Following on from the Global Reinsurance contract certainty panel discussion what does the new code of practice mean for the London market? asks Nigel Allen
"Absolute contract certainty is not achievable," said Steve Hulm, a consultant with the Market Reform Programme Office, at a recent Market Reform Forum in London. "There is no such thing as contract certainty. All we can hope to achieve is more clarity." Hulm's words echo those of Nick Prettejohn, CEO of Lloyd's, who informed attendees at the Global Reinsurance contract certainty panel discussion in October that while the perfect contract was unattainable, what the market could strive to achieve was to "have full and complete agreement at inception".
On 10 October, the Market Reform Group, chaired by Nick Prettejohn, issued the Contract Certainty Code of Practice, coupled with a series of guidance notes and a contract certainty checklist to add flesh to the bones of the process which began on 13 December 2004, when John Tiner FSA chief executive announced in New York that the UK regulatory body was throwing down a challenge to the London market to get its contract house in order by the end of 2006. According to the code of practice, contract certainty is "achieved by the complete and final agreement of all terms (including signed lines) between the insured and the insurer before inception." The code goes on to call for fully agreed wording prior to any formal commitment to the contract by the insurer, with appropriate evidence of cover in place within 30 days of inception.
While all parties to the contract, insurer or reinsurer, broker and cedant, bear a collective responsibility for carrying these requirements through, it is not coincidental that seven of the eight principles (see table on page 15) begin with the word broker. "The onus is on the broker to start the process off on firm footing," stressed Hulm, charged as they are under the first principle with providing submissions that are contract certainty compliant in order to obtain firm quotes.
John Hobbs, director of market services at the International Underwriting Association of London, is convinced that in order to effectively fulfil their role in this process the broker must begin discussions with the client at a much earlier stage than they currently do. While acknowledging that new business will throw up its own problems, "for renewal business, let's start the discussions earlier and get ourselves to a point where we are in a good position to have contract certainty by inception." Duncan Boyle, at the time UK CEO of Royal & Sun Alliance, speaking at the panel discussion, was in full agreement that all parties to the contract should be seated around the table as early in the process as possible. "A bit more planning around moving things back a few months to give us a chance to get information and to get to a point where we actually know what we are talking about at the time of inception is what the guidance really needs to be about," he informed attendees.
"It's about timing and it's about planning," Dane Douetil, CEO of Brit, concurred. "Most of this is about moving the timeline from where we've got it at the moment - which is ultimately that it is in the courts that we get contract certainty whether we like it or not - back to prior to inception and actually educating our clients, our underwriters and our brokers to make certain they plan in advance."
Is the market ready?
Concerns that the London market is failing to adequately appreciate the efforts required to achieve contract certainty by the 2006 deadline are unfounded believes John Hobbs. "Every firm has been asked to nominate its board level sponsor, every firm has been asked to nominate a project manager," he said, "and without exception all of the firms, whether they be IUA, Lloyd's or broking firms, have done that."
To further ensure that the steps necessary to meet the 2006 deadline are being taken, following the release of the Contract Certainty Code of Practice, checklist and guidelines, chairman of the Market Reform Group, Lloyd's CEO Nick Prettejohn, called for a market-wide show of hands by requesting that each firm confirm that they have formally adopted the definition and principles of contract certainty at board level.
The timeframe targets laid down by the code for the extent to which contracts should have achieved certainty as defined above are clear. By the end of 2005, 30% of monthly volume in the market will be contract certain, rising to 60% by the end of June 2006 and to 85% by the end of 2006. The Market Reform Programme Office is charged with the task of informing the FSA on a monthly basis on the extent to which the market is on track to meet these targets.
In terms of conducting these measurements, the office has two channels of information. The first is the LMP slip. However, Steve Hulm is quick to point out that LMP slip compliance is not the end of the story. "You can have a perfect LMP slip and still not have contract certainty," he says, adding also that much of the business, which comes into the London market, does not come in on LMP slip.
The responsibility for compiling data on the progress of individual companies falls to the broker. This is unsurprising given their overview of the market. Information provided to the office will include data on contract volume, the percentage achieving contract certainty and the percentage of those contracts evidenced within 30 days of inception.
Concerns that brokers will be charged with fingering individual companies in the market for their failure to comply are unfounded, as all of the information compiled will be presented at an aggregate level to give the FSA a view of the market in its entirety. "But that doesn't mean that individual companies do not have the responsibility for keeping their own statistics," Hobbs warns. "At any point the FSA could challenge any one of those companies, be they brokers or carriers, to see what their respective position is."
Each organisation is responsible for its own performance to the FSA, states the code of practice, and as such, it must collect and store all data relating to contract certainty for each individual contract. In order to help companies assess levels of certainty for individual contracts, the Market Reform Group has also issued a checklist, which details both pre-inception and post-placement requirements, plus a series of six primary attributes of contract certainty. These are:
- Is the submission clear and unambiguous?
- Is law and jurisdiction and arbitration clearly referenced and complete?
- Are all terms clear and unambiguous?
- Are all duties clearly allocated, including processing of contract changes, document production and claims processing?
- Is any supporting information clearly referenced?
- Is the submission compliant with regulatory requirements?
This checklist, coupled with the code of practice and guidelines, have served to allow organisations to solidify their strategies for achieving contract certainty, believes Hobbs, "and if the FSA comes to ask them questions they will be able to answer with some confidence and demonstrate what they are doing."
Furthermore, it should be noted that companies will also be required to expose their failures in reaching satisfactory certainty levels. To this end companies are being called upon to undertake steps to ensure that those contracts of which they are aware that certainty has not been achieved are taken apart in an effort to ascertain why this specific contract failed and to consider measures which can be taken to avoid this.
A model approach
The issue of bespoke versus standardised wording and the extent to which increasing the degree to which contracts are framed using standard wordings will be at the expense of the flexibility and entrepreneurial nature of the London market, which many believe has allowed it to become such a renowned repository of the most diverse of risks, has split the market. Duncan Boyle is convinced that the market is guilty of over-bespoking. "One of the problems that we have is that everybody in the market may feel they want to get a competitive edge by bespoking wordings down to a fine detail, and that's part of what causes a lot of the problems around getting the contracts out in a timely fashion. John Muir, senior partner and contract certainty business project sponsor at Willis, however, while agreeing that the market needs to improve its ability to deploy model wordings believes it is imperative that "we retain the entrepreneurial capability to draft and craft wordings to satisfy our clients."
Contract certainty is not about eliminating bespoke wording, but if such certainty as defined by the code of practice is to be achieved within the limited timeframe imposed, then it is clear that having a model wording structure upon which to frame the contract prior to inception, is essential. "Standard-based wording will help us get there," believes Douetil. "What we're trying to say is let's start with certainty and move to a bespoke contract. At the moment we start with a blank piece of paper and then desperately try to fill it up with bespoke clauses. So you can get to the bespoke - you may not get there at inception - but you can continue to negotiate afterwards and, by agreement, change it to a bespoke wording." As Nick Prettejohn put it, let's at least have a wording in place "around which we can have a dispute, rather than going through some sort of post-event kind of archaeological exercise to reconstruct what we think the wording might have been."
A question posed by one of the attendees at the contract certainty panel discussion in October was whether or not achieving contract certainty would be at the expense of the market's ability to service clients seeking "last minute" cover. John Hobbs is of the opinion that it will still be possible for the broker to tackle late orders if model wordings are used. "It may be that with the use of model wordings one can achieve the position where perhaps 85% to 90% of the client's requirements can be met by inception." The remainder, he added, apologising for using such a simplistic example, can be agreed later and put in place by way of endorsement. "The client can still end up with the cover and there was certainty at the time of the contract all be it that there might not have been to the extent of the cover that the client and the broker were desirous of getting at that point."
This does raise the issue of the importance of establishing an adequate library of wordings for the market. While Xchanging offers a market wordings repository a number of practitioners believe this is insufficient and overly cumbersome for the job in hand. "This will be an area that will be looked at as the issue of model wordings develops," assures Hobbs, "and people start to think more along those lines."
A further issue raised by Andrew Hobson, a partner at Reynolds Porter Chamberlain, is whether any potential pressure placed on the market to implement model wording might be deemed counter to EU competition laws. Model wordings he argues have the potential to reduce flexibility for the purchaser, likening it to buying a suit off the rack but no longer being able to get one tailor made. As the EU continues its investigation into anti-competitive practices, will they turn their attention to contract certainty?
The achievement of certainty of wordings will also have clear implications for the role of the wordings technician. A rather shy, retiring creature which some in the London market believe has become extinct, the wording technician will be expected to play a much more prominent role in the contract process. "Rather than providing a checking role at the time of the placement or even after," says John Hobbs, "they will actually be involved in the process ahead of the insurer putting their line down." Going forward the technician will be required to play much more of a supportive role in relation to the underwriter.
A firm quote
Another question that has been posed is at what stage in the quoting process do the contract certainty requirements kick in? Ask a broker and an insurer when a quote can be deemed to be a firm or legally binding quote and you will probably get two different answers. As Steve Hulm suggests, put the question to a broker and they will likely respond that they consider the quote legally binding even if there is no scratch. Pose the question to an insurer, and their view will probably be that only when they have put their scratch down are they bound by the quote. Further adding to the confusion, introduce a lawyer to the discussion and they will probably say it depends on how the quote was phrased.
In its comments on the issue of firm and indicative quotes, the contract certainty guidance reads as follows:
"A firm quote should be given only where the insurer has ensured that the submission meets the contract certainty definition. An indicative quote may be given where the submission is not compliant or has not been checked, but rework will be reduced if all submissions are checked prior to quotation. An indicative quote supported by a follower may, if they have so specified, become firm once the leader has changed his indicative quote to a firm quote or bound line."
However, there is no uncertainty as to when the quote must be contract certain. "If you are providing a quote which is legally binding then it must be contract certain," says Hulm. This obviously has workload implications for the broker in their efforts to check that contract certainty has been achieved, as there may be five or six quotes to be assessed.
So what is contract certainty designed to achieve? "It's about really replacing an inefficient system with an efficient system," believes Patrick Devine, a partner in the regulatory group at Reynolds Porter Chamberlain. "It's about accelerating certain processes that traditionally have taken place after inception of the risk and bringing them forward to the front end and loading the task and the work up front."
As Nick Prettejohn explains, the hidden costs of the lack of contract certainty are massive. Citing the fact that the London market spends some £500m per year on outside advisors, with the majority going to lawyers in relation to claims adjusting, Prettejohn also highlighted the costs of E&O exposure, of misallocating capital and of mispricing the insurance product itself. "I mean what more costs do you need to convince you that this is an important economic issue, and therefore for us to invest, whether it's in technology or training or whatever it is, to be able to solve the issue, strikes me as being a pretty critical and pretty obvious investment that we need to make."
Duncan Boyle perhaps put it most succinctly when he said, "It's not about computer systems, it's not about bureaucracy, it's actually just about basic cultural discipline and process that we need to bring into our companies, and we all need to do that."
A full transcript of the Global Reinsurance "Countdown to contract certainty" panel discussion is available at www.globalreinsurance.com
Contract certainty principles for the London market
1. Brokers will provide submissions that satisfy the contract certainty definition and checklist to obtain firm quotes and place firm orders.
2. Each insurer will be satisfied that the submission meets the contract certainty definition and checklist before formally committing to the contract, ensuring that any conditions or subjectivities are clearly expressed.
3. Brokers will notify all terms to their client and obtain their client's agreement before inception.
4. Brokers will calculate signed lines by inception and notify them to each insurer no later than 30 days after inception date, or by inception date on request.
5. Brokers and insurers will not take part in post-inception over-placing.
6. Brokers and insurers will ensure that post-inception amendments are documented and agreed as endorsements.
7. Brokers and insurers will each collect and maintain data on their contract certainty performance at individual contract level.
8. Brokers and insurers will ensure that appropriate evidence of cover, including security, is issued within 30 days of inception.
- Nigel Allen is editor of Global Reinsurance.