Demise of the "Deal Now, Detail Later" Culture?

A version of this article was previously published in the Insurance and Reinsurance Law Briefing (Sweet and Maxwell)

Contract Certainty is a phrase you will hear in the London Insurance Market (both in Lloyd’s and the Companies Market) at present— but what does it mean, and how will it affect the placement of business in the London Market? The recently issued Contract Certainty Code of Practice (which will be discussed in more detail below) makes it plain that "Contract Certainty" is required for all contracts, whether insurance or reinsurance, whether relating to single or "mixed"markets (e.g., a London market placement, which includes overseas placements via London brokers) whether open market or binding authority/line slip business, and whether traded via paper or electronically.This article is intended to provide a brief explanation of what Contract Certainty is,why it matters, what it will entail, and whether it is achievable.

It is a simple fact that, at present, not every contract of insurance or reinsurance entered into in the London Market has been fully documented at the time of inception. This failure to finalize the contractual documentation before inception of a risk, or what has been described by John Tiner, Chief Executive of the Financial Services Authority ("FSA") in a speech on December 13, 2004, as the "deal now, detail later" culture, is a significant cause for concern for the FSA, which assumed responsibility for the regulation of the Lloyd’s Market on December 1, 2001 (pursuant to the Financial Services and Markets Act 2000). The FSA is committed to rectifying this situation and ensuring that all contracts are properly documented before inception. The following quote from the FSA’s London website encapsulates why the FSA is committed to achieving contract certainty in the market:

"The work fits within the FSA’s strategic aim of promoting efficient, orderly and fair markets, working with the grain of the market wherever possible. It will reduce the operational and legal risks to brokers and insurers and improve service and clarity of offering to customers. It will enhance transparency whilst preserving the diversity and competitive position of the market. (http://www.fsa.gov.uk)

In the FSA’s view, it is essential for all parties involved in an insurance transaction to understand and identify all the terms of the contract before they are bound to the risk. At a practical level, this will minimize the broker’s E&O exposure, allow the Insurer to properly assess its exposure from the time it goes on risk, and enable the Insured to clearly understand the cover it has purchased.

The FSA has set the insurance industry a challenge to secure a market-driven solution to the "Contract Certainty" problem by December 2006. This challenge was set in John Tiner’s speech of December 13, 2004. Following a meeting between the Industry and the FSA on December 20, 2004, two industry working groups were set up to respond to the challenge to achieve Contract Certainty (covering the Subscription market, and "Non-slip" non-Subscription market). It is worth noting, therefore, that, although this article will concentrate on the Subscription market, the entire insurance market is currently working in parallel towards Contract Certainty.

The London Market Reform Group ("MRG") (comprising the IUA, LMA, LMBC and Lloyd’s) has led the drive towards Contract Certainty in the Subscription market. The MRG is assisted by the Market Reform Programme Office ("MRPO").

Until May 2005, there was no clear definition of Contract Certainty within the London Market. One of the first tasks for the MRG had been to produce a definition of what "Contract Certainty"meant to the London Market. The current definition of Contract Certainty is as follows:

In effect, as long as a wording complies with the requirements listed above,many different forms of documents could comply with the Contract Certainty requirements in respect of the "full wording."

Contract Certainty Attributes

The above definition makes it clear that the Insurers have the final say on what form the full wording should take, although it seems likely that, in practice, the London Market Principles BRAT slip ("LMP Slip") can be expected to be the basis of that full wording.

The LMP Slip project formed an earlier stage in the London Market reforms. Since January 2, 2004 it has been mandatory for risks placed in the Lloyd’s market to comply with the requirements of the LMP Slip. To describe fully the project would require an article in itself but in brief, by imposing minimum requirements on matters that had to be included as part of the slip’s clauses, the LMP Slip was intended to:

• ensure clarity and completeness of contractual terms;
• assist in the administration of slips and help ensure that they comply with fiscal and regulatory requirements; and
• facilitate the accurate production of insurance documentation and thereby deliver benefits to brokers, underwriters and policyholders.

The MRG has identified nine "Contract Certainty Attributes" which are intended to act as a benchmark to measure compliance of the LMP Slip with the above definition of contract certainty:

1. Wording

2. Law, Jurisdiction and Arbitration

3. Duties Clearly Allocated

4. Commercial terms

5. Sound Legal Basis

6. Risk Disclosures

7. Single Agreed Version

8. Compliance

9. Comprehensible

This bullet point list is opaque — but it is intended to prompt the following questions about the wording of any insurance contract:

1. Is the submission clear and unambiguous?

2. Is law and jurisdiction and arbitration clearly referenced and complete?

3. Are all terms clear and unambiguous?

4. Are all duties clearly allocated, including processing of contract changes, document production and claims processing?

5. Is any supporting information clearly referenced?

6. Is the submission compliant with regulatory requirements?

Twenty-six different items on the LMP Slip have been linked to one of the above contract certainty attributes. These 26 items are listed on the LMP Slip Checklist (available from www.lmp-reforms.com).

It is clear that a compliant slip will be one step towards achieving Contract Certainty.The MRPO has set up the "Lloyd’s Slip Audit team"which is now marking 25% of all slips submitted to X-changing Insure Services against the "LMP Slip Checklist" to ascertain if the slips are compliant with the check list, and hence the contract certainty attributes. In July 2005, 33% of Lloyd’s Slips were fully compliant with the 26 point checklist.

In the chart below, the figures published in the LMP Slip Quality Market Report from Lloyd’s dated July 2005,demonstrate the progress made towards fully compliant slips up to July 2005.

*Please note that the figures have been rounded to the nearest percentage.

On October 7, 2005, Nick Prettejohn, Chair of the MRG, wrote to the CEO’s of all London Market firms to circulate the "Contract Certainty Code of Practice" and "Contract Certainty Check List."Copies of both the letter and the Code of Practice and Check List can be obtained from the London Market Reform website — www.lmp-reforms.com.These documents provide the first clear, concrete guidance as to the steps that the various sections of the market should be taking to achieve "Contract Certainty" in their dealings, beyond ensuring that every LMP Slip contains the 26 specific items contained on the LMP Slip Check list.

The Contract Certainty Check List sets out a guide as to whether the contract certainty attributes have been met, and this should be viewed in conjunction with the LMP Slip Check list in ensuring that slips and wordings achieve "Contract Certainty."

The Code of Practice and Check List also identify eight "Contract Certainty Principles" that the London Market Reform Group recommends as the sound basis for achieving Contract Certainty in London Market contracts. The first three principles, applicable to the pre-inception stage, are:

1. "Brokers will provide submissions that satisfy the contract certainty definition and checklist to obtain firm quotes and place firm orders.

2. Each insurer will be satisfied that the submission meets the contract certainty definition and checklist before formally committing to the contract, ensuring that any conditions or subjectivities are clearly expressed.

3. Brokers will notify all terms to their client and obtain their client’s agreement before inception."

Plainly the responsibility for achieving a clear, final wording rests with both parties to the transaction as well as the broker. The remainder of the requirements relate to the post-inception stage:

4. "Brokers will calculate signed lines by inception and notify them to each insurer no later than 30 days after inception date, or by inception date on request.

5. Brokers and insurers will not take part in post-inception overplacing.

6. Brokers and insurers will ensure that post-inception amend amendments are documented and agreed as endorsements.

7. Brokers and insurers will each collect and maintain data on their contract certainty performance at individual contract level.

8. Brokers and insurers will ensure that appropriate evidence of cover, including security, is issued within 30 days of inception (this can be an insurance policy, copy of complete slip, certificate of insurance or broker insurance documentation)."

Contract Certainty should have already been achieved by the time these further five principles apply.They may therefore be considered a statement of "best practice" that brokers and insurers should comply with, in order to ensure that the benefits of achieving Contract Certainty on inception are not wasted.

The onus for implementing "Contract Certainty" rests with the London Market firms themselves (i.e., brokers and insurers). Firms were required to adopt the Code of Practice, through their own corporate governance processes, before the end of 2005 and then to implement it as quickly and fully as possible. Although the "Market Reform Programme Office" will report to the FSA on overall progress, each firm is separately responsible to the FSA for its own performance and is required to maintain data on contract certainty "performance" for each individual contract into which it enters. This is why the collection and maintenance of data is one of the central principles of Contract Certainty (item 7 identified above). The Market is therefore responsible not only for putting its house in order, but proving that it has done so.

The Check List has been designed to assist firms in ensuring compliance and on November 9, 2005, the MRG published guidance describing the requirement on Brokers and Insurers to collect data in more detail to measure these targets. The Guidance again stresses the need for each individual broker and insurer to "collect and maintain its own granular statistics for potential review by the FSA."The guidance states Lloyd’s Managing Agents may elect to base their statistics on the results of the X-changing Insure Services checking, but brokers and non-bureau companies are required to set up and maintain their own quality monitoring and measuring processes. Proof of compliance with the 26 points on the LMP Slip check list will not suffice as evidence that Contract Certainty has been attained. For example, a broker, to satisfy the FSA that they have attained Contract Certainty in their dealings, should also be able to demonstrate that the slip was compliant prior to inception, that they are able to provide signed lines on inception, and that they do provide satisfactory evidence of cover and satisfactory documentation of amendments. Therefore that broker will need to determine how such criteria will be measured, and ensure that the internal procedures are in place so that the statistical data is captured.

It should be remembered that Contract Certainty applies to all risks placed in the London Market, and therefore it applies to all brokers, insureds and reinsureds who place business in the London Market.

Nick Prettejohn’s October 2005 letter to the market stated that the MRPO would contact each firm before the end of 2005 to seek confirmation that the definition and principles of Contract Certainty have been communicated to the Board of Directors of each firm, and that the Board has committed to these principles. All "relevant" staff should be provided with copies of the Checklist and Code of Practice and given relevant training. The MRPO is offering assistance in relation to training.

The FSA has stated that it would formally review progress at the end of 2005 to determine whether the market is on track to achieve satisfactory performance. In addition, Julian Adams, head of the Wholesale Insurance Department, FSA, announced in his talk to the "Acord" Forum, on October 20, 2005, that the FSA was intending physically to audit London Market firms during November 2005.

It is recognized that the achievement of Contract Certainty will be a gradual process. Indeed, the Code of Practice contains targets for the proportion of contracts which need to meet the definition of contract certainty:

The market’s own targets do not envisage 100% compliance with Contract Certainty by the end of 2006, although this in part must reflect the fact that some business will come to Lloyd’s which cannot be fully compliant, i.e., there will always be some occasions where an insured/reinsured seeks cover post inception. There has been no suggestion that a failure to comply with Contract Certainty principles is intended to affect the enforceability of a contract of insurance or reinsurance. The incentives are market reputation and good business practice, but any dilatory company is likely also to be influenced by the threat of FSA intervention. Indeed the FSA’s stated position is that:

David Strachan, director of the FSA’s retail firms division, recently emphasized at a meeting at the Lloyd’s Library that if sufficient progress was not being made at the end of the first quarter 2006 then the FSA would be ready to intervene: "New regulations are not our preferred option, market change is, but we will act as necessary.We want to act less as a stick and more as a carrot.We will be looking very carefully at firms and sectors that are not making sufficient progress." There clearly remains a question as to whether the market can reform itself on time, by December 2006, or whether the FSA will be forced to wield a bigger stick. In a meeting with the MRG on December 9, 2005, the FSA made it clear that "although momentum has been gained, there is still much work to be done to change behavior and working practices at the coal face. Proof of progress will be seen once data is available from the market."

Whether the carrot or the stick prevails, it looks likely that it will eventually become the norm in the London Market that finalized contract wordings are agreed by inception. So what will the achievement of "Contract Certainty" mean for the London Market ? If anyone expects that "Contract Certainty" will mean just that — certain contracts — and an end to disputes arising out of "uncertainty," they will be disappointed. Contract Certainty will not prevent disputes from arising, but at least it will assure that the disputes that do arise are about a known and agreed document.

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.