Although the courts are often at pains to point out that insurance law is merely a subset of general contract law and should be applied without any concession or discrimination simply because the subject matter is insurance, there are, in fact, several aspects that are peculiar to insurance. An understanding of these anomalies will assist in penetrating the sometimes arcane depths of insurance law. They include:
- the payment of brokerage and premium;
- secret commissions;
- the status of warranties and conditions;
- the role of the broker;
- consequential loss;
- the Block Exemption Regulation; and
- the courts’ attitude towards insurers in the interpretation of their contracts.
BROKERs AND PAYMENT OF BROKERAGE AND PREMIUM
Given that the broker acts primarily for the insured, and owes them fiduciary duties in the negotiation and placement of their insurance, it is counter-intuitive to suggest that they are remunerated by the insurer (in a manner rarely transparent to the insured). Nevertheless, the proposition that the insurer is responsible to the broker for the payment of their brokerage for introducing the insurance business to them (in the absence of an agreement to the contrary) is generally accepted judicially, although never conclusively decided.1 Lloyd’s also take the view that the insurer or reinsurer is liable to pay brokerage.2
The liability for the payment of premium is clear in all marine insurance. Section 53 of the Marine Insurance Act 1906 provides that the broker is directly responsible to the insurer for the premium payable for marine insurance, although the insurer is directly responsible to the insured for claims and (perversely) for any returnable premium.
This section codified the practice whereby an insured required an additional period of time to pay the premium, but the Lloyd’s marine underwriters were only prepared to extend credit to the person with whom they were actually dealing, ie the broker. This practice gave rise to the extraordinary fiction that the broker pays the premium to the insurer who then loans it back to the broker, who then owes it to the insurer. It has also not been judicially conclusively decided whether the broker placing any insurance at Lloyd’s is liable for the premium, because historically the only way to a Lloyd’s underwriter was via a Lloyd’s broker, but it now seems that this is not true.3
Thus the broker is paid by the party to whom they should be in an adverse negotiating position and in respect of marine insurance to whom they are directly liable for the premium. It is also true that an insured is fully entitled to an indemnity for an insured non-marine loss, even though they have not paid the premium, unless such payment is made a pre-condition of liability, because the consideration for the insurance is the liability to pay the premium. Non-payment is simply a breach of a contractual term, which is not necessarily repudiatory. Another anomaly is that insurers usually agree with brokers that the payment of a premium by the insured to the broker constitutes good payment to the insurer, but that the payment of a claim by the insurer to the broker does not constitute good payment if the broker becomes insolvent before remitting the claim to the insured.
CONTINGENT COMMISSIONS: there and back again
Contingent commissions are payments by insurers to brokers calculated according to the volume of business placed and are often given a veneer of legality by being dressed up as valid payments for services carried out by brokers for insurers, such as for general administration (eg the storage of documentation shown to the insurer on placing), processing premiums, processing claims (eg the collection and disbursement of claims, instructing and liaising with solicitors, adjusters and surveyors, and circulating their reports) and marketing (eg supplying information to underwriters, such as policy development, and general and local market developments and information obtained by the broker).
Notwithstanding the enquiries engendered more than five years ago by Eliot Spitzer as New York State Attorney, the fact that the Financial Services Authority (FSA) has not (then or since) mandated any substantive obligations in this regard means that the issues of broker remuneration and inducement have not gone away. European risk managers view a recent US legal ruling as paving the way for all brokers to resume taking contingent commission payments on insurance contracts and several global brokers have been negotiating with various US state regulators to reinstate the collection of contingent commissions.4
The existence of any contingent commission, however, is rarely disclosed to the insured, so that it could, in certain circumstances, amount to a secret profit, contrary to the fiduciary obligations of the broker. A secret profit becomes a bribe if it has been paid by a third party (ie to the contract of agency) to the broker. It has been judicially stated that there is an irrebuttable presumption that the agent is influenced by any bribe and the motive for payment is irrelevant, even where the agent has acted in the best interests of their principal.
It is, however, clearly absurd to suggest that the mere fact that an underwriter is technically liable for the payment of brokerage to the broker to secure the introduction of the principal’s business to the underwriter is sufficient to turn the commission into a bribe simply because that payment is made by a third party, although this may be true if the brokerage agreed by the underwriter is so high that it cannot be interpreted as anything else. There are several older cases that indicate that it is perfectly acceptable for brokerage to be paid by the other party to the contract, so that this technicality can be ignored.
Thus even without the consent of the insured, in the right conditions contingent commissions can be justified legally, which is why they remain available despite the furore. If, however, the broker receives an agreed fee from the insured and a profit commission from the insurer, they should properly inform the insured because they are clearly being paid by both parties, which cannot validly occur without their consent. In the absence of the insured’s informed consent, the broker is clearly making a secret profit, with potentially extremely adverse consequences.
The FSA has not mandated specific rules on contingent commissions, but has categorised the voluntary code prepared by various insurance trade bodies for commercial customers as Industry Guidance. This indicates that intermediaries should consider whether a relationship with a party other than the commercial customer has influenced the advice to the commercial customer in arranging insurance or in the selection of the insurer, and that it is the duty of an insurance intermediary to manage conflicts of interest so that the intermediary’s interest does not conflict with the interests of commercial customers and of any insurers on whose behalf they may act, either by disclosure or withdrawal from the engagement. An insurance intermediary must decline to act for the commercial customer unless, in the particular circumstances of the case, disclosure and informed consent are sufficient to resolve the conflict.
The Association of Insurance and Risk Managers (AIRMIC) also broadly supports the industry guidance, but believes that more detail is required, and has prepared standard letters for intermediaries that set out earnings, capacity, services and a disclosure checklist.5 In March 2010 Lloyd’s set out requirements for the reporting of fees paid to brokers, including a provision for managing agents to disclose to the corporation’s management ‘any arrangement for amounts paid, for any reason, to any intermediary that is not disclosed on a slip’.
The FSA (also in March 2010) introduced final rules for ‘adviser charging’, which means that firms should be paid by retail charges that they have set out upfront and agreed with their clients, rather than commissions set by product providers (including ‘soft’ commissions, paid in non-monetary forms), reflecting the services provided to the client, not the particular product provider or product being recommended. These rules apply to pensions and life products, and they do not allow adviser firms to receive commissions offered by product providers, even if they intend to rebate these payments to the client.
The broker can therefore receive a contingent commission without necessarily breaching their agency obligations to the insured at common law and only since March 2010 have they been subject to any regulatory obligation to disclose such commission.
REVERSAL OF STATUS OF WARRANTIES AND CONDITIONS
The status of conditions and warranties in mainstream contract law is reversed in insurance law. Thus breach of a condition sometimes gives rise to a right to terminate the contract if the breach is repudiatory (eg an unambiguous intention not to pay any premium) and accepted as such, but more usually only to a remedy in damages, while breach of a warranty automatically terminates the contract from the date of breach unless waived.
The benchmarks of a warranty include whether:
- it goes to the root of the transaction;
- it is descriptive of, or bears materially on, the risk of loss; and
- damages would not be a satisfactory remedy for breach.6
A warranty usually confirms:
- that a state of affairs exists;
- that it will continue to exist;
- that it will exist in the future; or
- the converse, ie that something does not exist.
A condition can be ‘pumped up’ by the insurer simply by converting it into a condition precedent, which does not require any damage. The mere breach of it is enough to provide the insurer with a remedy. As if the breach of condition or warranty were not enough, the insurer also has the benefit of the (otherwise rarely applied) duty of good faith, whereby the insured is obliged to reveal all facts that the insurer might consider material to their assessment of the risk, with a failure to do so enabling the insurer to rescind the contract. The Consumer Insurance (Disclosure and Representations) Bill (the Bill) will change this, but its passing by Parliament has been interrupted by more pressing business.
ROLE OF THE BROKER
The broker is the agent of the party seeking insurance and they must not allow any other duty to conflict with their obligations to their primary principal. In some circumstances, a broker may act in a dual capacity as agent for both the insurer and the insured, eg where the policy provides for notice of the claim to be given to the broker, who would owe a duty of care to the insurer to inform them of the claim, or where the broker is entitled to issue cover notes for temporary insurance on the insurer’s behalf. If a conflict is perceived to exist, the broker must obtain the principal’s fully informed consent to the broker acting in a dual capacity. In Anglo-African Merchants Ltd v Bayley  the court stated that:
‘Such a relationship with the insurer, inevitably, even if wrongly, invites the suspicion that the broker is hunting with the hounds whilst running with the hare… a custom will not be upheld… if it contradicts the vital principle that an agent may not at the same time serve two masters two principals in actual or potential opposition to one another: unless, indeed, he has the explicit, informed consent of both principals.’
It has been recognised by the Court of Appeal that some functions carried out by the broker do not sit easily within the general principle that the broker is the agent of the insured, but there is surprisingly little comment on dual agency in the case law, given the roles that brokers often assume.7 What little comment exists is limited solely to the issue of the premium fiction in marine insurance and does not consider other aspects of dual agency. In this respect they have been regarded as irrelevant to non-marine insurance.8 The Law Commission is also considering the impact of the broker’s status when receiving material information from the insured for disclosure to the insurer. The Bill fails to make any change to the proposition that information passed to a broker is not deemed to have been received by the insurer.
Consequential loss is in most cases a (secondary) financial loss that arises from, or following, a primary event of a physical nature. Loss of profits, for example, is clearly a consequential loss.
So why is its meaning in the world of insurance different from that of commerce? The short and obvious answer is that there may be more than one (generic) meaning of ‘consequential loss’, and that it will not always be possible to rely on judicial comments in previous cases without ensuring that the contractual and background matrices are compatible with the problem under consideration.
Another reason why consequential loss has a different meaning is that insurance is primarily a matter of contract in which the insurer agrees to insure against something specific, so that insuring a property against material damage is not at all the same thing as agreeing to indemnify the property owner against all loss arising out of that damage, unless that loss is an insured peril (eg fire or business interruption, which always requires material damage before it can apply) or an all-risks policy. Loss proximately caused by an insured peril is directly covered, but anything else is not and any consequential damage is caused instead by the loss of the insured subject matter, not the operation of the peril. A consequential loss is usually a different type of loss, eg pure economic loss, and occurs at a later date. An alternative reason might simply be that consequential loss is excluded as a result of a term implied in a property damage contract as a result of market custom and practice. All this adds up to the fact that it is not necessary, whatever its underlying rationale, for an insurer to exclude cover for consequential loss. It is excluded unless specifically covered.
There is, however, another anomaly of insurance law that could operate to the benefit of the insured. As a matter of ‘normal’ contract law the injured party must mitigate to recover. In insurance law the insurance is in place specifically to protect the insured against the effects of their own negligence and a failure to mitigate if negligent may well remain covered.
In State Of Netherlands v Youell & ors the insurers attempted to defend a claim under a shipbuilding insurance policy on the grounds that the insured was in breach of the duty to mitigate. The Commercial Court applied standard rules of causation in determining the scope of the duty and held that the duty to mitigate would only be breached if the insured’s conduct or inactivity was so significant that it displaced the prior insured peril as the proximate cause of the loss. The court added that a breach of the duty to mitigate was unlikely to afford a defence to insurers as the conduct or inactivity that became the proximate cause of the loss could itself amount to a separate insured peril, under the cover given for negligence in many standard forms of policy. This will be a question of the wording and the facts, but it might be thought that the liability of the insurer has to end somewhere, rather than extend to any loss and then to a line of further negligence by the insured. If such further negligence is covered, it would be in breach of any express and implied ‘obligation’, and it might therefore be thought that the insurer would be entitled to deduct any loss that it has suffered from a failure by the insured to comply with that express or implied term. As a matter of policy, a court might treat such an exclusion as contrary to the ethos of insurance, but the doctrine of fundamental breach no longer exists and so a clear wording restricting the rights of the insured should, in theory, be upheld.
The short answer is that if the further negligence is causally connected to the loss and is not therefore a novus actus interveniens, and it is negligent, ie not wilful or reckless, there is a good chance that it will be covered unless it is specifically restricted by the contract.
BLOCK EXEMPTION REGULATION
The subscription market, whereby individual risks are pooled among many insurers, is cost-effective and highly efficient if the terms of the policy are consistent, without the time-consuming need to address and negotiate every term individually with every underwriter. Until 1 April 2010 the insurance industry benefited from a Block Exemption Regulation from the European Commission, which allowed policies to be written on standard terms and a premium set by the leading underwriter. Its renewal no longer included this concession, so that insurers will have to self-assess their competition compliance, which may result in higher costs for the industry and this may well be passed on to insureds.
COURTS’ ATTITUDE TOWARDS INSURERS IN THE CONSTRUCTION OF THEIR CAREFULLY CRAFTED CONTRACTS
The courts have set their collective cap firmly against insurers, who should have the incentive and resources to clarify their wordings, particularly given the usual absence of material input to any drafting from the insured. Thus: ‘If necessary… in case of doubt, one should construe an insurance policy in favour of the insured.’9 Similarly:
‘It is more important to reinforce the message that insureds are entitled to clear wordings and to the benefit of any ambiguity…. If any insurer does not like our decision, it can for the future formulate its policies differently, provided that it makes its intention clear.’10
- Accepted judicially in Pryke v Gibbs Hartley Cooper Ltd  1 Lloyd’s Rep 602. However, there is some inconclusive case law to the contrary, eg Carvill America Incorporated & anor v Camperdown UK Ltd & ors  EWCA Civ 645.
- See draft decision paper headed ‘Grossing up and Net Equivalent for Lloyd’s Regulatory Board’, 25 July 1994 (para 2.6(a)).
- See Pacific & General Insurance Co Ltd v Hazell  LRLR 65.
- See People v Liberty Mutual Insurance Company  52 AD 3d 378, 379.
- Association of Insurance and Risk Managers Guidance ‘Transparency, disclosure and conflicts of interest in the commercial insurance market’.
- See HIH Casualty & General Insurance Ltd v New Hampshire Insurance Company & ors EWCA Civ 735.
- Recognised in the Court of Appeal byChapman & Co Ltd v Ve Ticaret  EWCA Civ 400 and in Heath Lambert Ltd v Sociedad De Corretaje De Seguros & anor  EWCA Civ 792. The broker can be personally liable to the insured, see Punjab National Bank v de Boinville  1 Lloyd’s Rep 7.
- See Goshawk Dedicated Ltd & ors v Tyser & Co Ltd & anor  EWHC 461 (Comm).
- See Hawley v Luminar Leisure Ltd & ors  EWCA Civ 18.
- See Dodson v Peter H Dodson Insurance Services (a Firm)  EWCA Civ 320.