UK: Insurance Briefing - Anomalies of Insurance Law

Last Updated: 1 December 2010
Article by Jeremy Hill and Christopher Henley

Insurance briefing from Debevoise & Plimpton LLP published in the May 2010 issue of The In-House Lawyer

Although the courts are often at pains to point out that insurance law is merely a subset of general contract law and should be applied without any concession or discrimination simply because the subject matter is insurance, there are, in fact, several aspects that are peculiar to insurance. An understanding of these anomalies will assist in penetrating the sometimes arcane depths of insurance law. They include:

  • the payment of brokerage and premium;
  • secret commissions;
  • the status of warranties and conditions;
  • the role of the broker;
  • consequential loss;
  • mitigation;
  • the Block Exemption Regulation; and
  • the courts' attitude towards insurers in the interpretation of their contracts.

BROKERS AND PAYMENT OF BROKERAGE AND PREMIUM

Given that the broker acts primarily for the insured, and owes them fiduciary duties in the negotiation and placement of their insurance, it is counter-intuitive to suggest that they are remunerated by the insurer (in a manner rarely transparent to the insured). Nevertheless, the proposition that the insurer is responsible to the broker for the payment of their brokerage for introducing the insurance business to them (in the absence of an agreement to the contrary) is generally accepted judicially, although never conclusively decided.1 Lloyd's also take the view that the insurer or reinsurer is liable to pay brokerage.2

The liability for the payment of premium is clear in all marine insurance. Section 53 of the Marine Insurance Act 1906 provides that the broker is directly responsible to the insurer for the premium payable for marine insurance, although the insurer is directly responsible to the insured for claims and (perversely) for any returnable premium.

This section codified the practice whereby an insured required an additional period of time to pay the premium, but the Lloyd's marine underwriters were only prepared to extend credit to the person with whom they were actually dealing, ie the broker. This practice gave rise to the extraordinary fiction that the broker pays the premium to the insurer who then loans it back to the broker, who then owes it to the insurer. It has also not been judicially conclusively decided whether the broker placing any insurance at Lloyd's is liable for the premium, because historically the only way to a Lloyd's underwriter was via a Lloyd's broker, but it now seems that this is not true.3

Thus the broker is paid by the party to whom they should be in an adverse negotiating position and in respect of marine insurance to whom they are directly liable for the premium. It is also true that an insured is fully entitled to an indemnity for an insured non-marine loss, even though they have not paid the premium, unless such payment is made a pre-condition of liability, because the consideration for the insurance is the liability to pay the premium. Non-payment is simply a breach of a contractual term, which is not necessarily repudiatory. Another anomaly is that insurers usually agree with brokers that the payment of a premium by the insured to the broker constitutes good payment to the insurer, but that the payment of a claim by the insurer to the broker does not constitute good payment if the broker becomes insolvent before remitting the claim to the insured.

CONTINGENT COMMISSIONS: THERE AND BACK AGAIN

Contingent commissions are payments by insurers to brokers calculated according to the volume of business placed and are often given a veneer of legality by being dressed up as valid payments for services carried out by brokers for insurers, such as for general administration (eg the storage of documentation shown to the insurer on placing), processing premiums, processing claims (eg the collection and disbursement of claims, instructing and liaising with solicitors, adjusters and surveyors, and circulating their reports) and marketing (eg supplying information to underwriters, such as policy development, and general and local market developments and information obtained by the broker).

Notwithstanding the enquiries engendered more than five years ago by Eliot Spitzer as New York State Attorney, the fact that the Financial Services Authority (FSA) has not (then or since) mandated any substantive obligations in this regard means that the issues of broker remuneration and inducement have not gone away. European risk managers view a recent US legal ruling as paving the way for all brokers to resume taking contingent commission payments on insurance contracts and several global brokers have been negotiating with various US state regulators to reinstate the collection of contingent commissions.4

The existence of any contingent commission, however, is rarely disclosed to the insured, so that it could, in certain circumstances, amount to a secret profit, contrary to the fiduciary obligations of the broker. A secret profit becomes a bribe if it has been paid by a third party (ie to the contract of agency) to the broker. It has been judicially stated that there is an irrebuttable presumption that the agent is infl uenced by any bribe and the motive for payment is irrelevant, even where the agent has acted in the best interests of their principal.

It is, however, clearly absurd to suggest that the mere fact that an underwriter is technically liable for the payment of brokerage to the broker to secure the introduction of the principal's business to the underwriter is sufficient to turn the commission into a bribe simply because that payment is made by a third party, although this may be true if the brokerage agreed by the underwriter is so high that it cannot be interpreted as anything else. There are several older cases that indicate that it is perfectly acceptable for brokerage to be paid by the other party to the contract, so that this technicality can be ignored.

Thus even without the consent of the insured, in the right conditions contingent commissions can be justified legally, which is why they remain available despite the furore. If, however, the broker receives an agreed fee from the insured and a profit commission from the insurer, they should properly inform the insured because they are clearly being paid by both parties, which cannot validly occur without their consent. In the absence of the insured's informed consent, the broker is clearly making a secret profit, with potentially extremely adverse consequences.

The FSA has not mandated specific rules on contingent commissions, but has categorised the voluntary code prepared by various insurance trade bodies for commercial customers as Industry Guidance. This indicates that intermediaries should consider whether a relationship with a party other than the commercial customer has infl uenced the advice to the commercial customer in arranging insurance or in the selection of the insurer, and that it is the duty of an insurance intermediary to manage confl icts of interest so that the intermediary's interest does not confl ict with the interests of commercial customers and of any insurers on whose behalf they may act, either by disclosure or withdrawal from the engagement. An insurance intermediary must decline to act for the commercial customer unless, in the particular circumstances of the case, disclosure and informed consent are sufficient to resolve the conflict.

The Association of Insurance and Risk Managers (AIRMIC) also broadly supports the industry guidance, but believes that more detail is required, and has prepared standard letters for intermediaries that set out earnings, capacity, services and a disclosure checklist.5 In March 2010 Lloyd's set out requirements for the reporting of fees paid to brokers, including a provision for managing agents to disclose to the corporation's management 'any arrangement for amounts paid, for any reason, to any intermediary that is not disclosed on a slip'.

The FSA (also in March 2010) introduced final rules for 'adviser charging', which means that firms should be paid by retail charges that they have set out upfront and agreed with their clients, rather than commissions set by product providers (including 'soft' commissions, paid in non-monetary forms), refl ecting the services provided to the client, not the particular product provider or product being recommended. These rules apply to pensions and life products, and they do not allow adviser firms to receive commissions off ered by product providers, even if they intend to rebate these payments to the client.

The broker can therefore receive a contingent commission without necessarily breaching their agency obligations to the insured at common law and only since March 2010 have they been subject to any regulatory obligation to disclose such commission.

REVERSAL OF STATUS OF WARRANTIES AND CONDITIONS

The status of conditions and warranties in mainstream contract law is reversed in insurance law. Thus breach of a condition sometimes gives rise to a right to terminate the contract if the breach is repudiatory (eg an unambiguous intention not to pay any premium) and accepted as such, but more usually only to a remedy in damages, while breach of a warranty automatically terminates the contract from the date of breach unless waived.

The benchmarks of a warranty include whether:

  • it goes to the root of the transaction;
  • it is descriptive of, or bears materially on, the risk of loss; and
  • damages would not be a satisfactory remedy for breach.6 A warranty usually confirms:
  • that a state of aff airs exists;
  • that it will continue to exist;
  • that it will exist in the future; or
  • the converse, ie that something does not exist.

A condition can be 'pumped up' by the insurer simply by converting it into a condition precedent, which does not require any damage. The mere breach of it is enough to provide the insurer with a remedy. As if the breach of condition or warranty were not enough, the insurer also has the benefit of the (otherwise rarely applied) duty of good faith, whereby the insured is obliged to reveal all facts that the insurer might consider material to their assessment of the risk, with a failure to do so enabling the insurer to rescind the contract. The Consumer Insurance (Disclosure and Representations) Bill (the Bill) will change this, but its passing by Parliament has been interrupted by more pressing business.

ROLE OF THE BROKER

The broker is the agent of the party seeking insurance and they must not allow any other duty to confl ict with their obligations to their primary principal. In some circumstances, a broker may act in a dual capacity as agent for both the insurer and the insured, eg where the policy provides for notice of the claim to be given to the broker, who would owe a duty of care to the insurer to inform them of the claim, or where the broker is entitled to issue cover notes for temporary insurance on the insurer's behalf. If a confl ict is perceived to exist, the broker must obtain the principal's fully informed consent to the broker acting in a dual capacity. In Anglo-African Merchants Ltd v Bayley [1970] the court stated that:

'Such a relationship with the insurer, inevitably, even if wrongly, invites the suspicion that the broker is hunting with the hounds whilst running with the hare... a custom will not be upheld... if it contradicts the vital principle that an agent may not at the same time serve two masters two principals in actual or potential opposition to one another: unless, indeed, he has the explicit, informed consent of both principals.'

It has been recognised by the Court of Appeal that some functions carried out by the broker do not sit easily within the general principle that the broker is the agent of the insured, but there is surprisingly little comment on dual agency in the case law, given the roles that brokers often assume.7 What little comment exists is limited solely to the issue of the premium fiction in marine insurance and does not consider other aspects of dual agency. In this respect they have been regarded as irrelevant to non-marine insurance.8 The Law Commission is also considering the impact of the broker's status when receiving material information from the insured for disclosure to the insurer. The Bill fails to make any change to the proposition that information passed to a broker is not deemed to have been received by the insurer.

CONSEQUENTIAL LOSS

Consequential loss is in most cases a (secondary) financial loss that arises from, or following, a primary event of a physical nature. Loss of profits, for example, is clearly a consequential loss. So why is its meaning in the world of insurance diff erent from that of commerce? The short and obvious answer is that there may be more than one (generic) meaning of 'consequential loss', and that it will not always be possible to rely on judicial comments in previous cases without ensuring that the contractual and background matrices are compatible with the problem under consideration.

Another reason why consequential loss has a diff erent meaning is that insurance is primarily a matter of contract in which the insurer agrees to insure against something specific, so that insuring a property against material damage is not at all the same thing as agreeing to indemnify the property owner against all loss arising out of that damage, unless that loss is an insured peril (eg fire or business interruption, which always requires material damage before it can apply) or an all-risks policy. Loss proximately caused by an insured peril is directly covered, but anything else is not and any consequential damage is caused instead by the loss of the insured subject matter, not the operation of the peril. A consequential loss is usually a diff erent type of loss, eg pure economic loss, and occurs at a later date. An alternative reason might simply be that consequential loss is excluded as a result of a term implied in a property damage contract as a result of market custom and practice. All this adds up to the fact that it is not necessary, whatever its underlying rationale, for an insurer to exclude cover for consequential loss. It is excluded unless specifically covered.

MITIGATION

There is, however, another anomaly of insurance law that could operate to the benefit of the insured. As a matter of 'normal' contract law the injured party must mitigate to recover. In insurance law the insurance is in place specifically to protect the insured against the eff ects of their own negligence and a failure to mitigate if negligent may well remain covered.

In State Of Netherlands v Youell & ors [1997] the insurers attempted to defend a claim under a shipbuilding insurance policy on the grounds that the insured was in breach of the duty to mitigate. The Commercial Court applied standard rules of causation in determining the scope of the duty and held that the duty to mitigate would only be breached if the insured's conduct or inactivity was so significant that it displaced the prior insured peril as the proximate cause of the loss. The court added that a breach of the duty to mitigate was unlikely to aff ord a defence to insurers as the conduct or inactivity that became the proximate cause of the loss could itself amount to a separate insured peril, under the cover given for negligence in many standard forms of policy. This will be a question of the wording and the facts, but it might be thought that the liability of the insurer has to end somewhere, rather than extend to any loss and then to a line of further negligence by the insured. If such further negligence is covered, it would be in breach of any express and implied 'obligation', and it might therefore be thought that the insurer would be entitled to deduct any loss that it has suff ered from a failure by the insured to comply with that express or implied term. As a matter of policy, a court might treat such an exclusion as contrary to the ethos of insurance, but the doctrine of fundamental breach no longer exists and so a clear wording restricting the rights of the insured should, in theory, be upheld.

The short answer is that if the further negligence is causally connected to the loss and is not therefore a novus actus interveniens , and it is negligent, ie not wilful or reckless, there is a good chance that it will be covered unless it is specifically restricted by the contract.

BLOCK EXEMPTION REGULATION

The subscription market, whereby individual risks are pooled among many insurers, is cost-eff ective and highly efficient if the terms of the policy are consistent, without the time-consuming need to address and negotiate every term individually with every underwriter. Until 1 April 2010 the insurance industry benefited from a Block Exemption Regulation from the European Commission, which allowed policies to be written on standard terms and a premium set by the leading underwriter. Its renewal no longer included this concession, so that insurers will have to self-assess their competition compliance, which may result in higher costs for the industry and this may well be passed on to insureds.

COURTS' ATTITUDE TOWARDS INSURERS IN THE CONSTRUCTION OF THEIR CAREFULLY CRAFTED CONTRACTS

The courts have set their collective cap firmly against insurers, who should have the incentive and resources to clarify their wordings, particularly given the usual absence of material input to any drafting from the insured. Thus: 'If necessary... in case of doubt, one should construe an insurance policy in favour of the insured.'9 Similarly:

'It is more important to reinforce the message that insureds are entitled to clear wordings and to the benefit of any ambiguity.... If any insurer does not like our decision, it can for the future formulate its policies diff erently, provided that it makes its intention clear.'10

Footnotes

1. Accepted judicially in Pryke v Gibbs Hartley Cooper Ltd [1991] 1 Lloyd's Rep 602. However, there is some inconclusive case law to the contrary, eg Carvill America Incorporated & anor v Camperdown UK Ltd & ors [2005] EWCA Civ 645.

2. See draft decision paper headed 'Grossing up and Net Equivalent for Lloyd's Regulatory Board', 25 July 1994 (para 2.6(a)).

3. See Pacific & General Insurance Co Ltd v Hazell [1997] LRLR 65.

4. See People v Liberty Mutual Insurance Company [2008] 52 AD 3d 378, 379.

5. Association of Insurance and Risk Managers Guidance 'Transparency, disclosure and confl icts of interest in the commercial insurance market'.

6. See HIH Casualty & General Insurance Ltd v New Hampshire Insurance Company & ors [2001] EWCA Civ 735.

7. Recognised in the Court of Appeal by Chapman & Co Ltd v Ve Ticaret [1998] EWCA Civ 400 and in Heath Lambert Ltd v Sociedad De Corretaje De Seguros & anor [2004] EWCA Civ 792. The broker can be personally liable to the insured, see Punjab National Bank v de Boinville [1992] 1 Lloyd's Rep 7.

8. See Goshawk Dedicated Ltd & ors v Tyser & Co Ltd & anor [2005] EWHC 461 (Comm).

9. See Hawley v Luminar Leisure Ltd & ors [2006] EWCA Civ 18.

10. See Dodson v Peter H Dodson Insurance Services (a Firm) [2000] EWCA Civ 320.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.