06 June 2016
No one has a clear idea of how the new Insurance Act is going to work, says Anthony Hilton
Whatever he may have achieved in business and politics while he served as right hand man to US President George W Bush, Donald Rumsfeld will probably be best remembered for his comment about ‘known unknowns’. He categorised information into what we know, what we know we do not know and, most crucially, what we do not know we do not know.
This made for an interesting twist on an observation penned more than 100 years earlier by another American, the author and journalist Mark Twain. He suggested that the big problems in life are not caused by the things you do not know – they are caused by the things you did know, but which turned out not to be true.
It seems a bit of a stretch to say that these thoughts come to mind because of the requirements of the Insurance Act, which will come into force in August. There is however a very clear link and one which boards and senior management teams need to be aware of.
The Act is the first significant bit of insurance legislation for a century. By replacing the Maritime Act of 1906, it fundamentally changes the nature of all insurance contacts in the UK, which in turn changes the basis of the relationship between the insurer and businesses.
The Act is completely new and works to different principles so it sweeps away all the legal judgements and precedents that currently govern insurance law and practice. In time, of course, new cases will come to court and test the parameters of the new legislation, but that is for the future.
For the moment, although one can certainly say insurance will never be the same again, no one can know for sure how things will develop. Given that no business can function without being properly insured, this is potentially a big issue.
This fundamental change in the law is about to happen and no one – not the insurance companies, the 3,000 or so insurance brokers who service the business community, or their hundreds of thousands of business clients – has a totally clear idea of how the new system is going to work.
The effect on boards comes from the new obligations on disclosure. The big flaw in the current legislation, at least from the customer standpoint, is the scope it gives insurance companies to wriggle. If there is any breach of the insurance conditions – the basis clauses – even if these had nothing to do with the claim, the insurer can allege that the policy conditions had been breached and the policy is therefore voided.
Though the story may be apocryphal, it is said that an insurance company once refused to pay a claim for flood damage because a fire door had been wedged open in a different factory covered by the same policy. Although in practice things may not have been carried to such extremes, the scope for argument is such that all too many insurance claims degenerate into a legal wrangle, which can take many years to resolve.
The new Act makes it much harder for insurers to wriggle but the quid pro quo is that companies must be much more assiduous in informing the insurer of the risks the business – and therefore the insurers – face.
It sounds only reasonable that the insurer should be fully informed in advance about the risks the firm is taking on but it could prove challenging. Though boards are more preoccupied with risk than ever before, and companies spend far more on risk identification and risk mitigation that they ever have done in the past, it is still not clear whether this activity will yield the required information. For one thing, a lot of risk analysis is related to regulation and corporate governance rather than the commercial activities, which are an insurance underwriter’s primary concern.
Risk managers also frequently lack the internal clout to move horizontally through organisations – a lot of the information is still siloed and therefore not in a form which gives the insurance company what it needs.
However the new law says that everything the buyer knows about risk in the business will have to be disclosed to the insurance underwriter. This covers not only the traditional insurance risks, but all the other stuff thrown up by regulatory requirements, process controls and incentive systems too.
For the insurance to be valid, the buyer also has to disclose risks that the board and management could reasonably be expected to know about, or to have discovered after a reasonable search. This might require an effort to pin down some of Rumsfeld’s known unknowns.
It matters that this is done properly. If a subsequent claim is disputed and litigated – and the board or senior executive team are found not to have collated and passed on the risk information as well as they might reasonably have been expected to have done – they may find the judge declares their insurance invalid.
Given that the whole thrust of governance is towards boards and senior directors being expected to know and understand all the risks in the business, this could be a seriously embarrassing judgement. At the very least the directors’ reputations would be in tatters; at worst it would open the door to them being sued by shareholders.