Negotiating insurance contracts to protect your business
If these last few months have taught us anything about insurance, it’s the importance of knowing exactly what you’ve bought and where you stand legally when things go wrong – whether it’s ambivalent advice from your insurance broker, a business interruption policy that doesn’t cover your particular business interruption, or a contract with a major customer that imposes insuring obligations on you that you can no longer perform.
In the last decade, there has been a general improvement in the way businesses assess and monitor their risks, leading to better risk retention and risk transfer strategies and, where appropriate, better placement of risks into the insurance market. This is partly due to management boards placing greater focus on risk (the development of enterprise level risk registers being one outcome of this) and partly due to the Law Commission’s drive to get the 2015 Insurance Act onto the statute books. And yet, businesses still complain of inadequate insurance programs, inappropriate policies and contractual wrangles with insurers alleging breaches of insuring obligations resulting in uninsured losses.
At a time of global economic and operational instability, and with business risks seemingly increasing exponentially, this is a totally unacceptable position for any business to find itself in.
So, what is still going wrong and what can be done about it?
Problems with the insurance placement process
Insurance market commentators such as Mactavish and (dare we say) ourselves, have been highlighting the need for a much greater level of technical analysis and legal input into the insurance placement process, to complement the risk management, risk presentation and market access expertise that experienced insurance brokers provide to their clients.
The 2015 Insurance Act demands a fair presentation of a business’ risks to insurers and, in our experience, there are too many examples of this being done in an inadequate fashion. Too much focus is placed on bald numbers rather than the context of risks, too much reliance is placed on undocumented exchanges between insureds, their insurance brokers, and their insurers, and there are too many cases of material errors and omissions. This results in mismatches of understanding between insurers and insureds which, in turn, leads to poor insurance programs with coverage gaps and inappropriate policy terms. Worryingly, when we ask a business for a copy of their insurance submission to insurers, too many of them admit to not having a copy or never having seen one.
It would be all too easy to lay the blame for this at the door of insurance brokers – they, after all, are ‘all things insurance’ in the eyes of most businesses – but this would be unfair for three main reasons. First, subject to an overriding duty to treat customers fairly, insurance brokers tend to do what they have been contracted to do, and are being paid to do, by their clients. Secondly, the engagement of an insurance broker does not relieve a business of its own duty to present the requisite data to its insurers, via its insurance brokers or otherwise, and to respond accurately to questions asked of it by its insurers. Thirdly, many insurance brokers have bent to competitive pressure on their broking fees, making it increasingly uneconomic for some to deliver the depth of service and wider support to clients that they once could.
Problems with insurance policy wordings
Insurance policies are, of course, legal contracts, and comprise their own unique lexicon and their own peculiar forms of conditions, exclusions, and warranties. Unlike most other business contracts, which tend to underpin the profit and loss account of a business, insurance policies are largely designed to underpin the balance sheet of a business i.e. to enable the business to meet a financial loss that it knows it could never afford to meet on its own. An insurance policy is, in essence, a contract of risk transfer, whereby a business transfers the unknown cost of a future adverse event from its own (perhaps modest) balance sheet to the (stronger) balance sheet of an insurer for a fixed price (or premium).
The structure and wording of each policy a business buys is therefore extremely important, and the consequences to a business of a defective policy can be mission critical. You only have to look at the current position with some cyber and business interruption policies to see the immediate and potentially life-threatening pressure this can put on a business. In our view, policies often fail because too many of them are being put in place without scenario testing by independent risk analysts and without the negotiation of customised policy wordings supported by specialist insurance lawyers. In our experience, good insurance brokers welcome such input, as the upside for them is clients with client-focused policies in place and claims being paid. And as few businesses can survive a major uninsured loss, this must be good for everyone.
Insurers are currently under intense pressure due to rising claims, reducing investment returns on reserves, increasing market competition and shareholder scrutiny. Insureds must expect insurers to take an increasingly robust approach to claims and to take technical points on policy wordings that they once might have let go. The Financial Conduct Authority cannot be relied upon to step in and seek retrospective policy ‘interpretation’ which is what they currently seem to be doing with their business interruption Supreme Court test case.
Problems with insuring obligations to others
Many contracts that businesses enter into (with suppliers, service providers, joint venture partners, customers, and others) contain provisions dealing with the allocation and transfer of risk during the period of the contract, and often beyond. These provisions will govern which party is to take out the appropriate insurance to cover the allocated risks, and on what terms.
Too often, these contract provisions are drafted by advisers who do not have the requisite knowledge of insurance law. Consequently, the terminology used is often meaningless or, worse still, plain wrong. So it is common to find nothing specified about important matters such as indemnity limits, maximum excess levels, responsibility for paying and evidencing the payment of excesses and premiums, potential un-insurability of risk issues, potential double-insurance issues, what is to happen if breaches of policy conditions result in no cover, and how policy proceeds are to be applied.
Problems also arise where businesses fail to appreciate the serious implications of using their own insurance program to take on contractual risks. This can, and often does, result in insurers refusing to meet claims arising from the arrangement, and this can have business-wide consequences.
In our experience, there is insufficient legal input from insurance lawyers into the drafting and negotiation of insuring provisions of key contracts, and this is exposing businesses to unmanaged and unnecessary commercial risks.
A three-step solution to these problems
Step 1 – Obtain advice from an insurance lawyer on the terms of engagement of your insurance broker
This is important because it will ensure that your insurance broker is properly instructed to do the job you need doing, as opposed to the job they are offering to do for you. Important provisions are those which seek to limit the brokers liability to you if things go wrong, their transparency of earnings and how matters are to be managed in the event you wish to change broker at some point in the future.
Step 2 – Obtain advice from a risk analyst and insurance lawyer on your insurance policy wordings
This is important because risk analysis and the negotiation of policy wordings will ensure that policies properly correlate to your actual risks, and that any unreasonable conditions, exclusions, warranties and other terms are removed or customised to your needs. Crucially, it will also increase your understanding of exactly what each policy does, and doesn’t, cover.
Step 3 – Obtain advice from an insurance lawyer on the insuring provisions in your business contracts
This is important because it will reassure you that any insuring obligations you take on, not only work, but also sit comfortably with your own insurance program, and don’t cut across any rights of subrogation your existing insurers may have. And where you are the party imposing the insuring obligations on another party, the provisions in the contract give you the means to compel the other party to honour such obligations.
These three ‘simple’ steps should give you the tools to manage your business risks more effectively, and allow you the one luxury every business leader seeks – the ability to sleep easy at night.