A Spotlight on Corporate Risk and Insurance

Helen Grimberg on the Mactavish Report and Protocols

A clear understanding of risk, accurately described to a knowledgeable risk carrier who can then correctly price that risk is a paradigm around which every stakeholder in the insurance sector can agree. Yet a report on the corporate insurance market by the Mactavish Group, a research consultancy specialising in risk and insurance suggests that there are a host of reasons why a fog of uncertainty can shroud the best intentions of those looking to place and bear risk.

The report suggests that this results in a collective failure of the market participants to acquire or deliver the product needs of its clients resulting in potential mis-pricing and misunderstanding of  the risk with a grave danger that should the risk crystallise, cover, thought to be in place, is not.

The report – without blaming any group within the insurance industry – paints a picture of significant market failure in the provision of corporate insurance, especially to medium-sized firms at a time when economic drivers have led to substantial remodelling of businesses and significant cash flow challenges. The changes in risk are not perceived as such in a busy commercial environment and the focus is too often on the premium rather than the coverage. The terminology of the transaction is apparently common but the definitions are unique to insurance and not commerce so a dialogue of the deaf ensues with agreement assumed but not in fact achieved – an outcome ultimately to the detriment of all.

The clarity of analysis and depth of research is excellent but the report goes further  suggesting seven areas of reform the "Mactavish Protocols", to address this failure. We endorse those recommendations believing that they would if adopted (and we accept that the horizon for some is distant) serve the insurance industry and its customers well. A better description of risk would mean better (perhaps cheaper) pricing and a focus on risk resulting in better coverage and opportunities for new products for customers. A consequence might also arise of reducing the transactional costs that are associated with the problems of parties trying to define and understand risks thought to have been placed after the contract is formed.

In this article we summarise the report's anatomy of market failure and then respond to the Mactavish Protocols. Even if those protocols do not see the light of day the consideration and discussion of this articulate report can only improve knowledge and understanding and we hope that this article also goes some way to addressing those issues.

"A real threat to UK firms"

What makes the Mactavish report stand out is the depth of qualitative research into the corporate insurance market which it embodies. Throughout the report insightful anonymised quotations from interviews with insurance buyers, brokers and underwriters make the point that the legal framework of insurance law and the trends in the market, are not serving businesses as well as they could but conspire to ensure that risks are not perceived or defined or communicated.

Many of the difficulties stem, it seems, from the fact that insurance law operates on principles which are not intuitive, nor widely known beyond legal specialists. As one Company Secretary of a major manufacturing firm told the researchers: "I've never looked at insurance law myself. I firmly put myself in the category of not having a clue". The report identifies the onerous duty of disclosure as the chief problem leading to firm's policies being ineffective when they bring a claim. It also points out that terminology in insurance contracts may have different meanings to the ordinary meaning of the words in general commercial contracts.

There are powerful justifications for a heavy burden of disclosure falling upon the insured, that are related to the problem of moral hazard. However, given the fact that an innocent failure to disclose a material fact can lead to a policy being declared void – with a firm being rendered uninsured often at the point that it faces a major claim – the insurance industry collectively should, in our submission, ensure that the duty of disclosure is understood by its customers. The figure of 87% of buyers being unaware of the extent of the duty which is cited in the report suggests that more could be done. The report's analysis of the widespread failings in disclosure documents, to identify clearly the risk factors underpinning business's operations, can also be traced back to firms' lack of understanding of the seriousness of the duty to disclose. A lack of careful scrutiny of the disclosure documents prior to a claim, by either brokers or underwriters, also appears to be contributing to the problem. Mactavish do not heap blame on insurers for this: they point out that it is the result of stiff competition where consumers have little means of distinguishing between competing insurance products.

The other broad criticism of the status quo relates to the operation of the market. According to the report, the placement process whereby brokers submit risk to underwriters is a "black box" to buyers, who therefore have little understanding of the options that may be available to them. According to the report a clear majority of buyers, 65%, do not review the submission documents used to place risk, which again raises the likelihood that material risks will not be disclosed. Furthermore, fewer than 2% of buyers apparently review wordings and have a discussion with their brokers about how their policy would respond to various loss scenarios. The information which brokers provide buyers about potential underwriters therefore appears to be limited to information about credit-worthiness, rather than how the underwriter would respond to the claim. Another factor in this complex picture is the role of re-insurers, whom the report claims rarely communicate with the buyer but may play a key role in determining whether a claim will be disputed.

Mactavish fairly point out that insurers are not regularly refusing claims on the basis of poor disclosure, although they do suggest that the avoidance of policies through the courts is on the increase. The main consequences identified by the report are delays in the processing of claims, and refusals by insurers to meet the full amount of the claim. The risk, if the picture that Mactavish paints is accurate, is twofold: damage to the commercial interests of small to medium-sized enterprises and a loss of confidence in the insurance market.

The Mactavish Protocols

In summary, the reforms which the report calls for are the following seven Protocols:

• "Explaining the burdensome nature of the duty of disclosure" and "other tenets of insurance law", including providing buyers with a briefing on developments in case-law.
  
  
• All involved in the process should take steps towards "more forensic risk assessment". This will involve company risk managers or insurance buyers conducting fuller investigations prior to disclosure, with input from operational managers. Secondly, there should be customer review and approval of submissions to underwriters.
  
  
• An "enhanced two-stage tender process" would encourage fuller risk assessment rather than the current single deadline, which the report suggests leads to rushed submissions. A pre-tender submission exercise would allow for a "beauty parade" of shortlisted insurers, and foster a dialogue between buyer and underwriter.
  
  
• Buyers should insist on insurer presentations of risk understanding.
  
  
• Buyers should quantify the financial value of insurance to their business.
  
  
• Insurers should "discuss major loss scenarios", so that a common understanding of coverage may be encouraged at the start of the policy period.
  
  
• "Detailed loss response service elements" should be specified up-front, including information and resource requirements in the event of a claim.

Response to the Protocols

The identification of seven areas whereby the insurance market could be improved is, in our view, a significant step forward. The Protocols are focused on improving the quality of the dialogue between insurers and the insured so that a fuller appreciation and communication of risk may take place. What is so very promising is that reform along these lines would represent a "win-win" for all of the parties involved in the insurance market: firms would find it easier to obtain the coverage they deserve, underwriters would obtain a fuller understanding of the risks which they are taking on, and brokers would be able to offer a richer level of service. For brokers, products based upon implementation of the Mactavish Protocols could allow them to compete on value as well as price.

Although a step forward, some doubts arise about whether, even with fuller dialogue, businesses will be able to obtain security of coverage. For example, discussion of some risk scenarios with insurers may not mean that the actual risk scenarios which materialise will have been contemplated. Secondly, it is not clear that insurers will be comfortable discussing the meaning of policy wordings, given the danger of making misleading representation to buyers. The conclusion might be drawn from this that businesses might wish to obtain some comfort from legal advisors reviewing the terms of policies and the content of disclosure submissions during the course of an extended two-stage tendering process.

The problems of internal risk assessment have also recently been highlighted by a Cass Business School report produced on behalf of AIRMIC ("Roads to Ruin: A Study of Major Risk Events: Their Origins, Impact and Implications"). From case studies of eighteen recent major corporate failures, such as Enron, Northern Rock and the Buncefield explosion, the Cass researchers suggest that failures at board or executive level to understand or respond to risk were a root cause. A particular problem, when considered next to the Mactavish report, is Cass's suggestion that organisational complexity or "glass ceilings" may lead to risks not being communicated through a corporation. Linked to this may be the lower rank of risk professionals within the firm's hierarchy, as a result of which they may feel less inclined to offer independent critique to senior management. This analysis suggests that increased dialogue between insurers and risk professionals or insurance buyers may not always establish the true risks that beset a company unless the broader understanding suggested by Mactavish does become embedded and percolate upwards in some larger organisations.

Despite these doubts the Mactavish Report and Protocols remind us that, as a commodity, the value of insurance to its consumers depends upon the quality of the dialogue between purchasers and sellers. Buyers of insurance, as with any other product, cannot expect to have the optimal insurance to suit their needs unless they become active and informed participants in the formation of their insurance contracts. Implementation of the Protocols, together with a review of their effects, would help empower insurance purchasers to become informed agents in the process.

For more information or to discuss the content of the webcast or article, please contact Helen Grimberg directly at Helen.grimberg@blm-law.com or 020 7865 8473.