Broker focus - Premium liability: That boat has sailed

After more than 100 years, it finally looks as though an odd piece of legislation in force throughout England, Wales and Scotland will be given the boot. Section 53 of the Marine Insurance Act 1906 makes brokers responsible for paying their clients' premiums to underwriters, an anomaly which was acceptable in a very different age, but which now appears quite anachronistic.

This is now an issue that has been studied in depth by the Law Commission. Back in 2006, it produced some detailed work in a joint scoping paper that questioned whether section 53 still reflected the realities of the insurance marketplace and should be reviewed. Of the 93 responses received, some 72 said they believed this should be included with the full review of insurance contract law currently taking place.

Following this, in July, the Law Commission set up a formal consultation on section 53, which closes on 19 October. Although there is no guarantee that reform will occur, many experts believe if it does not happen now, it never will since there is more momentum than ever before.

Inconsistent decisions
David Hertzell, the law commissioner leading the project for England and Wales, commented: "The courts' efforts to grapple with the complexities of section 53 have generated many inconsistent decisions - so it is difficult to be sure what the section means. It appears to place the broker at risk if the policyholder becomes insolvent. But it may also pose risks to insurers if a broker becomes insolvent. It is possible that the section would prevent an insurer from recovering the premium from the policyholder, but that the insurer would still be liable to pay claims. Section 53 may be out of step with modern commercial practice."

And, as Professor Hector MacQueen, the Scottish law commissioner, said: "It is the policyholder who benefits from having insurance, so why should the policyholder not be liable for the premiums? This paper sets out our preliminary thinking on section 53 and asks whether there is a case for reform and, if so, what the solutions might be."

Mike Fountaine, head of marine at brokers Cooper Gay, comments: "I've had 32 years' experience in this market and this has always been viewed as something that is unfair — I don't feel now that it is right for marine to be treated differently to other classes of business. While there were arguments in the past, these have ceased to exist now."

The reason why brokers were deemed liable were linked to the mores of the time, when it was obvious that brokers would have a far closer relationship with their global clients than underwriters, who would probably have no knowledge of them at all. But, market practice based on trust, has to a large extent been replaced by sophisticated ways to assess credit risk and, arguably, now underwriters should be able to make sound judgements.

Mr Fountaine continues: "We are not bankers but brokers are having to handle what can be large instalments and deal with late payers on occasion. Notably, underwriters have tightened up their procedures. Terms of trade were once 90 days, now they may be shortened to 30. That puts us under additional pressure. Looking back to the many board meetings I've attended over the years, funding issues have always been on the agenda."

While he says there are protections available, far more clarity is needed and this is why he believes a legal change is essential. "I sit on the London & International Brokers' Association marine executive and we have been doing a lot of work to get rid of involuntary funding. I am now confident reform will happen. Right now, it is just a road block."

Notably, however, most brokers are not being particularly vociferous about change. Marsh, Aon and Willis were all contacted to see if they had views, but they did not.

However, most lawyers do think change makes eminent sense. As Alexander Denslow, partner with CMS Cameron McKenna, says: "Section 53 is an anomalous statutory provision that overrides contemporary agency law. It codified the legal 'fiction' that the broker had paid the premium to the insurer (thus discharging the policyholder's liability to pay) and that the insurer had then lent the money back to the broker, so creating a personal debt as between the broker and the insurer."

Archaic law
He says the courts have struggled to "consistently apply this archaic rule of common law in the modern insurance market. The reform proposed by the Law Commission, whereby it would be the policyholder, not the broker, that would be liable to pay the premium due under marine insurance policies, would bring marine insurance law into line with agency rules and would allow parties to agree their own contractual arrangements on credit risk. More generally, it would provide greater certainty to brokers, insurers and their insureds, particularly upon the insolvency of the insured or its broker."

Lawyer Nigel Brooke, partner with Clyde & Co, comments: "Section 53 largely only causes problems if the insured or broker goes bust. If this was the case with a large broker then clearly it would be a major event, but over the years, there has been only a limited amount of litigation, much of which is referred to in the consultation paper. I think most brokers just see it as an irritant. They need to get the money in and potentially deal with matters like additional premiums. The law as it stands is haphazard and because it is now receiving some attention, this is the best shot brokers have had for a long time."

Parliamentary time
Michael Mendelowitz, partner with Norton Rose, agrees. "The law is messy and confused but, while it makes sense, the key question is whether parliamentary time will be available. However, even though insurance contract law may not be deemed a priority as much as some other areas, there has been a lot of focus on the consumer reform aspects — and I have heard that the House of Lords is in the early stages of drafting a bill. Section 53 could be part of a raft of changes in this area."

Despite this, he says that one of the reasons why brokers are not generally up in arms about section 53 is that there have been a number of defences in place to protect brokers from having to fund premiums.

He explains that brokers will often work with underwriters and wordings may include premium payment warranties, which mean the insurer will specify when payment must be received and brokers' cancellation clauses. This means that, if premium is not received, then the broker has the right to cancel the policy. "Brokers also use terms of business agreements, which allow them to state terms — although these are far from proven. While these may be different ways round a problem, the aim with reform will be a tidying up."

However, in its consultation paper, the Law Commission did state: "We doubt whether a Toba between the broker and the insurer would be sufficient to contract out of section 53 unless the policyholder is a party to the agreement. If section 53 applies, the broker may remain liable to pay the premium, even if it has not received it from the policyholder."

Tim Goodger, partner with Elborne Mitchell, says this is a sector which has traditionally sought to work in partnership to mutually protect both parties. He points out that after reconstruction and renewal at Lloyd's, an agreement was reached between the Lloyd's Market Insurance Brokers' Committee and Lloyd's that brokers would not be liable under section 53, but five years later, this position reverted to type.

"Since then, brokers have spoken up more and steadily complained about the law. Although it remains the case that brokers are almost certainly going to know clients better than underwriters, there is now far better intelligence gathering and insurers should be able to gain a more accurate picture of the credit risk.

"Whichever way you look at it, it would seem to be unfair that brokers are liable to pay the premium and the Law Commission has said, namely, this is a mess, and reform is needed. The main problem is going to be whether there is sufficient time."

Likewise, Paul Castellani, partner with Reynolds Porter Chamberlain, adds: "This needs to be brought up to date — it is a law that does not stack up now. It is fortunate for brokers that cases do not happen very often, but it does mean they are exposed to a potential risk that is contrary to the existing laws of agency."

The status quo
But are there are any reasons actually in favour of maintaining the law as it stands? Jon Sharp, partner with Browne Jacobson, says he can see two different positions. "Some brokers will argue it is an additional burden, that it is already complicated dealing with international business let alone when they have to chase premium payments. Beyond that, I am currently dealing with a case where the broker has gone under — and this is bad news for the insurer, because it has not been able to recover the premium as yet."

On the other hand, though, he emphasises this is not a common occurrence, because it is rare for a broking firm to collapse — and the marine market is largely well regulated and established.

However, he adds that brokers who do have slick systems for premium collection may also benefit financially from holding funds, even if this is for a relatively short time. "If you have large sums of money involved and brokers are holding this say for a few weeks then they could benefit — they have to weigh this up with being on the hook in terms of their liability if premiums are not received. I would not be surprised though if there are some who are prepared to keep the status quo."

As Mr Sharp says: "Some brokers will say that despite the risks, we are used to doing business this way and are set up to take premiums and control this. Others will find it a huge relief if they no longer have to do the administration. I am aware of one small marine broker who has six people working in accounts — this will be a big financial burden for them and would not be necessary if the law changed."

As an aside, Aswin Mistry, chairman of broker buying group Brokerbility and Leicester-based broker Brett & Randall, argues that brokers are often highly experienced in premium collection and may have recourse to a premium finance provider or the insurer if they run into problems. He points out that brokers are primarily at risk if the client goes into liquidation — which it has to be argued, is happening more frequently as a result of the economic conditions.

'Moral' responsibility
While the concept of client knowledge and strong relationships was at the heart of the 1906 thinking, Mr Mistry is convinced that brokers still have a role to play in premium collection, even if they are not bound by law. "Brokers have a 'moral' responsibility for collection, irrespective of any method of payment. Insurers will take a dim view of any broker producing low quality clients, especially with regard to honouring premium payment."

And looking at the wider issue outside of marine, Mr Mistry points out that brokers are already collecting income for HM Treasury through insurance premium tax. "It has recently increased to 6% and I can only see it going one way in the future."

It is clear that, although all parties have worked with the current law, it is unwieldy to say the least. Mr Denslow points out: "For example, the legal 'fiction' has resulted in the status of adjusted premium clauses and premium payment warranties under marine insurance are far from clear."

Simply having "get out" clauses, which may or may not prove effective, is not in the best interests of any party. Notably, the Australians have tackled the problem. Section 59 of the Australian Marine Insurance Act 1909 was identical to section 53 of the Marine Insurance Act 1906, but has now been repealed.

It may be that brokers are benefiting in terms of earning some interest from funds held before these are handed over but, at the same time, they do also need to meet the cost of extra accounts staff and of having the systems in place. There may be advantages for underwriters in this case, but it cannot be welcomed that under the present law, the insurer cannot recover the premium from the policyholder. Just because the various parties are used to operating in a certain way does not make it right — and at long last, it seems the Law Commission will be pressing ahead to do something about it.

Will reform happen? Read the latest development on postonline.co.uk