A new set of guidelines for reinsurance purchasing practices may help reduce litigation in the future.
Reinsurance has a way of fuelling court disputes like few other industries, and many of the cases will centre around very detailed technicalities that have little application outside the specific case in question. Occasionally, however, a judgment will be made that potentially has large ramifications for the industry and its conduct – the pay as paid issue springs to mind, for example. A recent House of Lords decision in the UK about the role of a reinsurance broker may be one such case.
The case revolved around a reinsurance contract placed by broker Johnson & Higgins (J&H) with Bermuda-based Aneco Reinsurance in 1989. According to Andrew Symons, a partner at London law firm CMS Cameron McKenna that acted on behalf of Aneco's liquidators, Peter Mitchell of PricewaterhouseCoopers and Chris Hughes, said the ruling was the first successful claim of its type against a reinsurance broker. The action arose out of a reinsurance contract J&H placed with Aneco, he explained. J&H also advised Aneco on the availability of reinsurance for Aneco's exposure, but negligently advised that reinsurance was available at a certain price when, in fact, it was not. J&H knew that Aneco was not prepared to accept the inwards contract without reinsurance in place, said Mr Symons, and the reinsurers subsequently gave notice of avoidance, exposing Aneco to a series of catastrophic losses, including Hurricane Hugo and Exxon Valdez.
Having gone through arbitration in the early 1990s, the case went to trial in 1997. At that point, the commercial court ruled J&H had been negligent, and awarded Aneco damages equal to the voided reinsurance protection, a total of $12m. Aneco appealed the decision, arguing that its exposure under the inwards reinsurance contract was up to $60m, and that it would not have entered into the inwards reinsurance if J&H had not misrepresented the contract. The court of appeal agreed with the argument, awarding the full $60m in damages, and this decision was upheld by the House of Lords in October.
“In future, brokers will have to pay more attention to how they report back to their clients,” said Mr Symons. The case reinforced the requirement that brokers are under a duty to report back their findings when placing business; in the J&H case, the extensive paperwork from the reinsurance placement showed that the broker had not disclosed material facts to the coverage.
New scale of damages
This type of dispute is not new. The level of damages is, however, and serves as a warning. As Mr Symons pointed out, “Most London market business is just placed, with no written retainer agreement. We may start seeing broker retainer agreements,” as a result of the case.
In fact, these agreements may come about sooner. At the same time as the ruling was being issued, the City Disputes Panel (CDP), a London-based dispute resolution service, published guidelines for reinsurance purchasing practices, following concerns over the reinsurance industry's image. Areas of concern included:
In addition, there had been a general impression that the reinsurance sector had too frequently entered into ‘expensive and protracted' litigation, to the detriment of policyholders. Although US reinsurance intermediaries are regulated under the Reinsurance Intermediary Model Act of 1993, no similar legislation exists in the UK, and neither had best practice been adhered to across the industry.
“This is a serious attempt to resolve the problems which have arisen through a lack of candour, misunderstanding in the process, and a lack of clarity,” commented Anthony Gambardella, a partner in US law firm Rivkin Radler LLP which worked with UK law firm Norton Rose to draw up an independent ‘due diligence' questionnaire based on the findings of the report. “The questionnaire is to be used in the purchase of reinsurance to move the parties to an understanding of what their roles will be.”
By using the questionnaire, brokers and reinsurers are less likely to become embroiled in litigation, said Stephen Smirti, also a partner at Rivkin Radler. “Litigation should be the last alternative – the questionnaire is a way of recognising that these are the upfront questions to ask of a reinsurance intermediary.”
The questionnaire is a six-page document covering a number of areas, including expertise and experience, service provided and standards, conflicts and confidentiality, security, general practice, and compensation arrangements. It was developed on the back of the CDP report, but included input from Rivkin Radler to reflect the international nature of reinsurance business. As Susan Dingwall, a partner at Norton Rose, commented, “The report is released hard on the heels of the collapse of the Independent Insurance Co. Allegations have been made that reinsurance may have been purchased without the full knowledge of the board of directors. If those allegations are true, it reinforces the need for reinsurance buying to be in the domain of a senior defined committee including executive and non-executive board members who are not involved in the transactional side of the business.”
This was one of many comments made by the CDP panel members, Paul McNamara, a partner in Ernst & Young, Peter Downey, former chairman and CEO of Cologne Re London, and Sir David Calcutt, former chairman of the Takeover Panel. Initially, the panel sent questionnaires to a number of individuals and organisations in the UK, US and Bermuda re/insurance industries – though no re/insurance intermediaries were included in the questionnaire – and followed it up with interviews. Responses gleaned from the exercise resulted in a 21-page document outlining the perceived problems within the industry. In opening the section on causes of disputes, the panel noted, “There is an increasing willingness in society today to litigate; the insurance industry is no exception.... It is therefore all the more necessary that all the parties to insurance and reinsurance contracts are clear as to their responsibilities. It is a regrettable result of this social change that the long-established principle of ‘utmost good faith' is now seen as a slogan rather than a reality. Whilst the principle still remains a cornerstone of the insurance law, future practices must recognise that the interpretation of the meaning of good faith is shifting.”
One of the areas of dispute highlighted to the panel were problems with misrepresentation at time of placing business. “The arguments about misrepresentation are not always sound but frequently driven by a desire to minimise the extent of loss on a contract by trying to rewrite the terms of the risk as management of a reinsurer would have wished them to be,” according to the panel. “The increasing pressure for bottom line performance by London market insurance entities may well exacerbate this trend.”
Other causes of disputes identified by the panel included late supply of wordings by brokers, poor performance standards, incomplete placing information to following underwriters, and inconsistencies in documentation.
Specifically within the reinsurance market, the panel perceived that the relationship between reinsurer and broker was not necessarily a “long standing” association, as it is often characterised, but it is often notable by “a high degree of opportunistic purchasing, particularly in soft markets. The opportunistic purchasing is essentially driven by price and thus a commoditisation of the product.” Lack of long-term relationships can equal an increased potential for disputes, decided the panel, resulting in higher costs and greater uncertainty over whether there has been an effective transfer of risk. “We do not offer any solution specifically for the increased risk arising from opportunistic purchase, except to emphasise that where such purchasing occurs there is an even greater need to ensure that there is adequate explanation of the risks being reinsured and that there is not reliance on sorting out the extent of the coverage later, if needs be,” commented the panel.
It also criticised the standards of professionalism within the reinsurance intermediary industry, commenting, “the image of the broking industry has unquestionable suffered from the impression that the overwhelming objective of a broker is to generate commission income,” an impression not necessarily far from the truth in certain cases. “We consider that there have been and continue to be various manifestations of business practices which are indicative of poor adherence” to the objective of minimising reputation risk. “In particular, we are concerned as to the continued evidence of churning. This was most prevalent in the case of the LMX spiral but we believe that there have been subsequent manifestations.”
Compensation arrangements also came in for the panel's scrutiny, and it noted the general agreement that for large commercial risks, brokers should be remunerated more on a time/fee basis rather than through commissions. “Such a trend increases transparency and helps to associate remuneration with service performance and value,” commented the panel. “This change in the remuneration basis should be coupled by more specific terms of engagement than has been customary in the market if misunderstandings and disputes are to be avoided. This would be a cultural change for all parties,” but would be a further protection against drawn-out and expensive litigation as characterised by the J&H case.