Key Contacts

Maria Ross - Partner

maria.ross@nortonrose.com

Susan Dingwall - Partner

susan.dingwall@nortonrose.com

Laura Hodgson - Know how lawyer

laura.hodgson@nortonrose.com

Our analysis of key legal developments in the insurance industry over recent months

In this edition of Insurance focus, marine insurance experts, Ian Teare, David McKie and Professor Robert Merkin consider the recent Supreme Court decision in The Cendor MOPU which has confirmed the limitation of the inherent vice defence to losses proximately caused by something internal to the insurance risk.

From our Paris office, Franck Poindessault focuses on the recent campaign to remove gender discriminatory pricing from the insurance sector and Salvatore Iannitti considers the implications of marketing and transparency regulations, which have had a profound effect on both insurers and intermediaries in the Italian market.

We also publish the first in a series of articles which consider the growing market for micro-insurance. In the first article Jonathan Teacher and Isabella Jones discuss the challenges facing the global micro-insurance market and the role of regulation in facilitating its development.

In our case notes section we examine several recent cases of interest to insurers including Re Digital Satellite Warranty Cover class="abbr" title="Limited">Ltd in which the High Court considered whether the provision of extended warranties in relation to satellite television dishes constituted a contract of insurance.

We also include updates on regulation and insurance related developments from across our international practice.

The true scope of inherent vice – 'The Cendor MOPU'

The marine insurance market will welcome the important decision of the Supreme Court in The Cendor MOPU1, which has unanimously confirmed that the inherent vice defence is limited to situations where the loss has been proximately caused by something internal to the insured subject matter and not as a consequence of the operation of some external fortuity. Ian Teare, David McKie and Professor Robert Merkin consider the implications of the decision.

The Court very helpfully clarified the complex and at times difficult relationship between the insured risk of perils of the seas and the excluded peril of inherent vice, when it comes to establishing the proximate cause of a loss. As a result, the market should now see fewer coverage disputes on inherent vice issues; and although some difficulties may still remain those disputes which do arise should now be easier to resolve.

The loss

In May 2005 the assured purchased a self-elevating mat-supported jack-up rig, laid up in Galveston, Texas, for conversion to a mobile offshore production unit to be put into service off Malaysia. The rig had three tubular welded steel cylindrical legs, each 312 feet long. The rig's platform could be jacked up and down by engaging steel pins into holes in each leg.

For a dry towage voyage to Malaysia, the assured obtained insurance on the rig under a policy on the terms of the Institute Cargo Clauses (ICC) A (1982) subject to English law. The ICC A clauses insure against "all risks", subject to various exclusions, one of which (Clause 4.4) is for "loss, damage or expense caused by inherent vice or nature of the subject matter insured". This exclusion mirrors that found in section 55(2)(c) of the Marine Insurance Act 1906.

Despite some recommendations to the contrary, the assured decided to move the rig without cutting the legs, so that the legs remained attached to the jackhouse and extended some 300 feet into the air. The insurers required a warranty survey on the rig, which recommended the rig legs be inspected mid-voyage for expected signs of fatigue cracking. The rig left Texas on 23 August 2005. She was inspected at Saldanha Bay, north of Cape Town, on 10 October 2005. Approved repairs were made to the legs and on 19 October the voyage resumed. On 4 November 2005 the starboard leg fractured and was lost; the following day the remaining two legs broke in quick succession and also fell into the sea.

The fractures were the result of progressive stress fatigue cracking at the corners of the pinholes. Once the first leg had fractured and fallen off, the other legs were subjected to increased stress so that they also failed. The stresses were generated from the effect that the height and direction of the waves had on the pitching and rolling motion of the barge. The weather encountered was within the range reasonably contemplated for the voyage.

The insured claimed for the loss of the three rig legs. The insurers denied the claim on various grounds, including inherent vice.

The history of the claim

The High Court found the loss was very probable but not inevitable. The development of stress fractures did not of itself cause the legs to come off; rather, on the basis of the insurers' expert's evidence, what was required was a "leg breaking wave" to cause the fatal fracture. Nevertheless, applying the test used by Moore-Bick J in the Mayban case,2 the proximate cause of the loss was inherent vice, specifically the inability of the legs to withstand the normal incidents of the insured voyage, including the weather reasonably to be expected.

The Court of Appeal in The Cendor MOPU rejected that test and decided that the proximate cause of the loss was perils of the seas in the form of the "leg-breaking wave" which resulted in the starboard leg breaking off leading to greater stresses on the remaining legs. The insurers appealed.

The Supreme Court decision

The Supreme Court unanimously dismissed the insurers' appeal, all agreeing that the loss was proximately caused by a peril insured against, namely perils of the seas and not inherent vice (as properly interpreted). Four judges, Lords Saville, Mance, Collins and Clarke (with all of whom Lord Dyson agreed) gave concurring reasoned judgments, each perhaps slightly differing in emphasis.

The Court stressed that by virtue of section 55(1) of the Marine Insurance Act 1906 the key enquiry in any case is to establish the proximate cause of the loss, which is, applying the common sense of a business or seafaring man, that which is proximate in efficiency.3 To determine this it was necessary to establish the proper meaning of the phrase "inherent vice or nature of the subject matter insured". At the same time clarification was given as to what is meant by "perils of the seas".

In addition, the Court provided some comment on concurrent proximate causes and the true nature of the provisions of section 55(2) of the Marine Insurance Act 1906 and ICC A Clause 4.4 which will be of interest to practitioners.

Inherent vice

The dispute as to the meaning of inherent vice arose from the decision in Soya v White.4 In the Court of Appeal, Donaldson LJ commented that "a loss is proximately caused by inherent vice if the natural behaviour of the goods is such that they suffer a loss in the circumstances in which they are expected to be carried." In the House of Lords, Lord Diplock referred to "the risk of deterioration of the goods shipped as a result of their natural behaviour in the ordinary course of the contemplated voyage without the intervention of any fortuitous external accident or casualty." On the face of things, these two statements appear to be consistent, and Donaldson LJ's formulation (with some reinterpretation) was that adopted by Moore-Bick J in Mayban, relied on by insurers and adopted by Blair J at first instance in The Cendor MOPU.

The Supreme Court rejected the insurers' interpretation of Donaldson LJ's analysis, not least because "such a definition pays scant regard as to how and in what circumstances the loss occurred", and held that Mayban was wrongly decided. The effect of the decision would be to reduce much of the purpose of cargo insurance, and effectively to imply a warranty that cargo would be seaworthy on shipment which section 40(1) of the Marine Insurance Act 1906 expressly excluded. There was no prior case in which inherent vice had been held to encompass anything other than an internal defect in the subject matter; it had never provided a defence where the loss was caused by an external fortuitous event.

The Court quoted with approval early case law to the effect that "the purpose of insurance is to afford protection against contingencies and dangers which may or may not occur; it cannot properly apply to a case where the loss or injury must inevitably take place in the ordinary course of things".5 A good example is Noten v Harding itself, where gloves containing moisture were damaged when the moisture was given off by the gloves in the form of vapour which then condensed and dripped back onto the gloves. There was nothing external to cause the loss. Lord Mance emphasised in The Cendor MOPU that the loss in Noten v Harding was entirely foreseeable but the reason that there was no recovery was because the gloves had effectively damaged themselves and had not sustained any fortuitous external accident. The Supreme Court approved the decision in Noten, and also cited with approval a Canadian decision6 where laminated truck flooring was damaged by moisture absorbed by the flooring in the course of manufacture, which on the voyage had evaporated and condensed. Once again, there was no external fortuity intervening in the loss.

Consequently, the Court decided that a loss is caused by inherent vice where the sole reason for that loss is the nature of the cargo, in that it would suffer loss irrespective of external fortuitous events.

In discussing section 55(2) of the Marine Insurance Act 1906, Lord Mance, while denying that he was laying down any exact definition, felt able to suggest that "ordinary wear and tear and ordinary leakage and breakage would thus cover loss or damage resulting from the normal vicissitudes of use in the case of a vessel, or of handling and carriage in the case of cargo, while inherent vice would cover inherent characteristics of, or defects in, a hull or cargo leading to it causing loss or damage to itself – in each case without any fortuitous external accident or casualty."

Perils of the seas

Paragraph 7 of the Schedule to the Marine Insurance Act 1906 defines perils of the seas. The term "refers only to fortuitous accidents or casualties of the seas. It does not include the ordinary action of the winds and waves".

Approving the decision in The Miss Jay Jay,7 the Supreme Court stressed again that the word "ordinary" describes the word "action" and not "the wind and waves". The question is "whether the sea conditions were such as to have caused a fortuitous accident or casualty" – whether the winds and waves have had some extraordinary effect, rather than whether they were extraordinary in themselves. Any suggestion that a peril of the seas involves exceptionally heavy weather8 cannot survive the Supreme Court's reasoning in The Cendor MOPU. Lord Mance specifically held that that was not the law in relation to vessels and there was no reason why it should be treated as the law in respect of cargo. It is thus irrelevant that the loss was foreseeable and the weather conditions were readily anticipated.

Lord Mance also disposed of another issue which has on occasion given rise to some difficulty, explaining that mere incursion of water is not a peril of the seas: it is necessary for the assured to demonstrate a fortuitous event which led to the incursion of water.

Causation

On the facts of the present case, Lords Saville, Mance and Collins, applying the wide definition of "perils of the seas" and the narrow definition of "inherent vice", held that there was only one causative peril, namely, perils of the seas. Lord Clarke recognised that there were two perils, namely "the physical state of the rig and the "leg breaking" stress caused by the state of the sea at the time the first leg fractured", but that only the latter was a causative peril.

The outcome was the same whether there was one peril or two as there was unanimity that there was only one proximate cause. The legs fell off because there was a "a leg breaking wave of a direction and strength catching the first leg at just the right moment, leading to increased stress on and collapse of the other two legs in turn". Inherent vice had not caused the loss.

Lord Clarke stated that "the sole question in a case where loss or damage is caused by a combination of the physical condition of the insured goods and conditions of the sea encountered in the course of the insured adventure is whether the loss or damage is proximately caused, at least in part, by perils of the seas (or, more generally, any fortuitous external accident or casualty). If that question is answered in the affirmative, it follows that there was no inherent vice, thereby avoiding the causation issues that arise where there are multiple causes of loss, one of which is an insured risk and one of which is an uninsured or excluded risk".

It seems therefore that there is no possibility of these two particular perils working in tandem; if there is a loss by perils of the seas, then there is no loss by inherent vice. Nevertheless on the question of concurrent cause some members of the Court expressed views which will be of interest to practitioners in other situations. It is settled law that if there are two independent concurrent causes of a loss, one of which is insured and the other excluded, then the exclusion takes priority.9 It is also settled law that if there are two concurrent causes, one insured and one uninsured (but not excluded), the insured peril takes priority and there is coverage.10

In view of the express exclusion of inherent vice from cover under section 55(2)(c) of the Marine Insurance Act 1906 and under clause 4.4 of the ICC A it might have been thought the exclusion took priority. However, Lord Clarke considered that the so-called exclusion of inherent vice by section 55(2)(c) of the Marine Insurance Act 1906 was not an exclusion at all, but merely an amplification of the proximate cause rule and thus an example of a circumstance of a loss not proximately caused by a peril insured against. Lord Mance added that the exclusion of inherent vice in the contract ought not to have made any difference to its status as merely an uninsured peril under section 55(2)(c) of the Marine Insurance Act 1906. Indeed, in the view of Lord Mance this was not a case in which there was a true exception which took out of cover a specific situation giving rise to the risk but rather a situation of two events combining to cause a loss.

Implications of the decision

The facts of The Cendor MOPU case were somewhat unusual. Lord Mance thought it "close to the line", even applying the correct meaning of inherent vice. Had there been only gradual development of stress fractures in the rig legs due to the motion of the carrying vessel on the voyage, resultant repairs to the rig would not have been covered by the policy (as being due to fair wear and tear and/or inherent vice). However, since the "leg-breaking wave" was the proximate cause, and even though it was foreseeable and was foreseen, it provided the necessary element of external fortuity to enable the insured to recover under the policy.

The decision provides welcome clarification and guidance for the insurance market on many tricky issues, which should result in fewer and less complex coverage disputes. It is now clear that a loss is caused by inherent vice where the sole reason for that loss is the nature of the cargo, in that it would suffer loss irrespective of external fortuitous events.

The test in Mayban is no longer applicable, which will remove the need for complex expert evidence as to the conditions encountered on a voyage and whether these were reasonably to be expected. With confirmation of the strict limits of the inherent vice exclusion, insurers may now need to reconsider or seek advice upon existing cases in which this defence has been raised. Alternatively, if the effect of the decision is to expose insurers to risks they are not prepared to accept, for example where failure is very highly likely, some modification to rates or policy wordings may be required.

In addition to section 55(2) of the Marine Insurance Act 1906, inherent vice "exclusions" are found in the 1982 and 2009 versions of the Institute Cargo Clauses and many other cargo covers. While the meaning of inherent vice will normally be the same under all marine insurances, application of the principles will depend on the nature and characteristics of the particular goods insured and of the insured voyage. Ultimately (as here) each case will turn on the application of principles clarified in The Cendor MOPU decision to the specific facts of each case, in particular what, based on expert evidence, a court decides is the true proximate cause of the loss.

The inherent moisture-type cases are likely to prove relatively straightforward. However, complex causation issues may arise with certain types of project cargoes where there has been progressive damage to the insured property as a result of movement or vibration of the carrying vessel in the course of the voyage. In such cases, the question is likely to be whether or not there was some external fortuitous "straw that broke the camel's back", or whether the damage was simply the result of the way the insured property naturally behaves when being transported.

While it appears that inherent vice and perils of the seas cannot both be concurrent proximate causes of a loss, in other circumstances issues of concurrent proximate causes of loss, one of which is inherent vice, may still pose problems. In this context, while not part of the decision, members of the Court expressed some interesting views on the true nature of the provisions of section 55(2) Marine Insurance Act 1906 and ICC A clause 4.4 and, in particular, whether these are situations of excluded perils or an amplification of the proximate cause rule. It may be that inherent vice is not to be considered as an excluded peril but simply as an example of a situation which is not a peril of the seas.

We gratefully acknowledge the invaluable contribution of Professor Robert Merkin, consultant to Norton Rose LLP, to the text of this briefing; any errors are ours alone.

Footnotes

  1. Global Process Systems Inc and another v Syarikat Takaful Malaysia Berhad, The Cendor MOPU [2011] UKSC 5.
  2. Mayban General Insurance v Alstom Power Plants Ltd [2004] 2 Lloyd's Rep 609. A transformer suffered internal damage by violent movements of the carrying vessel on the voyage although the transformer itself did not move within the stow. It was common ground between the parties and so held in the case that the insurers would be liable only if the transformer was capable of withstanding the forces that it could ordinarily be expected to encounter in the course of the voyage. The evidence was that the conditions were neither extreme nor unusual so it was held that the loss could not have been caused by perils of the seas but was necessarily caused by inherent vice.
  3. per Bingham LJ in TM Noten v Harding [1990] 2 Lloyd's Rep. 283.
  4. Soya GmbH Mainz Kommanditgesellschaft v White [1983] 1 Lloyd's Rep 122.
  5. Paterson v Harris (1861) 1 B & S 336.
  6. Nelson Marketing International Inc v Royal and Sun Alliance Insurance Co of Canada (2006) 57 BCLR (4th) 27.
  7. [1985] 1 Lloyd's Rep 264; upheld for differing reasons by the Court of Appeal [1987] 1 Lloyd's Rep 32.
  8. As, for example, in Mountain v Whittle [1921] AC 615.
  9. Wayne Tank and Pump Co Ltd v Employers Liability Assurance Corporation Ltd [1974] QB 57.
  10. J J Lloyd Instruments Ltd v Northern Star Insurance Co Ltd, (The Miss Jay Jay) [1987] 1 Lloyd's Rep 32. The reasoning of the Court of Appeal is open to some doubt and the approach of Mustill J at first instance seems to have been more attractive to Lord Mance in The Cendor MOPU.

An end to discriminatory pricing in insurance contracts?

The insurance sector has benefited from an exemption to various non-discriminatory laws in place across Europe. This exemption has been used to justify insurers' ability to differentiate between men and women when pricing risk. Prior to the recent Test Achats ruling various European organisations challenged the validity of this exemption. Franck Poindessault in our Paris office considers one such challenge undertaken in France.

A French administrative authority, the HALDE (Haute Autorité de Lutte contre les Discriminations et pour l'Egalité) has challenged the use by insurers of criteria known as fields of discrimination, including age, health, and gender.

Under both French and European law, a narrow use of these criteria is authorised for the purpose of risk assessment and pricing. Nevertheless, the HALDE has invited all participants in the French insurance market to change their practices. To promote its cause the HALDE has issued a number of public recommendations to the insurance market, through a deliberation dated 13 December 2010.

Refusing to take into consideration insurers' explanations concerning market segmentation, the HALDE considers that using these discriminatory criteria for the assessment of premium could lead to prohibitive prices which deprive some insureds of access to coverage.

The deliberation published by the HALDE encourages the prosecution of any illegitimate discrimination, which is punishable under the Criminal Code in France. The courts can impose sentences of up to three years and fines of €45,000 (see Articles 225-1 & 225-2 of the Criminal Code). To this end, the HALDE wishes to strengthen its cooperation with several French prosecuting authorities; and on 3 January 2011 entered into a cooperation agreement with the Paris Prosecuting Attorney.

Beside enforcement of the criminal code, the HALDE promotes affirmative action in the insurance sector by inviting insurers to improve the tools that are already used on the French market for:

  • coverage of borrowers with aggravated health risks; and
  • universal coverage for tenants with insufficient security for leases (Garantie Universelle des Risques Locatifs)

Later this month the HALDE will merge with four other French administrative authorities whose aim is to promote human rights. The mergers will create a unique authority called the Protector of Rights (Défenseur des Droits). No-one yet knows whether the current focus on discriminatory factors in insurance pricing, promoted by the HALDE, will or will not be maintained following the merger.

Currently, there is no indication that Parliament will introduce a bill to support the HALDE's non-discriminatory agenda – even if French MPs are sensitive to the fight against discrimination as has been illustrated by a recent Act of the Parliament (dated 27 January 2011) which requires the boards of most corporate and public bodies to be comprised of at least 40 per cent of each gender within 5 years.

Test Achats – gender based pricing outlawed by ECJ

The Court of Justice of the European Union (ECJ) has handed down its much anticipated judgment in Association Belge des Consommateurs Test-Achats ASBL and others case (Case C-236/09).

The ECJ has chosen to follow the Opinion of Advocate General Kokott and ruled that gender based pricing in insurance contracts is incompatible with EU law. The ruling will have a fundamental impact on the insurance industry in the EU where differential pricing between men and women based on actuarial factors is widespread, especially in relation to life policies.

The ECJ has allowed a transitional period so that gender based pricing will be invalid from 21 December 2012.

The case, brought by a Belgian consumer association, examined whether Article 5(2) of Directive 2004/113/EC (Gender Directive) was compatible with fundamental EU rights. While EU law lays down a general prohibition on discrimination based on sex, the Gender Directive permitted Member States to allow gender based differences where sex is a determining risk factor that can be substantiated by relevant and accurate actuarial and statistical data.

The ruling will mean that differences in premiums and benefits in insurance contracts which are based on gender will no longer be lawful after the expiry of the transitional period.

The challenges posed by Regulation 35

From a regulatory point of view, 2010 was a year of change for companies active in the Italian insurance market. The implementation of Regulation 35/2010 (Regulation 35), which came into force on 1 December 2010, will have a profound impact on the market, requiring considerable changes to be made to insurers' documentation and procedures as well as distribution models. Salvatore Iannitti in our Milan office considers the effects.

Regulation 35 has required insurers operating in the Italian market to modify their procedures in relation to the issuing of documentation and model contracts. Additionally, it has forced insurers and intermediaries to re-design their bancassurance distribution models.

Regulation 35 was enacted by class="abbr" title="Istituto per la Vigilanza sulle Assicurazioni Private e d'Interesse Collettivo (Italian)"> ISVAP, the Italian insurance regulator, on 26 May 2010 following a consultation period which lasted for more than two years. It applies to all insurance companies operating in Italy, including class="abbr" title="European Union">EU insurance companies selling products subject to non-Italian laws and covers both life and non-life insurance products.

Regulation 35 focuses on transparency and applies to a wide range of activities. It specifies the information that must be included in the contractual documentation sent to policyholders and dictates the structure, form and content of such documentation. It also regulates the information that is published on companies' websites (this provision does not apply to insurers based in other EU States).

The five main areas that are affected by Regulation 35 are:

Marketing

Regulation 35 requires the marketing of insurance products to be transparent and consistent with the content and format of the information provided to consumers. The information should not misrepresent the extent of the coverage provided. Regulation 35 states that insurers should supply the client with an information booklet ( class="lang" lang="it" xml:lang="it">fascicolo informativo) before the contract is concluded. The booklet is expected to include an information notice, standardised policy wording, the proposal form and other documents that are required by law (ie, data protection information).

For life products, Regulation 35 does not impose any new requirements and simply reproduces the provisions contained in previous ISVAP legislation. Conversely, the marketing requirements will have a considerable effect on the sale of non-life insurance products. Prior to the implementation of Regulation 35, the information notice for non-life insurance products only had to contain basic information about the insurer and its complaints procedure. Under Regulation 35 it must now contain a summary of the main terms of the contract including information on the duration, scope of coverage, exclusions, limitations and claims handling procedure.

Applying the initial statements of ISVAP, it appears that the summary contained in the information notice should be based on the content of an insurer's standardised terms and conditions. Any derogation from the standard terms should be highlighted in the information booklet's appendix. Similarly, in the case of co-insurance, the information notice will only contain data relating to the leading insurer. The information booklet's appendix will contain additional information relating to the co-insurer.

Company websites

Regulation 35 requires insurers to publish information booklets on their websites. As stated above, the requirement does not apply to EU insurers operating under the freedom of services and freedom of establishment regime.

Responses to inquiries and complaints

Regulation 35 provides that insurers must respond to general enquiries received from policyholders within 30 days. As a separate requirement, insurers are required to respond to complaints from policyholders and other interested parties within 45 days.

Insurance products linked to mortgages or other financing

Alongside the provisions relating to information notices this is perhaps the most radical change introduced by Regulation 35. It provides that:

  • abstracts of the terms and conditions cannot be delivered as a substitute for the information package, even if the client is not purchasing an individual policy but simply adhering to a group policy;
  • in the case of the early redemption or transfer of the underlying financial product, insurers must reimburse the portion of premium that relates to the remaining period of coverage, net of administrative and issuance costs which were indicated when the product was sold; and
  • all costs connected to the contract, including mediation costs paid to intermediaries but excluding overriding and share profit commissions, must be disclosed to the client.

This is the second example of ISVAP introducing transparency in regard to commission payments. Similar provisions are in place for third party motor liability insurance policies.

Conflicts of interest

A provision relating to conflicts of interest may soon be inserted into Regulation 35. This could have serious implications for the bancassurance industry. In its draft form, Regulation 35 contained a provision concerning conflicts which was removed by the Administrative Court of Rome, as it had not been subject to a formal consultation procedure.

The provision would have prevented insurance intermediaries from being direct or indirect beneficiaries of the coverage that they distributed. This prohibition was strongly opposed by the Italian Banks Association and major banks and financial institutions operating in the Italian market, who instigated the challenge in the Administrative Court of Rome. Many of the detractors who challenged the decision derive most of their profits from the proceeds of bancassurance. This is especially the case for those involved in the consumer credit market.

Following the court's decision, ISVAP began a new consultation procedure concerning the conflicts of interest provision, which had been deleted by the court. The consultation period ended on 31 January 2011 and the provision is likely to be enacted in the first half of 2011.

Norton Rose Studio Regale has submitted a letter of comment to ISVAP stating our concerns about the enactment of the provision. Amongst other things, we are concerned that the provision may conflict with the Code of Insurance. Under the Code, insurance intermediaries are not subject to a prohibition against conflicts of interest but are required to manage such conflicts transparently and efficiently. As the provision will significantly restrict the business of banks and financial intermediaries we are also concerned that there was no joint consultation with the competent authority, the Bank of Italy.

In our letter, we suggested that ISVAP should consider redrafting the provision in a way that will not restrict business. The alternative wording will require banks and financial institutions to give clients a specific, transparent and clear warning about alternative insurance products available on the market. It would also incorporate a "cooling off" period following the conclusion of the contract. During this period the client would be able to terminate the contract if it was to procure alternative insurance coverage with better conditions.

Making micro-insurance manageable

At a time when many insurers view opportunities for growth in their core mature markets as restricted, it is no surprise that an increasing number of key industry players are moving into the micro-insurance sector as part of their investment in developing economies to drive their future growth. Jonathan Teacher and Isabella Jones consider the challenges facing the global micro-insurance market and the role of regulation in facilitating its development.

Incentives to enter the micro-insurance market are both philanthropic and commercial, including its sheer size, the significant prospects for growth, early mover advantages in establishing brand trust and loyalty with a view to future 'upselling' as policyholders become more financially literate and incomes rise. Some insurers have been reluctant to dedicate the resources to make significant ventures in this field. However, regulators in jurisdictions such as China and India are making the grant of some new insurance licences or extensions to international insurers conditional on a commitment to allocating a percentage (typically, 30 per cent) of the new capacity to a micro-insurance offering or specific micro-insurance projects.

What is micro-insurance?

Micro-insurance is a term used to refer to simple insurance products and alternative protection mechanisms designed for low income markets and which are characterised by low premiums and low coverage values.

It is generally accepted that a key strategy for enhancing economic development is to make financial systems more inclusive. However, in the absence of state provided social protection and access to cover from commercial insurers, many informal "insurance" schemes have emerged which operate in the legal gaps escaping regulation. The ambit of insurance regulation naturally varies between jurisdictions but, for example, many microfinance institutions routinely provide insurance to their customers on a "self-insurance" basis, community self-help groups may establish informal mutual arrangements and healthcare facilities often allow free or discounted access to medicine in exchange for regular payments (which are treated as a pre-payment for services). In some countries quite significant schemes can operate outside the ambit of regulation such as South Africa's informal burial societies which provide unregulated plans to an estimated 8 million members contributing in excess of class="abbr" title="United States Dollar">US$1 billion per annum in "premium".

Advantages of avoiding regulation include lower entry barriers and a lower cost of business (no minimum capital requirement, compliance with regulatory standards and supervisory burden) which gives freedom for providers to offer cheaper and more innovative products which may not be permitted under regulatory controls.

Unregulated schemes present some serious drawbacks too. Principally, consumers are not protected from the risk of mis-selling and, in reality, have little recourse if a provider fails to adhere to its promises. Such schemes do not have access to reinsurance because they are not technically insurance and are therefore vulnerable to the occurrence of catastrophic events against which it is difficult for them to acquire protection. Concerns with the unregulated sector are growing and reports of some microfinance institutions requiring customers to purchase unnecessary micro-insurance products at inflated premium evidence why. All of these factors detrimentally affect the reputation of the market and increase the difficulty for insurers to justify the allocation of resources for significant development of their micro-insurance offering.

Consequently, the regulation of nascent micro-insurance markets is critical to:

  • ensure stable and sustainable growth; and
  • build confidence in the industry for both customers and incoming insurers.

Regulating micro-insurance

In many developing economies, insurance regulations were developed with the higher value commercial and retail insurance market in mind and local regulators have understandably focussed their constrained resources on larger regulated (re)insurers which generally pose more significant risks to the local financial system. Such regulatory systems are generally not appropriate for micro-insurance. Several key factors are changing this landscape. Critically, governments and regulators are gradually recognising that a "one size fits all" approach does not allow micro-insurance providers to enter the regulated market as the barriers and ongoing costs, which may include substantial capital requirements, significant demands for key management and complex reporting obligations, can generally not be surmounted by local unregulated micro-insurance providers whilst making investment by international insurers economically unattractive or unviable (given their other expenses of developing a local micro-insurance offering).

It has also been recognised that regulatory barriers could prevent the utilisation of some of the more innovative distribution channels, including mobile phone companies and churches, which may be necessary to penetrate deeper into the low income market. The Ghanaian commissioner for insurance, speaking at the 2009 West African Insurance Companies Association education conference in Lagos, stressed the need to strike a balance between regulation of the industry and innovation in relation to the sale of micro-insurance products.

A solution is the development of a tiered regulatory system where micro-insurance products satisfying criteria as to premium, cover, class of business, terms and, potentially, distribution are subject to lower capital and ongoing compliance and reporting requirements. As the business grows and reaches better economies of scale, the regulatory requirements can step-up commensurately with the resulting greater risk to a larger number of consumers. An alternative approach is the application of principles based regulation which incorporates a proportionality principle that enables the regulatory regime to be applied appropriately to the nature and scale of an insurance business. In a principles based regulatory system, international insurers will require a high degree of confidence in the relevant jurisdiction's rule of law to provide the necessary comfort that the principles will be applied in a transparent and fair way.

Scale is critical to the long-term sustainability of micro-insurance. As the micro-insurance market grows, its regulation will become increasingly important. Regulated insurers should take the opportunity to engage with governments and international agencies to influence the direction that regulation will take, to balance efficiency with effective control and to encourage governments to adopt similar regulatory policies that, subject to local conditions, enable the application of similar models on a multi-national and scaleable basis.

Case notes

Re Digital Satellite Warranty Cover Ltd [2011] EWHC 122 (Ch)

Winding up petitions were presented against three companies allegedly carrying on insurance business in the United Kingdom without the authorisation required by section 19 of the Financial Services and Markets Act 2000 (FSMA). The companies' business was providing extended warranties in relation to satellite television dishes, digital boxes and associated equipment. The plans were all similar, and were offered to people who could be identified as having purchased Sky satellite systems and whose warranties were shortly to expire. For a monthly sum, the plans offered call outs for repairs, whether needed by reason of technology failure or accidental damage, but there was no option for the payment of money. The main exclusions were theft, fire and liquid spillages.

It was held as follows. (1) The activities constituted insurance at common law. The fact that what was provided was not money but services did not prevent the contracts from being insurance contracts: there was no distinction between a contract which indemnified a customer for payment and a contract which provided a service instead of payment. (2) If the plans had been confined to repair and maintenance, they would have fallen within General Insurance Class 16(b) ("loss attributable to the incurring of unforeseeable expense") or, if that was wrong, within General Insurance Class 16(c) ("risks ... not of a kind covered by contracts within any other provisions ..."). (3) The elements of the contracts which covered accidental loss fell within Classes 8 and 9 (fire, damage to property). In a mixed contract of that type the test was not to look to the primary purpose to classify the contract, but rather to determine whether there were identifiable elements of any class of insurance within the contract. (4) Winding up orders would be made.

Masefield AG v Amlin Corporate Member Ltd [2011] EWCA Civ 24

A cargo consisting of two parcels of bio-diesel, shipped on board the oil tanker Bunga Melati Dua, was insured by the defendant insurers under an open cover policy. The policy covered piracy, and excluded constructive total loss "unless the subject-matter insured is reasonably abandoned either on account of its actual loss appearing to be unavoidable or because the cost of recovering, reconditioning and forwarding the subject-matter to the destination to which it is insured would exceed its value on arrival".

The vessel, while en route from Malaysia to Rotterdam, was seized by Somali pirates on 19 August 2008. A notice of abandonment in respect of the cargo was served, but rejected on 18 September 2008. A ransom was paid and the vessel was released about 11 days after the service of the notice of abandonment. The cargo was taken to Rotterdam but was sold for about half of its insured value. The insurers denied liability for the difference.

David Steel J held that the insurers were not liable: there was no actual total loss under section 57 of the Marine Insurance Act 1906 because the claimants had not been irretrievably deprived of the cargo; there was no constructive total loss under section 60 of the Marine Insurance Act 1906. It could not be said that the subject matter had been reasonably abandoned because an actual total loss appeared unavoidable; and the ransom was not to be disregarded in determining whether there was an actual or constructive total loss because payment of a ransom was not illegal or contrary to public policy.

The assured appealed against the finding that there was no actual total loss. The Court of Appeal dismissed the appeal.

  • In marine insurance the test of "actual total loss" was applied rigorously.
  • There was no rule of law that capture or seizure was automatically an actual total loss.
  • There was on the facts no actual total loss by reason of piracy.
  • There was no actual total loss by reason of theft. Even though section 6 of the Theft Act 1968 provided that there was theft if a person appropriated property belonging to another without intending to permanently deprive that other of it, it could only be an actual total loss if there was irretrievable deprivation.
  • It was common ground that paying a ransom was not illegal and not contrary to public policy and the law did not require the possibility that a ransom would be paid to be disregarded.

AXL Resources Ltd v Antares Underwriting Services Ltd [2010] EWHC 3244 (Comm)

AXL, a company carrying on the business of metal trading, was insured against all risks of loss under a Lloyd's Marine Open Cargo Policy issued by the defendants. The policy excluded "Mysterious Disappearance and Stocktaking Losses".

A cargo of cobalt belonging to the assured disappeared from a warehouse in Antwerp in unexplained circumstances sometime between 21 October 2008 and 27 January 2009, and the insurers denied liability. The assured sought summary judgment, and by the time of the trial there was evidence in the Belgian police files that there had been an organised theft.

Gloster J held that the assured was entitled to summary judgment, on the ground that theft had been established. On this analysis there was no need to consider the relationship between the all risks cover and the mysterious disappearance clause but in her view, the assured bore the burden of proving a fortuitous loss, and thereafter the burden of proof switched to the insurers to prove that the loss was mysterious. On the facts they were unable to do so. The court also held that interest should run from 1 April 2009 rather than from the usual month after the date of the loss, because the claim made on 27 January 2009 was very brief and contained no detail and because the loss adjuster's report was not completed until 12 March 2009.

Harrison v Black Horse Ltd [2010] EWHC 3152 (QB)

In July 2003 the Harrisons borrowed £46,000 from Black Horse Ltd (the Bank), and at the same time took out a single payment protection insurance (PPI) policy costing £11,500. The premium was borrowed by means of a separate loan.

In July 2006 the Harrisons borrowed a further £60,000 (to discharge the previous borrowing and the PPI policy, with the balance on household improvements and a holiday), and they took out a further PPI policy at a cost of £10,200. The loan was repayable over 23 years, and the PPI was to last for 5 years only but the premium was payable co-termimously with the loan repayments. The 2006 loan was discharged in March 2009 and the PPI policy was cancelled, by which time it had cost the Harrisons £10,529.70. The PPI policy was sold by the Bank as agent of the insurers, Lloyds TSB General Insurance Ltd, and the Bank's commission was £8,887.49 (87 per cent of the premium): the Bank did not disclose either the fact or amount of this commission to the Harrisons. The Harrisons claimed damages from the Bank.

HHJ Waksman dismissed the claim on the following grounds:

  • Under section 150 of FSMA the Bank was under a statutory duty to comply with Insurance Conduct of Business Rules, and rule 4.3 required the Bank to take reasonable steps to ensure that any personal recommendation to buy an insurance contract was suitable for the customer's needs. On the facts the Bank had complied with the requirements of the rule, in that it had sought all relevant information by a detailed questionnaire. Further, there was no breach of rule 2.3 which prohibits the acceptance of an inducement by an agent to the extent that it was likely to conflict with the agent's duty to the customer: although the commission was an inducement, the salesperson acting for the Bank did not receive any part of the commission and was unaware of its extent – there was no causal link between the commission and the sale.
  • Insofar as there was a duty of care owed by the Bank, there was no breach of that duty.
  • There was no unfair relationship between the parties within section 140A of the Consumer Credit Act 1974: the Harrisons had not been told that the class="abbr" title="Payment Protection Insurance">PPI policy was compulsory, and they had been given an opportunity to consider it.

International focus

Germany

Decision of the German Federal Supreme Court, ZIP 2010, 935

A company obtained a permanent life insurance policy for one of its employees. When the company got into financial difficulties, the company terminated the life policy and requested payment of the repurchase value from the insurer. After the termination became effective, the insurer paid the amount to the company, not knowing that in the meantime the company had filed for bankruptcy. The bankruptcy receiver, after learning of the payment, demanded that the life insurer pay the amount again as the original sum had been spent by the insolvent company. The insurer refused and argued that it had no knowledge of the bankruptcy proceedings, and was never given notice by the bankruptcy receiver. The bankruptcy receiver argued that the insurer should have inspected the official electronic insolvency database, where the opening of insolvency proceedings is disclosed.

The German Federal Supreme Court dismissed the payment claim by the insolvency receiver on the following grounds:

Under section 82 of the German Insolvency Act, payment of any amount owed to a bankrupt entity over which a bankruptcy receiver has been appointed, does not discharge an obligation if the debtor, at the time of making the payment, knew about the bankruptcy. However, it was not disputed that the insurance company had no positive knowledge about the insolvency proceedings.

Statutory law does not require anybody to review the bankruptcy database regularly. Section 9 of the German Insolvency Act provides for the creation of a nationwide electronic database for insolvency proceedings, but this is mainly for information purposes. Section 9 does not create an obligation for anybody to review this database regularly. Also, a company cannot be expected to review the various existing official databases as this would put an undue burden on companies.

In this particular case it was proved that the insurance company had no positive knowledge about the bankruptcy proceedings against the company. Had the legislation intended not only to shift the burden of proof, but to make it a binding rule that after publication of an insolvency notice in the electronic register any third party is deemed to be aware about the opening of insolvency proceedings, a specific statutory provision would be required.

Italy

Changes to data protection and direct marketing regime

On 31 January 2010, a new law (Article 130, paragraph 3 of the Data Protection Code) came into force in Italy. The law relates to the use of personal data in direct marketing calls and will apply to insurance companies as well as call centres acting on their behalf.

The law concerns the use of contact information contained in public telephone directories. When using this information for direct marketing calls prior consent is not required unless the consumer's name is registered on the so-called 'Robinson List'. The Robinson List is a list of people who do not wish to receive marketing communications. Consequently, the Italian data protection and direct marketing regime has switched from being an opt-in system, where express consent is required, to an opt-out system.

The law only applies to the use of contact information provided by public telephone directories. It does not relate to the use of other databases.

China

CIRC issues Administrative Measures on Equities of Insurance Companies

After three years of consultation, the China Insurance Regulatory Commission (CIRC) has issued the long-awaited Administrative Measures on Equities of Insurance Companies (the Equity Measures), which came into force on 10 June 2010. The previous provisional measures regarding the acquisition of equities ceased to be effective at the same time.

Under the Equity Measures, foreign financial institutions with assets of no less than $2 billion and which have been graded A or above in respect of their long term credit rating for the previous three consecutive years are allowed to acquire equities in Chinese domestic insurance companies. The restriction that any single shareholder's (including affiliated parties) equity should not exceed 20 per cent of the total registered capital in a domestic insurance company can now also be lifted subject to prior approval from the CIRC on a case-by-case basis. Nonetheless, foreign equity must not exceed 25 per cent of the total registered capital in a domestic insurance company. Otherwise it would be regarded and regulated as a foreign invested insurance company which may be subject to more onerous restrictions in terms of geographical network expansion and business scope.

The new Equity Measures abolish the previous prohibition on investing in the same category of insurance companies in China. It is now possible for a foreign investor to invest in more than one insurance company in the same category if it can prove that the two insurance companies do not compete with each other. The new Equity Measures indicate that China is welcoming greater foreign investment into its domestic insurance sector through equity acquisitions.

Hong Kong

A total makeover of the Hong Kong insurance supervisory system?

As long ago as 2007/2008, amidst the financial tsunami, the Chief Executive of the Hong Kong Special Administrative Region saw the need to establish an independent regulatory body to replace its Office of the Commissioner of Insurance (OCI). The OCI, headed by the Insurance Authority (IA), is the only financial services regulator in Hong Kong still operating within the Government structure. As a consequence, the current regime puts Hong Kong out of step with accepted international practice that financial regulators should be independent of the Government.

On 12 July 2010, the Financial Services and Treasury Bureau (FSTB) of the Hong Kong Government released a consultation paper on the proposed establishment of an independent insurance authority (IIA) which will take over the work of the current OCI.

In broad terms, the Government proposes that the IIA, which will be financially and operationally independent of the Government, will be charged with regulating not only insurance companies, but also insurance intermediaries, including their financial stability and sales conduct, in order to maintain the general stability of the insurance industry and to protect policyholder interests. The IIA will, for example, be granted powers to issue licences, conduct routine supervision and inspect and impose disciplining sanctions against regulatory breaches.

The IIA will also play an active role in educating the public on the features and risks of insurance products, and in conducting thematic studies into market trends, regulatory issues and the issues affecting policyholders' interests.

The FSTB invited views from the insurance industry and the public in a 3-month consultation exercise (ending on 11 October 2010) for the purposes of drawing up more detailed legislative proposals and tabling draft legislation in 2011.

Indonesia

Indonesian insurance regulator to hold off issuing new licenses for the foreseeable future

The Indonesian insurance regulator, the Ministry of Finance (MOF), has indicated that it will not be issuing any new insurance company authorisations in the foreseeable future. The reasoning behind this is that there are a number of 'dormant' insurance companies, i.e. companies in run-off that the MOF wishes to see opened to new business rather than new companies being established. This means that any new entrants to the Indonesian insurance market must do so by acquiring an existing dormant insurer, ensuring that it has the right permissions for the type of business that the new entrant wishes to write and then writing business into that vehicle. Carrying out appropriate due diligence on any such dormant company will be essential to ensure that the acquirer is forewarned about the type and extent of residual liabilities in the dormant vehicle. The acquirer may also wish to consider opportunities to ring-fence or otherwise deal with the historic liabilities.

Singapore

MAS proposes enhanced powers for insurance dispute resolution

The Monetary Authority of Singapore (MAS) has issued a consultation paper on the Insurance (Amendment) Bill (the Bill) which proposes to amend the Singapore Insurance Act in order to empower the MAS to act expeditiously in situations where an insurer is in distress or in liquidation, by enhancing its involvement in such situations.

Under the proposals, when a distressed insurer is not yet in liquidation, the MAS may forestall the winding up of an insurer by applying to the High Court for a moratorium order. These amendments serve to preserve stability and protect policyholders when insurance companies fail.

A major proposed amendment provides MAS with the power to appoint a statutory manager to supervise the business of the insurer. A statutory manager would have all the duties and powers of the board of the insurer, and must take into consideration the interests of the insurer's policyholders when managing the business.

The Bill also repeals section 46 of the Insurance Act on the Policy Owners' Protection Scheme, which will be enhanced in the Deposit Insurance and Policy Owners' Protection Schemes Act.

Thailand

Changes to the Thai Insurance Acts – an update

In 2008 Thailand made wholesale amendments to its insurance acts (Life Insurance Act B.E. 2535 and the Non-Life Insurance Act B.E. 2535 (collectively the Insurance Acts)). A number of those changes make provision for a progressive roll out and grace periods for compliance. The clock is now ticking on some of these changes. A summary of the key changes is set out below.

  • Private insurance companies are required to convert to public companies.
  • The Office of the Insurance Commission (the insurance regulator) (OIC) was given discretion to increase limits on foreign shareholding and foreign directors.
  • Definition of a "Thai national" to be added the Insurance Acts.
  • Insurance companies permitted to issue preference shares.
  • OIC given additional prudential control tools.
  • Insurance companies permitted to outsource certain claims handling functions.
  • Introduction of licensing scheme for loss adjusters.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.