The reform of disclosure and warranty rules signals the end for passive underwriting, writes Paul Lowin, but that is no bad thing for insurers, brokers and their clients as long as they are prepared to work together

“The essential question is not really whether the law is fair,” said David Hertzell recently. That, added the author of the Law Commission’s proposals for reforming disclosure in insurance contracts, depends on your point of view. Instead, as he explained on a conference call organised by Airmic, the principal driver for the reform is that the world has changed since the passing of the Marine Insurance Act 1906, on which the current law is based. Insurers and businesses are bigger; risks are more complex and varied; and, particularly, “the ability to communicate, to transmit information and process information, are radically more sophisticated than they would have been 100 years or so ago”.

Yet, despite this, communication between insurers and their insured, has, if anything, declined in recent years, and in its place has been a marked increase in passive underwriting: Many insurers are willing to write property and casualty business with limited submission information or poor survey information.

As research group MacTavish and PricewaterhouseCoopers noted last year in their report Corporate Risk & Insurance: the Case for Placement Reform, “the system through which corporate insurance is arranged in the UK prioritises, above all else, low (and declining) transaction costs”. Standards of risk disclosure, the report added, were generally poor and inadequate.

Pointing the finger

It is easy to blame insurers for this. The prolonged soft market has seen them too keen to chase business, argue many, and, indeed, it is true that not many in the UK (in contrast to France or Germany) have resisted the temptation to lower underwriting requirements. AXA Corporate Solutions is one of relatively few, for example, to still insist on in-depth survey information underpinning property cover. But the trend has suited customers, too. With no trouble placing their business, less burdensome demands for underwriting information have generally been welcomed.

The financial crisis has brought unprecedented strategic and operational changes in the last couple of years. Risk managers must cope with their businesses looking to new markets for sourcing and sales; manufacturing and business processes changing; sites closing and staff being shed, even in risk management and health and safety departments. At the same time, capital expenditure and consultancy spending have been squeezed and the usual crop of new and evolving dangers, such as cyber risks, have required addressing,

The result has been a taxing mix of greater responsibility being met with fewer resources. It is little wonder then, that few risk managers have questioned too hard the availability of cover with even scant disclosure information. Moreover, education and the law itself exacerbate the problem. The legislation says too little of insurers’ responsibilities regarding disclosure, while many risk managers are ignorant of what the law truly requires. Blame, however, matters less than the fact that it cannot last. Time is already being called on this approach. Those who have not already will soon abandon passive underwriting. And while there are a number of reasons for this, they largely amount to the same thing – it is no one’s interests.

Changing times

For insurers, the pressure to tighten up underwriting comes from a number of sources. For a start, Solvency II and regulatory demands for a greater understanding of risks and capital requirements sit uneasily with casual approaches to underwriting. Moreover, the prolonged soft market has also eroded margins, leaving insurers more vulnerable to losses. Insureds, meanwhile, in neglecting their systems for collecting the necessary data, leave themselves poorly prepared for when the cycle does eventually turn.

Indeed that is already evident in certain lines. Following enormous losses from the Thai floods last year, for example – largely unforeseen by the insurance industry – the increased discipline in writing contingent business interruption policies has been notable. Notable, too, have been the varying fortunes of businesses seeking insurance on good terms. Those with an understanding and clear map of their providers and exposures have continued to find affordable cover. Others have had to pay significantly more or have failed to find cover at all.

More widely, and perhaps more worryingly, there are increasing signs that poor disclosure requirements and pressure on margins could lead to an increase in disputes over claims.

Airmic’s pre-conference survey earlier this year, for example, found risk managers’ top risk governance concern was that an insurer would refuse to pay a large claim. Indeed, 28 per cent had had a claim refused in the last two years, 10 per cent on grounds of non disclosure. That accords with the findings of a more recent research paper released in June which noted: “There is evidence of claims being questioned for reasons that seasoned market participants find surprising.”

At present, incidents in which claims are refused on disclosure grounds are relatively rare but, as the Law Commission notes, they tend to be the larger ones. The cost of less burdensome disclosure requirements for risk managers, therefore, is that they cannot rely on their cover to be adequate when it is most needed. But there are also costs for insurers, and these are only going to grow with the Law Commission’s proposals.

A false economy

At the moment, poor underwriting discipline on the part of some insurers is mitigated to an extent by the law on disclosure and warranties. The old Marine Act provisions enable insurers to avoid paying a claim due to the failure of the insured to disclose relevant information or comply with a contract term – even where these are not relevant to the claim. Failure to install a burglar alarm, for example, can entitle the insurer to refuse a claim for flooding.

Even as it is, the benefits to insurers are easily overstated. “Underwriting at the claims stage”, as the Law Commission terms it, might reduce some costs, but it’s not risk management, and it leaves much to chance. Disputes in any case are expensive and time consuming, particularly if they make it to court, and the Commission also noted the courts’ reaction to the perceived unfairness of the rule. It sometimes led them to strain interpretation of the law to say that no non-disclosure has taken place. The result is that insurers, as well as those they cover, lack certainty.

Furthermore, insurers’ lack of clarity on what information they require often leads to risk managers providing too much information as too little – dumping large amounts of irrelevant data on the insurer in an effort to protect themselves. That increases costs for both parties.

But in any case, whatever the precise outcome of the Law Commission’s consultation, there is little doubt insurers’ ability to rely on the warranties and disclosure failings to refuse claims will diminish when a draft Bill amending the law is published – probably by the end of 2013.

As the Association of British Insurers’ director of financial conduct regulation Maggie Craig recently put it: “[This] potential legislative reform of business insurance requires careful consideration as it may have significant ramifications for the way that insurers conduct their business.”

In truth, it is in both insurers’ and clients’ interests to begin to tackle this issue now. Doing so will require that they work together. Claims audits, post loss reviews and loss scenario testing (in which coverage is evaluated against detailed potential claims scenarios) can all help both parties understand their risks better. Vitally, joint policy read-throughs to ensure that the full intent and extent of the coverage provided by the wording is transparent to all parties will go a long way to preventing problems. In all cases, though, the key is greater and more open dialogue between insurers, insureds and brokers.

Putting that in place will require investment on both sides. Indeed, part of the task for insurers’ must be to help risk managers make the case to their boards for yet more resources given to preparing policy submissions. However, the results will ultimately be greater transparency of the coverage in place, better understanding of the exposures, and more effective risk management for both sides. It could, in fact, mean a fairer future for everyone.

Paul Lowin is regional commercial manager at AXA Corporate Solutions UK

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