In this article, we discuss three topical issues affecting the insurance industry.
REGULATORY REFORM TAKES SHAPE
The future shape of insurance regulation in the UK has become clearer following the publication of the latest paper from HM Treasury and a joint paper released by the Financial Services Authority (FSA) and the Bank of England.
Further details on the reform and the eventual structure of the financial services regulatory regime were provided in the latest consultation document and white paper released by HM Treasury on 16 June 2011, entitled ‘A new approach to financial regulation: the blueprint for reform’1. This publication provides the first glimpse of a draft bill that will amend the Financial Services and Markets Act 2000 to bring the government’s proposals into effect. Pre-legislative scrutiny of the bill will begin shortly and is expected to last for 12 sitting weeks. The bill is scheduled to be introduced at the end of this year.
The joint paper by the FSA and the Bank of England, entitled ‘Our approach to insurance supervision’, was released on 21 June 20112. The paper elaborates on the role of the Prudential Regulatory Authority (PRA), the new prudential regulator, in the supervision of the insurance market. It provides much-needed information on the regulation of insurance under the new regime, in response to concerns about a lack of attention and consideration given to the industry in previous government discussions and consultations.
The PRA will be the principal prudential regulator for all insurance and reinsurance companies, the Society of Lloyd’s and Lloyd’s Managing Agents, with the regulation of the conduct of these firms the responsibility of the Financial Conduct Authority (FCA). For insurance and reinsurance intermediaries, Lloyd’s members’ agents and the Lloyd’s broker, the FCA will be the principal regulator for both prudential and conduct matters.
To ensure that there is sufficient insurance focus in the PRA, it is proposed that it will have a statutory ‘insurance objective’, alongside its general objective of responsibility for financial stability through ensuring the safety and soundness of individual firms. In effect, there will be two complementary objectives for the PRA in its role as an insurance supervisor:
- securing the appropriate degree of protection for policyholders; and
- minimising the adverse impact that the failure of an insurer could have on the stability of the system.
The first objective will require the PRA to ensure that the insurers have sufficient financial resources to meet their obligations to policyholders (for example, in the payment of claims). This will be separate from the regulation of interaction and engagement with policyholders, which will be the remit of the FCA. The second objective will focus on insurers who pose a risk to financial stability in the UK, in particular the direct or indirect (via other financial institutions supported by insurers) impact on the UK economy caused by the withdrawal of insurance services.
There are key approaches of the existing regime that are likely to continue, such as credible deterrence and the risk-based approach (which involves increased supervision of firms posing the greatest risk to the UK economy). However, the new regulators will adopt a new judgments-based style of supervision, with a focus on being proactive and forward-looking, and intervening at an early stage.
To assist with the early identification of risk as part of ongoing supervision, it is proposed that the PRA will establish a Proactive Intervention Framework (PIF). The PIF will allocate firms into stages according to the level of the risks to their viability. The PIF is intended to enable suitable remedial action to be taken by firms and allow the PRA to prepare for the resolution of problems in advance. For example, firms that pose a low risk (stage 1 of 5) would be subject to a normal supervisory risk assessment process, whereas firms that pose a material risk (stage 3 of 5) would be required to submit a realistic recovery plan to address specific problems and initiate recovery actions alongside the PRA, who would intensify contingency planning for resolution.
The FCA will also have additional focus on early intervention in product life-cycles through new statutory powers of product intervention. The government believes that this will complement, rather than replace, the current approach to conduct regulation, which focuses on the sales process and product disclosure. The new powers are intended to focus on consumer-facing firms, such as those in the retail sector, rather than those dealing with wholesale and professional customers. To reflect this, the draft bill includes a provision linking the power to the FCA’s customer protection, efficiency and choice objectives, rather than market integrity. The FSA has already provided consultation on the proposed powers ahead of the formation of the FCA with its January discussion paper (DP11/1) and subsequent feedback statement (FS11/3). The FSA and the government have indicated that the power is not meant to provide pre-approval of all financial products. In practice, the FCA will have a difficult task in keeping to this intention, as intervention in the early stages of design, development and management of products will inevitably curb the ability and freedom of firms to develop new, complex and innovative products without first receiving FCA approval.
There will also be a new power for the FCA and the PRA to make directions in relation to unregulated parent undertakings which are financial institutions (with HM Treasury specifying the kinds of financial institutions that are included). The consultation papers suggest that this power will only be used on the rare occasions on which the powers against the authorised entity are ineffective and the activities of the parent undertaking have a material adverse effect on the authorised entity.
In the October 2010 edition of IHL we commented on the impact of the Bribery Act 2010, specifically in relation to the insurance sector. We gave guidance on what readers should be doing, and we looked at specific findings by the FSA in relation to the broker sector.
With the Bribery Act taking effect on 1 July 2011, it is time to revisit the delayed, but nevertheless welcome, guidance published by the Secretary of State for Justice in March 2011 (the Guidance).
Readers should take comfort from the following statement in the Guidance:
‘Rest assured – no-one wants to stop firms getting to know their clients by taking them to events like Wimbledon or the Grand Prix.’
The Guidance notes that to proceed with the general bribery offence in relation to hospitality, the prosecution would have to demonstrate that the hospitality was intended to induce conduct that breached an expectation that a person would act impartially, in good faith or in accordance with a position of trust. The test would be assessed on the basis of what a reasonable person in the UK would think.
In cases relating to the bribery of a foreign public official, prosecutors will have to show that an advantage was offered, promised or given at the official’s request, or with assent or acquiescence. They will also have to prove that the advantage was one that the official was not permitted to receive under local law. Therefore, expediting payments that have some basis in local law may be permissible.
In cases relating to the failure of a commercial organisation to prevent bribery, a full defence is obtained where an organisation can demonstrate that it has adequate procedures in place to prevent persons with which it is associated from committing bribery.
While making it clear that the payment of small bribes to facilitate routine government action can amount to offences under the Bribery Act 2010, the Guidance recognises that, in certain parts of the world, the eradication of facilitation payments will require economic and social progress, sustained commitment to the rule of law, and collaboration between international bodies, governments, businesses and other commercial organisations. This may indicate a degree of flexibility when authorities assess non-material breaches absent knowing culpability.
The Guidance also notes that a public interest test will be considered when deciding whether to prosecute. The more serious the offence, the more likely it is that prosecution will be in the public interest.
Finally, the Guidance sets out six key principles in relation to the procedures that must be put in place by commercial organisations. Procedures should:
- be proportionate;
- be derived from the top layer of management;
- include periodic, informed and documented risk assessment;
- include due diligence procedures, embedding the proper assessment of risk mitigation;
- include proper communication (including training); and
- be subject to continued monitoring and review.
The Guidance is helpful, though it is only as we watch the application of the Bribery Act 2010 in practice that what is permissible will become clear.
European Union Regulation No 961/2010 (Regulation 961/2010), published on 27 October 2010, consolidated the existing sanctions regime against Iranian entities and introduced various restrictive measures, including those in relation to Iran’s access to EU insurance and bonds markets. This includes a prohibition on the provision of insurance or reinsurance to the government of Iran and its public bodies, an Iranian person or entity (other than a natural person), or a person acting on behalf or at the direction of either of these groups. The prohibition applies to all insurance, aside from compulsory or third-party insurance to Iranian persons or entities based in the EU.
In addition to the prohibition of new insurance, Regulation 961/2010 prohibits the extension or renewal of insurance and reinsurance agreements concluded before 27 October 2010 (see Article 26(4)). However, compliance with such existing insurance and reinsurance agreements is not prohibited. In other words, these agreements are allowed to run their course, including in relation to claims payments, to the extent that they comply with the other provisions of the sanctions.
The recent Court of Appeal decision in Arash Shipping Enterprises Company Ltd v Groupama Transport  has provided some guidance on the extent to which the courts will allow a policy to run its course under Regulation 961/2010 where there is a review clause (providing for an automatic right of renewal) in the existing policy. Arash, a Cypriot company controlled by an Iranian entity, was a co-assured on a composite policy of marine insurance covering hull and machinery risks. The assets insured under the policy comprised an Iranian fleet of oil tankers. The policy contained an Iran sanctions clause, which allowed the insurer to serve a notice of cancellation on the assured where:
‘The assured has exposed or may, in the opinion of the insurer, expose the insurer to the risk of being or becoming subject to any sanction.’
It also contained a review clause, which allowed for automatic renewal on unaltered terms, provided that the loss ratios were below a specified threshold.
The issues before the Court of Appeal were:
- Was the renewal of the policy in accordance with the review clause prohibited by Article 26(4)?
- Was the insurer entitled to serve its notice of cancellation, and was such notice effective?
In the court of first instance, Burton J held that, when properly construed, Article 26(4) prohibited all renewals, including those made under an existing right of renewal, and, in any event, the insurer’s notice of cancellation had validly and effectively cancelled the policy.
The Court of Appeal dismissed Arash’s appeal of the first instance decision, agreeing with Burton J that the insurer was entitled to serve its notice of cancellation, and that the notice was effective. As the notice had been effective, the Court of Appeal decided that it was unnecessary to decide whether Article 26(4) prohibited renewal of the policy under the review clause. Although the application of Article 26(4) was not fully considered by the court as a whole, Tomlinson LJ felt it appropriate to indicate his own preliminary view. He agreed with the decision of Burton J on this point and stated that the second part of Article 26(4) (which relates to compliance with existing agreements) was limited in scope as relating to the performance or run off of existing insurance or reinsurance agreements, rather than preserving the ability to enter into a contractual extension or renewal.
The decision by the Court of Appeal reflects the courts’ strict interpretation of the provision of Regulation 961/2010. With more sanctions being introduced in relation to areas of concern, such as Libya and Syria, it is important for insurers to protect their positions in relation to existing and current dealings with susceptible assureds. This may be achieved through the incorporation of sanctions clauses into policies and proper due diligence of assureds. The FSA’s increased interest in how firms are dealing with financial crime, including sanctions, is an added incentive for firms to understand the risks involved and take appropriate measures to combat such risks.