Fund managers and fund directors have a choice when it comes to buying insurance. They can accept an offer of an off the shelf product where the insurer’s obligation to pay a claim is limited not only by the express terms of the policy itself but also by the provisions of English statute and common law (which are of course readily available to any enthusiastic hedge fund manager, with time, in a local law library). Or, with a little more determination, they can insist on a product which, on the really important points at least, reflects what would probably be agreed between a reasonable insured and insurer across a table if they had the time and inclination to meet and agree on a fair and reasonable balance of responsibilities. Insureds do not have to accept standard wordings that create an unequal bargain or that have the potential to result in the total loss of cover in unexpected circumstances, for example as a result of an innocent mistake or an event over which they had no control or about which they had no knowledge. Nor need they accept a “one-size-fits-all” approach to the scope of protection afforded by the insurance cover, which may not take adequate account of the nature of their particular business. This is particularly important in the context of D&O insurance where recent research by the American Bar Association suggests that the insured’s principal concern may be criminal/regulatory exposure rather than “traditional” civil liability to third parties.
Three important areas where fund managers and fund directors should seek to drive a better bargain are as follows. First, in relation to the warranties or contractual promises made by the insured. Second, in relation to the disclosure of material information that an insured is required to give to the insurer before the contract of insurance is entered into, sometimes described as a fair presentation of the risk. Third, in relation to some of the express conditions of the policy itself which impose positive obligations on the insured as a condition of cover.
Such is the state of English insurance law that Parliament has recently intervened to protect consumers (but not yet businesses) in the purchase of insurance by passing the Consumer Insurance (Disclosure and Representations) Act 2012 which received Royal Assent on 8 March 2012 and will come into force in March 2013. On 26 June 2012, the Law Commission published a Consultation Paper covering the business insured’s duty of disclosure and the law of warranties. The consultation period ended on 26 September 2012. The Law Commission proposes to publish a final report and draft bill on business insurance by the end of 2013. It is highly likely that the Marine Insurance Act 1906 and the common law that underpins it will be amended in ways favourable to the insured. Fund managers and fund directors do not, however, have to wait for Parliament to come to the rescue. The terms of insurance contracts are freely negotiable and a commission is paid to the insurance broker to do precisely this. It is of course the case that the insured’s broker, for the amount of commission it receives, cannot always negotiate individual policy wordings on behalf of its clients. It can, however, sometimes improve its policy wordings for the benefit of all its clients and it can seek specific changes on the really important points which the insurer and insured would almost certainly agree upon given the opportunity of a short commercial discussion.
The negotiating position of the insurer will always be that it is entitled to strong contractual protection because there is an inequality of knowledge between it and the insured and because its willingness to accept the risk and its calculation of the premium are largely dependent on the quality and extent of information provided by the insured, and the insured’s own statements about the risk. These are entirely reasonable concerns which the policy wording needs to address. On the other hand, it is also an entirely reasonable concern of the insured that it should not be left without cover in circumstances where this is not fair, for example where it was not at fault. Even where it was at fault, there is still a case that the punishment should fit the crime and no more. The insured should not lose cover for what may only have been a technical breach that caused no great harm to the insurer.
There are a number of problems with insurance warranties. First, they are not always visible to the naked eye. They do not need to be labelled as a warranty to be one. For example, information provided by the insured and described as being “the basis of the contract” is effectively warranted as true. In many policies, the small print wording immediately above the signature box on the proposal form contains an agreement by the proposer that the answers in the proposal form shall be the basis of the contract. This will result in all the information provided in or in conjunction with the proposal form being warranted. Second, a breach of warranty discharges the insurer from all liability under the insurance contract from the date of breach and cannot be remedied. Third, the breach of warranty does not have to be material. It can be minor. Fourth, it matters not that the breach of warranty has nothing to do with the loss claimed under the policy. It can be totally unrelated. There are a variety of ways to defuse this particular depth charge or at least limit the collateral damage it can cause. For example, imagining our reasonable insured and insurer in their short commercial discussion, the parties might agree that the insurer should only be discharged from liability under the policy as a result of a breach of warranty if:
• The breach was sufficiently serious or fundamental to the insurance contract; or
• The breach was material and caused the loss claimed under the policy. To the extent the loss would have happened anyway, the claim would be payable or payable in part; or
• The breach was known to the insured and within its control; or
• The warranty in question was specific and clearly identified as such in the policy rather than found in some other document such as the proposal form.
The point is that there are any number of wordings which should give the insurer adequate protection and the insured adequate cover. Generally speaking, an insured may be willing to warrant specific information or a state of affairs that is fundamental to the insurer’s decision whether to underwrite the risk. The problem at the moment is that warranties are often not limited in this way and there tends to be a one-size-fits-all remedy which is really only appropriate in the most serious of cases or where the insured was aware of the breach but did nothing to correct or disclose it.
Similarly, there are a number of problems with the insured’s obligation to give disclosure to its insurer of all material information prior to the insurance contract coming into effect. First, the bar for the insurer to prove non-disclosure is low. The insurer only has to establish that the information would have influenced the decision of a prudent underwriter whether to accept the risk and the amount of premium to charge and did in fact influence the actual underwriter. Second, the consequence of a non-disclosure is that the insurer can avoid the policy from inception meaning that the premium has to be returned to the insured (absent any fraud) and paid claims returned to the insurer. The insured is left uninsured. Third, the insured has to make a judgment about the information that its insurer might consider to be material in addition to the questions asked in the proposal form. This is a somewhat uncertain and unsatisfactory basis on which to buy a product that is intended to protect the business and its directors against potentially catastrophic situations including crippling claims. Again, it would undoubtedly be agreed between the parties in a short commercial discussion that the insurer should be protected against a presentation of a risk that was not fair and which induced the insurer to accept the risk when it would not otherwise have done so or to charge a premium that did not adequately reflect the degree of risk. But the remedy does not have to be the total loss of the policy except perhaps in the most serious of cases. The parties could agree for example to any of the following (or a combination thereof):
• The insurer’s right to avoid the policy should be limited to a deliberate material non-disclosure or misrepresentation by the insured; or
• If the information not disclosed would have resulted in different terms being agreed (excluding premium), the contract should be treated as if it included those terms; or
• If the information not disclosed would have resulted in the insurer charging a higher premium, the insurer should be able to reduce proportionately the amount to be paid on the claim; or
• The insured’s disclosure obligation should be limited to answering the questions in the proposal form honestly and reasonably and providing copies of documents requested.
Business people are of course used to operating within the constraints of agreed contractual terms and know that breaching those terms will have consequences. In the context of a contract of insurance, however, some may not realise that even an oversight can effectively rob them of the entire benefit of the policy. For example, this applies to a notification provision drafted as a condition precedent. Typical wording might be: “As a condition precedent to the insurer’s liability hereunder the insured must give immediate notification of any claim [or notification within a limited number of days]”. This means exactly what it says. If immediate notice is not given (for whatever reason) the insurer may refuse to pay even if the delay is not a long one and, importantly, even if the insurer has not suffered any loss as a result. Many would question the fairness of this but, like other inappropriate terms, it is a problem that can be addressed by negotiation before the policy is taken out. There are other similar issues such as in whose opinion should a set of facts or circumstances be said to be likely to develop into a claim or circumstance to trigger notification obligations. These too can be clarified, often in the policyholder’s favour, before the policy is taken out.
Bearing in mind the importance of insurance to fund managers and fund directors, it is somewhat surprising perhaps that some policy wordings have yet to anticipate the changes that are likely to come as a result of the work of the Law Commission. We expect this will change as it becomes clear how the law of business insurance will develop at the instigation of Parliament. In the meantime, however, there is scope for parties to all contracts of business insurance to agree on responsibilities that more fairly reflect their legitimate expectations and genuine concerns.
Christopher Braithwaite and Ian Lupson are partners in Jones Day’s Global Disputes and Insurance Recovery Group.