In this article we consider the insurance broker’s role and why it’s important that fund managers invest time and effort into choosing their broker wisely. Price and knowledge of the business should not be the only reasons for selecting the right broker.
The role of the insurance broker is often overlooked when fund managers purchase insurance for their business critical risks of professional negligence, liability of directors and fraud. The role is often considered to be ‘execution only’. It is not. The insurance broker’s role is far more sophisticated and in the eyes of the regulators and the courts, the broker has a complicated advisory role, as well as a critical commercial one in sourcing the right cover at the right price.
Your broker is your agent
As with other professional advisors, the courts have imposed upon brokers a wide range of duties to their clients. The Court of Appeal has established that the relationship is one of trust and confidence – the law demands loyalty from the broker to its client: the broker must always act in good faith, must not make a secret profit and he must not place himself in a position of conflict with his client. In return for such loyalty, the broker is entrusted with the authority of the client to act as their agent and to create legal relations between the client and third parties. This will usually entail the broker having the authority to conduct negotiations for the purchase of insurance on behalf of the client and to bind the client to the terms of insurance contracts.
A broker’s authority is a powerful thing – the law favours the third party in such arrangements, such that if your broker acts outside its warrant of authority in binding you to an insurance contract when it had no authority to do so, you are nevertheless likely to be bound to that contract and must look to the broker for compensation for any loss suffered.
As well as acting as the client’s agent, the broker has a complex advisory role. The courts and regulators have established that the broker must:
• Ascertain the client’s insurance needs
• Advise on the scope of insurance cover available to meet those needs
• Ensure that the cover is appropriate for those needs
• Ensure that the client understands their duty to disclose material information
• Ensure that a fair presentation of the risk is made
• Draw unusual terms to the client’s attention
• Advise on the adequacy of the sums insured
Why is such an onerous burden placed on the broker?
English insurance law is heavily weighted in favour of insurers.
Insurance contracts are complex and are far from being financial guarantees. In order to trigger the indemnity they provide, the insured needs to have complied with pre-contractual duties regarding disclosure of material information, ensured that any representations made about the risk are fair and accurate, and they must have complied with various warranties and terms and conditions of the policy over the course of its duration. The broker’s role is to ensure that this happens.
To complicate matters further, many brokers use binding authorities to write insurance business on behalf of insurers. This creates an agency and a contractual duty of care to the insurer. In such circumstances, a broker can find itself owing duties to the insurer as well as the insured, and needs to be careful to ensure such duties do not conflict. Critically, a broker in such circumstances must disclose the facts relating to the binding authority and its commission to the insured to certify that it is not making a secret profit. Wearing different hats at different stages of the transaction provides a lot of scope for confusion as to the broker’s role and who is agent of whom.
What happens when things go wrong?
Your claim may not get paid if your broker has failed to do something on your behalf as your agent, or has failed to advise you properly regarding your obligations to your insurers, or your compliance with the policy terms. For example:
• a broker’s failure in not properly notifying claims or circumstances to insurers on your behalf in compliance with the terms of a policy could lead to insurers legitimately denying liability for a claim;
• a broker failing to advise you of your obligation to disclose material facts or to pass on those material facts you have advised them to pass on could mean insurers are able to rely upon that non-disclosure to avoid liability in relation to a claim, and they could potentially avoid the whole policy;
• a broker failing to point out to you, and advise you upon, conditions in a policy that are conditions precedent to insurers’ liability, could lead to your non-compliance with such conditions and insurers denying liability for a claim.
As far as denying liability for non-disclosure, misrepresentation and non-compliance with policy terms, the law favours the insurer. The draconian effect of this is that insureds such as fund managers, or the funds themselves, through no fault of their own, can be left with no insurance cover at precisely the point in time when they need it – when they are facing a substantial claim.
If an insurer denies liability for a claim, you may have to pursue your insurance broker for the loss of the cover for that claim. If the claim you are facing and which you hoped was going to be insured for is, say £30mn, your claim against your broker will be for £30mn. Is your broker worth suing for this amount? Probably not if they don’t have enough professional negligence insurance cover of their own or sufficient assets that could be called upon in excess of or in place of that insurance cover, or they have successfully limited their liability to you in their retainer. Remember, a broker may have insurance coverage problems in relation to your claim against it, so making sure they have substantial assets and not just insurance cover is vitally important.
What you should ask your broker?
There are some key questions you should be asking of your insurance broker, such as:
• How much professional liability insurance cover do they buy?
• What is their capital or asset base?
• Do they have the qualified and experienced staff in enough numbers to ensure they can comply with all of their legal obligations on your behalf?
• Are all the staff, critical to servicing your business, in one location?
• Is your business placed with a binding authority on behalf of an insurer?
• Do they use outside service providers for claims handling, and if so, to whom is the duty of care owed?
• How will they be remunerated for each transaction and by whom?
Both managers and directors should be aware of the pitfalls that would allow an insurer to legitimately deny their claim. In a world where prices have fallen substantially and insurers are struggling to maintain profitability, insurers are likely to look very carefully at every claim.
In today’s fund management market, investors are often seeking the quality of a boutique manager but with the critical size and capital to be able to service their business effectively and to comply with an increasingly regulated market. Should you notbe asking the same of your insurance service providers?