Comment - commercial insurance: Trouble brewing

In response to the Mactavish-Pricewaterhouse Coopers report into the failings of the commercial lines insurance market, John Hurrell, chief executive of the Association of Insurance & Risk Managers said last week: "For well over a year, Airmic has been warning of trouble brewing in the commercial insurance market." (www.postonline.co.uk/2036606)And Mactavish itself came out and said it clearly: "Commercial insurance is not fit for purpose."

However, despite this unwelcome message to our industry, Mactavish's conclusions could be turned to advantage by pioneering young insurers and brokers, whose interest in their future demands a unique selling point. To achieve that requires a closer look at the irreconcilable clash between the principles behind the Marine Insurance Act 1906 — of utmost good faith and the duty of disclosure — and insurers' much-claimed defence for refusing claims: their fiduciary responsibility to shareholders.

Goodwill and common sense

"Only the goodwill and common sense of most insurers makes the system workable," said Mr Hurrell, "but that is not something on which buyers should have to depend." In other words, the duty of disclosure as described in the Act is too broad to be understood by insureds.

But what is the real alternative? Surely the insured party to a contract founded upon utmost good faith ought to be able to rely upon this good faith being exercised at all times? This would bring reason and proportionality to the interpretation of what otherwise is a sound principle underlying the contract.

Remove that principle and the contract reverts to being an ordinary one — and it is not commercially feasible to make a contract of insurance with a party who does not have to tell the insurer about the nature of the risk. Ergo, utmost good faith is an essential prerequisite of a contract of insurance.

That is obviously not an original thought on my part, but that principle has been lost sight of by some insurers in the day-to-day conduct of insurance. And that is the root cause of the findings that enables Mactavish to declare the industry not fit for purpose.

This was not so in December 1906 when the Act was introduced, eight months after the San Francisco earthquake that brought fame to Cuthbert Heath and Lloyd's of London for an act of overt good faith — when he instructed his representatives in the US to "pay all claims irrespective of the terms of the policies".

It seems that the Act got it right and modern practice has got it wrong.

The fiduciary duty of insurers to their shareholders is often cited as a reason for insurers not paying claims: when their lawyers have highlighted a technical reason by which the insurer can deny the claim but which reason does not go to the intention of the policy or is otherwise contrary to utmost good faith. In other words, cases where an insurer can reasonably pay a claim in accordance with utmost good faith but elects not to — citing fiduciary duty to shareholders as the reason.

Dubious defence

Should this be a defence? If so, it runs fundamentally counter to the principle of utmost good faith. There is the clash.

Is it an act of bad faith to do so? If so, should utmost good faith be deemed to over-ride the fiduciary duty to shareholders? Who is the industry serving first? And is insurance an economic necessity to be entered into in good faith or a game to be played by unequal parties?

This is where the industry needs direction from itself as a matter of ethics and professionalism as well as from the courts as a matter of good law. Many of the senior decision makers in the industry are qualified to ACII or FCII level and some hold additional relevant qualifications. It is disingenuous to suggest that these qualified, experienced people habitually need a lawyer to tell them when to pay a claim or not.

If the industry took more responsibility for itself and justified its actions to shareholders by reference to good faith, it is unlikely there would be a kick back from shareholder investors who knew what was good for them.

Getting it together

Insurers cannot, as recommended by Mactavish, expect higher levels of prudence and understanding from insureds with whom they do not effectively engage. In my industry experience of more than 40 years, the last nine of which have been involved in claims dispute resolution, I find most insureds are honest and co-operative with insurers. But, as Mactavish has found, there is massive ignorance by insureds of what really matters to insurers in the context of material information and disclosure.

Why is that surprising to insurers? It happens because some insurers simply do not make it clear. They could and should but it makes you wonder why they don't.

Materiality is a complex subject, even to the experts in the industry. It is as mysterious to insureds as 'hyperbolic discounting' probably is to most of us. The only effective way to get an insured to understand the vast array of things that constitute what is meant in any given case by material disclosure — the 1906 Act's "every circumstance is material which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk" — is to engage with them in a non-hostile way and demonstrate levels of reasonableness, proportionality and good faith that promote a mutual trust between insured and insurers.

Mactavish's eight proposed protocols for refining risk placement, including one of a two-stage tender process, are well intentioned. But even so, they leave the entire infrastructure of insurance trading at risk if the underlying duty of utmost good faith is undermined.

Roger Flaxman is managing director Flaxman Partners