If the upheaval of ongoing regulatory scrutiny were not enough, the verdicts from a handful of recent cases could have additional implications on the way insurance brokers go about their business, explains Carolyn Haigh.
Within the last 12 months brokers have seen their duties, rights, and role in transactions change, in some cases to a fundamental extent. The legal landscape for brokers has altered, with various areas being impacted by key judicial decisions.
In mid-2005, in a case concerning the avoidance of a quota share reinsurance, for the non-disclosure of the criminal background of the chief operating officer of the company that managed the underlying insurance, the Commercial Court in London found that when a replacement broker was appointed, he had a duty to correct inaccurate information given at a previous placement when he became aware of that inaccuracy (ERC Frankona v American National Insurance).
This extension to the duties understood to exist for brokers could raise obvious difficulties for the replacement broker. But the Commercial Court considered the facts carefully, and on this occasion decided that as it would not have been possible, in the ordinary course of their business, for the reinsured or the replacement broker to have known of the oral representation having been made by the original broker at a previous renewal. Even though the subject matter of the representation had later ceased to be accurate, no duty arose on renewal for it to be corrected.
It was stated clearly, however, that where there is a record of a representation having been made, in the information provided to a replacement broker, any information which has subsequently become inaccurate must be corrected. This may become increasingly relevant where brokers are now being encouraged to more carefully record this kind of information to the market, and such papers are then passed on to replacement brokers.
Breaking with custom
In early February 2006 came the eagerly awaited ruling of the English Court of Appeal in Goshawk v Tyser and Co. Goshawk and other syndicates had provided cover to viatical companies, the cover being placed by Tyser. Later, the syndicates' run-off managers sought access to documents contained in Tyser's placing and claims files, which had previously been made available at the time the risk was placed or when claims were presented. They also sought production of accounting documents evidencing the premiums due, charged and paid.
Where the broker received consent from its clients to do so, it handed over the documents requested. However, it refused to disclose documents where the clients either could not be located, or did not give express consent. The syndicates commenced proceedings against the broker.
Lloyd's was stunned by the Commercial Court's first instance decision in March 2005 that, without the consent of his client, the broker could not hand to underwriters the papers previously shown to them. This decision was felt to contradict the commonly-understood market practice or custom that brokers should give underwriters access to such files.
The Court of Appeal permitted the syndicates to advance different arguments, and ruled that for business necessity, a term should be included in the insurance contract, that the placing and claims documents previously shown to underwriters and premium account documents necessary to the operation of the contract, where retained by the broker, should be made available to underwriters. Albeit limiting this availability to cases where disclosure is reasonably necessary.
Although fairly neutral in its direct effect on the extent of brokers' duties, this decision could present problems for brokers, who may find that the ruling conflicts with their obligation to act in the best interests of their client. Although the case was concerned with practices in the Lloyd's market, the decision may well also be of relevance to brokers in the wider insurance market. The Court of Appeal judgment represents the last word for Goshawk v Tyser, permission having been refused to appeal to the House of Lords on 9 May 2006.
Duty of care
On 13 March 2006, in BP v Aon, it was held by the Commercial Court that, despite the existence of a service agreement between Aon Texas and BP, and an initial undertaking by Aon Texas to effect a construction open cover to insure offshore projects worldwide for BP, there was such a close relationship between the sub-broker Aon London and BP, and repeated direct contact between them, that Aon London had assumed responsibility, and was independently responsible for procuring the insurance for BP. Aon London thus owed BP a duty of care in tort and in the circumstances had breached that duty by failing to make timely declarations of all construction projects to be insured to all relevant underwriters.
Sub-brokers should heed this warning that, on the existence of certain facts, they may owe a duty of care to any person who they know to be placing reliance on them personally to obtain coverage, whether or not they have contact with that person. This duty of care to the ultimate client, the insured, could catch out sub-brokers who may previously have thought that only the main broker owed such a duty. This case gives a clear signal that the courts are willing to take a commercial view of the true nature of the arrangements between the parties, rather than abiding strictly by the contractual relationships.
Furthermore, Justice Colman rejected the argument that BP should have purchased alternative insurance when equivalent replacement cover was not available and the cost would have been prohibitive. He did recognise that if a policy which had been rendered defective through the broker's negligence could have been replaced with equivalent cover at an economically viable cost, the situation might have been different. Aon intend to appeal this judgment.
Two days later on 15 March 2006, the Commercial Court handed down judgment in HIH v JLT, holding that insurance brokers had a duty, post-placement, to alert insurers to matters of potential concern as to coverage, albeit that in the circumstances there was failure to prove that the loss complained of was caused by a breach of that duty.
In that case, the risk insured was that certain slates of films known as Hollywood 1, 2, and 3, would fail to generate sufficient revenue to repay the loan notes used to finance the low-budget productions. Slip policies were placed, providing for slates of six, ten and five films, for Hollywood 1, 2, and 3 respectively. There was one sum insured per slate and the risk was that the set number of films would not generate the set amount of revenue. The broker JLT placed the insurance and the reinsurance on a "back to back" basis.
HIH claimed that JLT negligently failed to obtain reinsurers' agreement to a reduction in the number of films on each slate, and that JLT should thus be liable to HIH for damages in respect of HIH's inability to recover under the reinsurance. However, Justice Langley did not accept that JLT were permitted only to act as a mere post-box, and believed that brokers should seriously consider alerting insurers to matters which insureds think may affect cover, despite insurers and reinsurers receiving the same risk management reports, referring to the reduction, as JLT.
Discussion of the post-placement duties of brokers had previously been limited primarily to the duty to advise of changes to insurers' and reinsurers' security. This case extends brokers' duties in favour of insurers, to an arguably significant extent.
The regulators have also been getting in on the act. In February, the Financial Services Authority (FSA) banned insurance broker Xsavi from trading, after it was found to have sold 2,000 invalid travel policies. Although Xsavi had been in genuine negotiations via an agent with an insurer to provide cover, it had allowed policies to be sold before agreement for that cover was in place.
The FSA made it clear that although, before regulation by the FSA, it would not have been uncommon for an insurer to provide retrospective cover, such behaviour would no longer be permitted, and firms would be penalised for such conduct. Brokers will need to protect their own positions by ensuring that they do not breach regulatory rules, whilst carrying out the role required by their clients. This may require undertaking some re-education of insureds as to what they can expect from their brokers.
But despite the concerns that brokers may have over these recent legal decisions, not all changes over the past year were negative for the broking community. In mid-2005, the Commercial Court's judgment in Carvill v Camperdown, as confirmed by the Court of Appeal, opened the door for a challenge to be made to a commonly-understood custom of the London market.
In the matter, US insurer XL had appointed Carvill America to act as its broker in placing two reinsurance treaties. The letter of appointment included a provision that remuneration earned by Carvill would be paid entirely by reinsurers, as was customary in the industry. When cover commenced, gross premium was paid to Carvill, which deducted brokerage and paid net premium to reinsurers. However, disputes arose and XL terminated Carvill's retainer during the policy period, such that Carvill stopped receiving premium and thus brokerage, despite cover continuing beyond the termination. Carvill started English proceedings to recover brokerage from European reinsurers, and joined XL in the proceedings. XL challenged the reason for service against it, arguing partly that the claim against it raised no serious issue to be tried.
In considering whether there was a serious issue to be tried, the Court showed willingness to reconsider the custom that, although the broker is the agent of the insured, he earns his commission by placing the business and that payment is made by the underwriters.
Although it seems unlikely that such claims will become common, given any broker's desire to remain on good terms with his client where a relationship has been irreparably damaged, or where commercially appropriate, a route for brokers to recover their brokerage from reinsureds may now be open.
- Carolyn Haigh is a solicitor in the insurance and reinsurance group at Lawrence Graham.