UK: Evolution Or Revolution? Survival In A Changing Market

Last Updated: 4 December 2008
Article by Joanne E Staphnill

Contract Certainty and Contract Quality

In June 2007 the FSA published its new Code of Practice on Contract Certainty ('the Code'). The Market Reform Contract ('MRC') has also been published, the guidance notes to which provide further practical illustrations of how the Contract Certainty guidelines are intended to operate.

The Code consolidates the contract certainty work that has taken place over the past two years. Therefore, the Code should not require brokers to undertake any really major changes. However, it does require some changes of practice. For example, contracts now have to comply with the contract certainty requirements from the time of entry into the contract, rather than inception. Accordingly, contract certainty procedures must be followed even if there is to be retroactive inception. Further, all post-contract changes, endorsements and side-letters have to comply with the Code. This increases the scope of the broker's duty to ensure that the protections of contract certainty are in place for the client.

There is another significant change in the provisions relating to signing down. Postinception signing down is now to be avoided. Also, the only signing instructions an insurer can give is 'line to stand' or nothing at all. However, the Code also sets out that the client's instructions should be taken at an early stage as to whether the non-'line to stand' lines should be signed down in equal proportions or disproportionately. The requirement to include signing-down provisions in the contract, before any lines are written, emphasised that even participation proportions need to be as certain as possible. The requirement to take client instructions at an early stage places even more pressure on the broker to plan the placing of the risk to ensure that contract certainty can be achieved. In many ways, traditionally 'back room' skills of contract drafting are now needed even during the placing of the risk.

In other areas, there are no substantial changes to practice, but a new emphasis is emerging. The guidelines on the drafting of subjectivities have not been changed, but an example of a compliant subjectivity has been provided by the FSA. This is seven paragraphs long, so it is clear that the FSA requires a strict approach to the drafting of subjectivities, if their use cannot be avoided. This certainly highlights the difficulty that a time-pressured broker will face to ensure that any subjectivities are compliant. Further, there is a greater emphasis on ensuring that the terms used are 'clear' as well as certain. This complements the explicit references to contract 'quality' in the MRC guidelines. The FSA has explicitly stated that its next focus will be on ensuring that all contracts achieve the requirement of 'quality' as well as certainty. The FSA wishes to ensure that contracts no longer contain inconsistent or contradictory terms, and that in general the contracts are clear in their effect.

Accordingly, it seems inevitable that brokers will soon be required to ensure that only 'quality' contracts are concluded. It will be difficult for the FSA to find ways to improve the drafting quality of the huge volume of contracts that are agreed each year. Therefore the FSA may have to act radically to tackle its new challenge. It remains to be seen to what extent the FSA intends to 'revolutionise' existing practices.

At present however, only contract certainty is required, but the Code contains provisions requiring brokers to 'demonstrate' that it is being achieved. The FSA permits brokers to use whatever method or combination of methods is most appropriate for their business. Unlike the previous guidelines which required adherence to inflexible checklists, the new Code permits brokers to develop their own compliance system. The job of demonstrating compliance can be outsourced. However, the opportunity to create a tailored, flexible compliance system has an inherent risk. If a compliance system is created that is not adequate, all the contracts that are checked using the system could themselves fall short of the requirements. Accordingly, great care is needed when developing the compliance system, or it could potentially leave the broker open to claims.

The publication of the new Code and the guidance in the MRC represent an important stage in the development of the market and a broker's role within it. The Code formalises the need for a broker to plan for, and help to ensure, contract certainty even from the earliest stages in the creation of a contract. From every perspective (not least an Errors and Omissions one), there has never been more pressure on a broker. In the near future, an even greater burden will be placed on brokers as the contract quality project gathers pace. Every broker needs to start considering what potential changes need to be made to prepare for the FSA's contract quality campaign, at the same time as ensuring that the current contract certainty Code is complied with.

Electronic Trading

The MRC preamble states that it is designed to ensure it can be used in electronic trading, by making the information compatible with existing electronic platforms such as the Acord systems. The fact that the MRC is designed in this way reflects the increasing use and importance of electronic placing and electronic claims files in the market.

Electronic placing and claims files have clear benefits for the market, and commentators have noted the increase in efficiency that the new methods will bring. It seems inevitable that the market will continue to embrace the new technology as part of its continuing evolution. Electronic trading will probably increase significantly and may become the usual way of trading in the future. However, the implications for the broker's role have not been fully explored, including ways to avoid the potential pitfalls of electronic trading.

Electronic placing and claims platforms provide an integrated method to share and store placing or claims-related documents. A traditional paper file is retained by the broker, and accordingly the insurer does not have legal control over the documents. The Goshawk -v- Tyser (2006) case held that there is an implied term that insurers can see all documents previously shown to them. However, obtaining documents can still present difficulty and delay, and tends to highlight the fact that the insurer is potentially considering legal action. By contrast, with electronic systems, the documents are stored electronically and centrally. Anyone involved in the risk can see them at any time. Therefore, the need to request documents should be greatly reduced in the future, as any insurer would have all the information regarding the documents that were shown easily to hand.

There are dangers inherent in such a system for brokers, however. For example, it will be easier to mistakenly make confidential or privileged documents available to the whole market. If the incorrect 'permissions' are set on a confidential document, then the whole market will be able to see the document as many times as it wishes. The consequences of a simple slip could therefore be large.

Further, most electronic placing or claims platforms reduce or eliminate the need for any oral broke. If an insurer has questions or comments, they can be typed into the appropriate comments box and are usually visible to everyone involved in the risk. The broker will be expected to respond in the same way, by typing the answers or uploading the appropriate document. The response may potentially also be seen by the whole market. This signals a significant change in the way brokers will be expected to do business. Traditionally, the skills and experience needed to present a risk orally have formed an important part of a broker's role. However, those skills now need to be translated into an ability to get precisely the right message across in writing as part of the electronic process.

The importance of this cannot be underestimated. The information that is written on the electronic system will be a permanent record of what comments and information was provided. The market will be able to refer back to it at any time. If a dispute arises, there can be no doubt about what the broker said. The only question will be whether the comments or information presented was inaccurate, unclear or misleading in any way.

In the future, therefore, claims against brokers may not turn on oral evidence of what exactly was said, as many do now. The comments and information actually provided will be carefully analysed to determine the dispute.

Summary of Implications for Brokers

There is a clear trend towards the writing and drafting skills of a broker becoming extremely important. Whereas previously, contracts were drafted without too much time pressure by specialist contract drafters in the 'back office', those skills will now need to be deployed during the placing stage and under a great deal of time pressure. Further, brokers will soon have to ensure the 'quality' of a contract which will itself add to the amount of work that is needed to produce the contract. For electronic trading, brokers need to carefully consider the dangers of having to provide written answers where previously a face-to-face discussion would have taken place. Will there be a temptation to rush out a written answer just because it is an electronic format rather than an oral presentation? Are the brokers clear on what words and phrases will get the right message across accurately, or will there be a tendency to use broad-brush language that lacks precision? Are brokers being sufficiently trained to adapt to the developments in the market?

The market is rapidly changing and evolving. Brokers must carefully analyse the new risks that it presents, and ensure that they adapt effectively to survive and compete in the future.

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.

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