately preceding the fire, coupled with the Club’s significantly increased turnover when it re-opened. With regard to the Club’s trading history prior to the fire, the judge agreed that it was very difficult to discern any underlying trend in the business over such a short period of trading but that the general condition of the Club and the expertise of its main investor pointed to a modest increase in turnover.

The judge was also unable to draw any reliable conclusions from the turnover achieved by the Club after the reinstatement works. This was for a number of specific reasons, including the extensive additional refurbishments undertaken, the increase in the Club’s capacity and a phenomenon labelled the ‘TOWIE effect’. This referred to the Club’s appearance on a well-known television show (The Only Way Is Essex – which the judge admitted he had not seen), resulting in an influx of new customers. Unfortunately for the policyholder, the overall effect of these factors was that the business was not comparable in its post-fire condition.

Relief for BI insurance brokers

In the Eurokey case, the problem faced by the policyholder (a waste recycling company) was that it had significantly under-insured by approximately £16 million. When its premises burnt down in May 2010, insurers threatened to exercise their avoidance rights on grounds of material non-disclosure relating to the under-insurance and a negotiated settlement was reached. In this action, the policyholder attempted to recover the shortfall in cover from its former broker (‘Giles’), claiming that it had been negligently advised.

The central issue in the case was therefore whether Giles had discharged its duty to provide sufficient information for the claimant to calculate its indemnity period and the appropriate BI sum insured (including an explanation as to the insurance definition of ‘gross profit’). The extent of the information which Giles was required to provide depended in turn on the level of the client’s sophistication. This was a wholly evidential question which was decided in Giles’ favour, based on what was found to have been said at a number of pre-renewal meetings and the client’s familiarity with BI insurance concepts.

More notably, the claimant also put forward an argument in connection with a set of draft accounts sent to Giles immediately following inception. These draft accounts had been sent to Giles for onward transmission to a premium finance company. Crucially, they showed a far higher figure for the turnover of the business than the figure on which the sum insured had been based. Relying on HIH Casualty & General Insurance Ltd v JLT Risk Solutions Ltd [2007] EWCA Civ 710, it was the claimant’s case that Giles should have reviewed the draft accounts in order to identify potential coverage issues, notwithstanding the purpose for which they had been sent.

The judge disposed of this argument in short order, observing that there was nothing to alert Giles to the fact that the draft accounts might contain materially inconsistent information. As a result, Giles had been entitled to pass on the draft accounts without reviewing them.

Conclusion

Except for confirming that the policyholder bears the burden of proving that its losses exceed the applicable excess, the Ted Baker and Sugar Hut cases decide nothing in the way of new insurance law. However, both cases clearly demonstrate that policyholders must provide cogent evidence of their BI losses, even if precision is not required. This applies as much to proving that lost profit attributable to an insured peril surpasses the excess, as it does to showing an underlying trend in the business when relying on a Trends Clause.

As for Eurokey, this decision provides a modicum of comfort to brokers that there are circumstances in which it is appropriate to act as a postbox. It is therefore a positive development for brokers and will be particularly welcome news for those who operate in the BI insurance market. As a result, HIH v JLT remains the high-water mark for post-inception duties.

International focus

France

Raising the bar of consumer protection measures through the Loi Hamon

Law no. 2014-344 on consumer rights (Loi Hamon) dated March 17, 2014 is intended to reinforce consumer protection by offering ‘new levers to rebalance power between consumers and professionals’. As a result of this ambitious goal, Loi Hamon encompasses several areas of consumer contracts, including insurance.

Loi Hamon introduces new provisions into the French Insurance Code which have been qualified as ‘innovations in insurance contract law’: while some of them may seem desirable, the relevance and purpose of others appear to be more questionable. These new measures have given rise to long parliamentary debates and criticisms or fears expressed by the industry’s stakeholders have been levelled at some of them.

The two main issues of relevance for insurers are the introduction of the right for insureds to cancel an insurance contract at any time after the first year on one month’s notice i.e. notice of cancellation may be given immediately after expiration of the first year, as from commencement of the thirteenth month following the date of conclusion of the insurance contract. This cancellation right may not give rise to the application of charges or penalties to be borne by the insured and the insurer must refund the premium paid up front on a pro-rata basis. Second level legislation is expected to clarify the scope of such change.  

Loi Hamon also aims to improve the scope of pre-contractual information delivered to the policyholder in order to avoid duplication of insurances in the case of 'affinity' or ancillary products. In the event the insured finds, after having entered into an insurance contract, that he already has cover for the same risk, Loi Hamon offers a remedy by providing a cooling-off period of 14 calendar days for the last concluded contract. The remedy is subject to limitations in its application: the contract must be a consumer affinity contract covering malfunction, loss, theft or damage to goods or damage or loss (including theft) to luggage and other travel risks; and the insured must show the existence of 'existing cover' for one of the risks covered by the affinity contract.

Pre-contractual information must be provided by the insurer (or, in practice, the intermediary) to the insured where there is potential for duplicate cover under the new contract with respect to the cover that the prospective policyholder already owns. This obligation is fulfilled by providing the insured 'before the conclusion of [the insurance contract] (…) [with] a document inviting him to verify that he does not already benefit from the coverage of one of the risks covered in the new contract' and by informing him of the cooling-off right in such case.

Such information will be required to be included in the distribution process for affinity insurances and raises questions regarding its implementation, in particular with regard to internet or telephone sales. Second level legislation is expected to clarify the form and content of such information. 

Italy

Insurers allowed to grant financing

In October, IVASS, the Italian insurance regulator, issued a new measure (the Provision) aimed at implementing the provisions of Law Decree no. 91 of 24 June 2014, converted with amendments into Law no. 116 of 11 August 2014 (the Decree).

The Decree allows Italian insurance companies to grant financing directly to borrowers (other than individuals and micro-enterprises) for the purpose of widening the range of potential lenders and boosting access to credit.

Insurers are required to adopt a ‘financing plan’, to be submitted to IVASS for evaluation, and they are allowed to consider such financings as investments covering their technical provisions, up to certain thresholds which have been set by the Provision.

Insurers must be assisted by a bank or financial intermediary in the activity of selecting borrowers, and such bank or financial intermediary shall retain an interest in each transaction, until the expiration of the transaction (but such interest is transferable to other banks or financial intermediaries). Alternatively, insurers may seek an authorisation from IVASS to directly carry out the activity of selecting borrowers.

Further implementation measures are expected to regulate access by insurers to the credit risk database kept by the Bank of Italy and periodic reporting to the Bank of Italy in respect of such financing business.

This development is consistent with wider efforts to encourage investment by insurers in the European economy.

China

Chinese Supreme Court interpretation on life insurance contracts law in consultation

The Supreme People’s Court of China is set to implement Interpretation III on Insurance Law. The Court issued its draft clauses of Interpretation III for public consultation in October 2014. It is estimated that Interpretation III will become law early next year

By way of background, China revised its Insurance Law in 2009 and subsequently the Supreme People’s Court of China issued Interpretation I and II to provide guidance on how the legislation should be interpreted and applied in practice. The upcoming Interpretation III is the latest in the series with a particular focus on life insurance contracts including health and accident insurance.

The penetration of life insurance in the Chinese insurance market is rapidly increasing. Up to September this year, primary life insurance premium income in China had reached £103 billion, which represents a 19.97 per cent increase year on year. For international insurers admitted in China, life insurance has also overtaken property insurance in terms of premium income in their business lines. Interpretation III, once passed, will no doubt improve the legal environment in which life insurers operate, boost contract certainty and ensure greater clarity of the insurer’s position when disputes arise.

To highlight some of the key provisions, on disclosure, the draft clauses provide that the assured only needs to disclose information as inquired by the insurers. In group life insurance, the assured only needs to disclose such information as inquired by the insurers relating to the insured group as a whole; the insurers cannot avoid the policy on the basis that no information for each individual in the group has been disclosed.

In relation to beneficiaries, the draft clauses provide that the nomination of a beneficiary must be agreed by the assured. The assured or proposer must notify the insurer of any change of beneficiary; otherwise it is not binding on the insurer. No request to change the beneficiary by the assured or proposer shall be allowed after the occurrence of the insured events. The beneficiary shall not be allowed to assign its rights to others without prior approval of the proposer or the assured before the occurrence of the insured events, subject to contrary provisions in the policy. The draft clauses also provide detailed rules on how to ascertain who the beneficiaries are and their order of priority when the contract is ambiguous.

On some other controversial issues, the draft clauses set out alternative positions for public comment and it is not entirely clear where the Supreme People’s Court will stand ultimately. For example, the right of subrogation in medical expenses insurance is not settled in Chinese law. The draft clauses invite the public to comment on whether insurers should or should not be given the right to pursue claims against a third party who caused the insured injury, illness or death within the extent of the compensation paid or similarly to deduct any sum paid by such third party to the insured from the compensation due.

Last but not least, the draft clauses provide that if the loss was caused by both insured and excluded perils, the assured or proposer is entitled to seek a percentage of the compensation in proportion to the extent that the insured perils had caused the loss.

It may take the Supreme People’s Court a number of months to consider the comments received from the public consultation. Once Interpretation III becomes law, insurers may need to review and redraft their policy terms to reflect the latest legal position. Watch this space!

Indonesia

New Insurance Law

A comprehensive new insurance law passed by Indonesia’s parliament could have major consequences for joint venture companies operating in this rapidly growing insurance market. On September 23, 2014, the Indonesian Parliament passed a new law on insurance (New Insurance Law) which came into effect on October 23 replacing Law No. 2 of 1992 on Insurance Business (Old Insurance Law).

The New Insurance Law sets out a comprehensive regulatory framework for Indonesia’s insurance sector. It applies to all insurance business companies (IBCs), whether insurers, reinsurers, brokers, agents or loss adjusters.

In addition to providing greater regulation of insurance business, the new law also has an underlying nationalistic sentiment, evidenced by the approach to foreign ownership. Whilst any change to maximum foreign ownership levels (currently 80 per cent) has been held over until an implementing Government Regulation is issued, which will happen within 30 months, the New Insurance Law does introduce several fundamental changes that foreign investors need to consider carefully.

Indonesian shareholders of IBCs must be fully owned by Indonesian citizens

Under both the Old Insurance Law and the New Insurance Law, Indonesian shareholders must hold at least 20 per cent of the issued capital of any joint venture IBC, while foreign shareholders can hold up to 80 per cent.

Under the Old Insurance Law, the Indonesian shareholders of an IBC could be Indonesian citizens and/or Indonesian legal entities fully owned by Indonesian citizens and/or Indonesian legal entities. The New Insurance Law has removed the italicised words meaning that an Indonesian corporate IBC shareholder must now ultimately be fully owned by Indonesian citizens in order to qualify as Indonesian. This now makes unlawful the use of the dual-layer PMA structure which foreign entities have utilised to ultimately own 100 per cent of an IBC.

Insurance companies have five years in which to either:

  • ensure that the shares that must be held by Indonesian shareholders are all directly or indirectly held by Indonesian citizens; or
  • conduct an initial public offering, we presume with a minimum free float of 20 per cent.

Since many joint venture insurance companies operating in Indonesia are currently fully controlled by foreign investors through utilising a dual-layer PMA structure to own shares in excess of the foreign direct investment limit of 80 per cent, this change in law could have a major impact.

Single presence policy

The new law also introduces a single presence policy for the insurance sector. Under the new regime, a person or other legal entity can, at any time, only be a controlling shareholder in one life insurance company, one general insurance company, one reinsurance company, one sharia life insurance company, one sharia general insurance company and/or one sharia reinsurance company. Such restriction will not apply to the Indonesian Government.

Shareholders with controlling interests in more than one such insurance company have three years to comply. It follows that several prominent global insurers presently operating in Indonesia will need to sell or merge their Indonesian operations in order to comply with this requirement.

Other noteworthy developments flowing from the New Insurance Law

  • Insurance and reinsurance companies must separate into a stand-alone entity all sharia divisions within ten years from the enactment of the New Insurance Law, or when the sharia component exceeds 50 per cent of the total insurance portfolio, whichever is the earlier.
  • The insurance for any asset or risk located in Indonesia must be placed with a local insurer, irrespective of ownership of that asset or responsibility for a risk, unless no local insurer is able or willing to underwrite the risk. This removes the previous concession that allowed foreign entities to purchase insurance from offshore insurers.
  • A new policy assurance programme replaces the existing mandatory guarantee fund, with the aim of providing protection to policyholders in case their insurer is liquidated or has its licence revoked.
  • Insurance and reinsurance companies must optimise domestic capacity. In other words, domestic insurers and reinsurers must provide local reinsurance coverage ‘as far as possible’. The intention is to encourage all insurers and reinsurers (both conventional and sharia) to assist with the expansion of the local market.

The New Insurance Law is going to have a substantial impact on the Indonesian insurance market.

UK

Regulators publish consultations on new regulatory framework for individuals

PRA proposals

On November 26, the Prudential Regulation Authority (PRA) issued a consultation paper (CP24/14) on Senior insurance managers regime: a new regulatory framework for individuals. The proposals seek to update the PRA’s approved persons regime in order to implement the Solvency II Directive (the Directive) and to closer align the regime for insurers with that being introduced under the Senior Managers Regime for banks.

In a move away from ‘intelligent copy out’ the proposed regime seeks to provide more detailed elaboration on the fit and proper measures set out in the Directive. The proposals aim to ensure that the senior persons who run insurers, or who have responsibility for other key functions within the business, behave with integrity, honesty and skill. Although broadly aligned with the regime for banks the proposals take into account the different business model of insurers and will take into account the different risks and features of the industry.

The following Controlled Functions will be designated as Senior Insurance Management Functions (SIMFs):

  • Chief Executive Officer (SIMF1)
  • Chief Finance Officer (SIMF2)
  • Chief Risk Officer (SIMF4)
  • Head of Internal Audit (SIMF5)
  • Third Country Branch Manager (SIMF19) (Third-Country branches)
  • Chief Actuary (SIMF20)
  • With-profits Actuary (SIMF21) (For with-profits firms)
  • Chief Underwriter Officer (SIMF22) (General (re)insurance and Lloyd’s managing agents)
  • Underwriting Risk and Oversight Function (SIMF23) (Society of Lloyd’s)
  • Group Senior Insurance Manager (SIMF7) (Group)

None of the sanctions contained in section 36 of the Financial Services (Banking Reform) Act 2013, nor the presumption of responsibility contained in section 66B of the Financial Services and Markets Act 2000 will apply to the above SIMFs. The certification regime being applied to banks will not be required by insurers for their employees. The PRA proposes that the scope of individuals subject to approval before taking up their roles will be more role-specific than is currently the case under the existing approved persons regime. These individuals will be held to account for the ongoing safety and soundness of their firms and for the appropriate protection of policyholders.

Other individuals, known as ‘key function holders’ (included in the Directive) but who do not hold either a PRA or Financial Conduct Authority (FCA) controlled function will be need to be pre-approved. The PRA will take appropriate action in relation to these individuals only where it considers that they do not meet fit and proper requirements on an ex-post basis. Other individuals on a parent/holding company board or holding key group functions will also be subject to this approach.

The PRA will apply a proportionate approach to the application of this regime with the result that smaller firms and third country branches may be able to combine responsibilities for different functions.

Key to the proposals will be the requirement for (re)insurers to maintain a ‘Governance Map’ identifying the individuals who run the firm along with the key function holders.

Certain ‘core’ responsibilities will need to be allocated amongst the controlled function holders (including FCA controlled functions) including such things as taking responsibility for ‘leading the development of the firm’s culture and standards’ and ‘embedding the firm’s culture and standards in its day-to-day management’. New conduct standards will be introduced for both SIMFs and key function holders.

FCA proposals

Also on November 26, the FCA issued a consultation paper (CP14/25) on Changes to the Approved Persons Regime for Solvency II firms. Solvency II requires that persons performing certain ‘key functions’ within firms are fit and proper. The FCA proposes to use its existing approved persons assessments but with adaptations where individuals will be carrying out Solvency II key functions.

The FCA anticipates that the existing FCA-designated controlled functions that are most likely to be Solvency II key functions are:

  • Significant Management (CF29)
  • Compliance (CF10)
  • Appointment and oversight (CF8)

The FCA is not proposing to expand the existing scope of the above controlled functions. Any individual performing any Solvency II key function which falls outside the above categories will be picked up by the PRA ‘key function holder’ regime.

The FCA proposes to amend the Fit and Proper Test for Approved Persons (APER) in order to take into account the Solvency II framework when making an assessment. This will include consideration of the firm’s own assessment of a candidate under PRA rules and requirements contained in either the Solvency II Regulations or the European Insurance and Occupational Pensions Authority (EIOPA) guidelines.

To more closely align the regime applied to insurers to that applied to banks, the FCA proposes to require pre-approval of all individuals taking up executive and other functions within firms not otherwise approved by the PRA. These people will become FCA Significant Influence Function (SIF) holders. The FCA will continue to consent to individuals performing PRA functions from a conduct perspective.

In the joint PRA/FCA Strengthening accountability in banking: a new regulatory framework for individuals (CP14/14), the regulators proposed new Conduct Rules for approved persons. The FCA believes that these Conduct Rules are appropriate to insurers as well as banks. For insurers, however, the Conduct Rules will only be applied to those functions that require pre-approval. The proposed conduct rules build on the existing APER rules with two additions: individuals would be obliged to pay due regard to the interests of customers and treat them fairly; and those in positions of particular responsibility must ensure that any delegation of their responsibility is to an appropriate person and that they oversee the discharge of the delegated responsibility effectively. The rules will be divided into two tiers: Individual Conduct Rules applied to all PRA and FCA approved persons in Solvency II firms; and a second tier applied only to FCA SIF holders in such firms.

The FCA proposes that the functions of Chief Risk Officer and the Chief Internal Audit Function should be designated as FCA SIF holders in Insurance Special Purposes Vehicles (ISPVs). Although the PRA proposes not to require pre-approval for these roles in ISPVs, the FCA believes that these functions remain important from a conduct perspective and will pre-approve candidates on this basis. Furthermore, not all controlled functions are required in the UK branches of EEA Solvency II firms and there will be a general override where the assessment of whether someone is fit and proper is reserved to the home state. However, where the functions are required and the override does not apply, EEA branches will be subject to the same approach as applied to UK firms.

Both consultations close on February 2, 2015.