'Conflict of interest' and the FCA business interruption review

Some sectors have fared better than others, whether because they were well-suited to the disruption or because they managed their reputations in such a way that they could be said to have had ‘a good pandemic’.

But the insurance industry is certainly not among them.

Indeed, the damage done to insurers’ reputations may have long lasting effects on the way in which companies and individuals approach risk transfer.

According to a McKinsey report, 60 per cent of small to medium-sized enterprises surveyed feel their insurers were not transparent over how Covid-19 would affect their policies.

One third say they are likely to stop buying business interruption cover altogether.

Ultimately, if policyholders do not believe that claims will be settled, they will not be willing to pay the premiums that keep insurers in business.

What is the current situation?

Put simply a great many businesses bought cover for issues such as business interruption - that they believed would cover them for pandemic related losses – only to find that insurers took a very different view.

Even before the lockdown took effect, the Association of British Insurers asserted: “Irrespective of whether or not the government orders the closure of a business, the vast majority of firms won’t have purchased cover that will enable them to claim on their insurance to compensate for their business being closed down by the coronavirus.”

Before long, pressure groups of small business owners were established to help pursue what they saw, and still see, as valid claims. It was at this point that the FCA got involved and published a plan to seek High Court declarations on a number of policy wordings.

The idea being that the declarations, while not binding, would help bring an early conclusion to disputes between insurers and policyholders.

Are these claims valid?

Broadly speaking there are three groups of claimants.

Put simply a great many businesses bought cover for issues such as business interruption - that they believed would cover them for pandemic related losses – only to find that insurers took a very different view.

Firstly, there are those who believe they explicitly bought cover (under business interruption and other classes of insurance) with the intention of insuring losses accruing from widespread outbreaks of infectious diseases such as Covid-19.

Secondly, there are many companies who did not intend to buy any such cover and were not given it.

But there remains a sizeable number who bought related cover extensions where the intention to cover pandemics may not have been explicit and where the insurer did not necessarily intend to include it, but the policy does not clearly exclude it.

The detail of these extension wordings and each client’s circumstances vary widely. The picture is clearly not as simple as the ABI suggested. 

It’s important to bear in mind that the intentions of both insurers and policyholders are not material to the FCA’s case.

As far as the courts are concerned, the insurance is either there in a given policy wording or it is not.

Unfortunately, these cases are not straightforward and each policy is, in effect, a tangled web of duties and obligations.

Understanding the complexities of business interruption insurance

Business interruption is a particularly complex area and a good example of the coverage uncertainty which affects many other classes of insurance.

Typically, coverage for pandemic related losses in these policies is included in extensions concerning infectious diseases or denial of access – albeit often with a sublimit covering a fraction of the losses most businesses are currently facing.

Despite that, those companies that did buy such extensions may find in the weeks and months ahead that they have a battle on their hands when it comes to recouping Covid-19 related losses, even within those sublimits. 

As far as the courts are concerned, the insurance is either there in a given policy wording or it is not.

Mactavish has analysed a large number of policies and found that, although Covid-19 business interruption cover does exist in some cases based on proper policy analysis, there are multiple additional barriers to a successful claim which must be analysed carefully – from causal analysis of actual business losses, geographical proximity of known cases and the specific types of diseases included by the policy to ‘wide area loss’ principles impacting cover for large-scale events like the current crisis.  

These barriers will not be obvious to most policyholders who, as non-specialists, are unlikely to have fully understood the nuances encapsulated in the policy.

It will be particularly galling for companies in this position to find that some infectious disease wording explicitly rules out ‘new’ diseases or global pandemics as opposed to localised outbreaks, yet they do provide cover for diseases such as cholera and bubonic plague.

Further, some property damage business interruption policies have extensions based on one narrow definition of ‘notifiable disease’ but exclusions in other sections based on a much wider definition of the exact same term.

This is far from clear and transparent to the policyholder, or indeed to anyone who isn’t extremely well-versed in insurance law.

Sadly, these issues are not specific to Covid-19; they have merely been made more prominent by it.

Mactavish’s own research suggests that 45 per cent of major claims are disputed, they take an average of three years to settle, and the typical settlement value is just 60 per cent of the amount claimed for.

Disputes have become the modus operandi of the industry.  

Will the FCA’s action settle the issue?

>Business interruption is a particularly complex area and a good example of the coverage uncertainty which affects many other classes of insurance.

The approach taken by the FCA is laudable. The declarations the courts make will provide a legal basis for speedier and less costly settlement for many policyholders.

However, in isolation, it will not solve the problems in their entirety, and we fully expect Covid-19 related disputes to roll on through the months and years ahead for two primary reasons.

Firstly, the FCA has limited its attention to just one class of insurance: Business Interruption.

While this is the class that most claims will fall into, it is not the only place in which related cover can be found, and even within BI the FCA case addresses only some of the coverage questions noted above.

This means that there will be a raft of similar potential claims that will be unaffected by the court’s declarations.

Secondly, and more importantly, the action is limited to an examination of the validity of claims based solely on the policy wordings.

This, in isolation, will not get to the heart of what has gone wrong in the industry over the last two decades.

Opaque policy wordings, confusion on the part of the buyer as to what is covered, and cosy relationships between insurers and brokers are all part of a broader set of structural issues that the FCA needs to get a much firmer grip on. 

Most important among these systemic problems is the role of the insurance broker.

This seems to us to be a major omission on the part of the FCA, and at the end of May we addressed a letter to them outlining our concerns in this area. 

In theory, brokers play an essential role in advising clients on what insurance to buy, who to buy it from, when they have a valid claim and how to go about managing it.

They are the intermediary that clients turn to for guidance; guidance that they are dependent on precisely because insurance contracts are now so difficult to understand. 

It is our view that policyholders who believed they had valid cover in place may well decide that the broker has either failed to place it as instructed or has failed to communicate the limitations inherent in the policy wordings they have been offered. In such cases they could accuse their broker of giving them poor advice or even, in some cases, of mis-selling. 

Similarly, if a client has been advised that they do not have a valid claim only to find that the High Court (or a legal ruling from a similar dispute) proves otherwise, they may seek indemnification from the broker.

We can see no good reason why the FCA could not have sought similar declarations on test scenarios involving broker negligence. Far from being theoretical problems, Mactavish has discussed exactly these types of errors and omissions with many policyholders over recent weeks.

A conflict of interest

The role of brokers becomes even more complex when one considers the way in which they are remunerated.

The approach taken by the FCA is laudable. The declarations the courts make will provide a legal basis for speedier and less costly settlement for many policyholders.

In a study we published in May this year, we built on the FCA’s own data to demonstrate that some brokers receive up to 80 per cent of their revenue from insurers and only 20 per cent in direct fees from clients.

As the British Insurance Brokers’ Association stated in response to our report, “Brokers are the agent of the client as well as the insurer and one of their fundamental roles under the Insurance Distribution Directive is to act in their customer’s best interests – which is exactly what they do”.

The obvious question is, ‘what happens when the interests of those parties come into conflict?’

It is difficult to imagine another sector in which an intermediary would be able to derive most of its income from one side of a financial or legal dispute, yet be completely certain that it always serves the interests of the other.

Yet this is the norm in the insurance industry.

Even worse, many of the arrangements broking houses have with insurers actually incentivise them not to act in the best interests of policyholders.

Firstly, the income they derive from placement of risks is often linked to the value of the premiums placed: as premiums increase, they stand to earn more.

Secondly, and incredibly, brokers often engage in ‘profit-sharing’ agreements with the insurers they place business with, meaning that any successful claims made by their clients will reduce their share of the revenue. 

This is not an issue of brokers mixing commission and fee income – it is a far more complex web of opaque payments which drives the more serious conflict.

Some of the arrangements go even further.

In some cases brokers themselves provide the policy wordings which are then underwritten by the insurers in return for an agreed volume of business.

In those instances, the broker is really acting as a distributor for the insurer, rather than as an agent for the insured.

In fact, several such broker defined and branded wordings are being looked at it in the FCA’s action, but this nonetheless stops short of looking at the role brokers played in how those policies were presented and sold. 

It is difficult to imagine another sector in which an intermediary would be able to derive most of its income from one side of a financial or legal dispute, yet be completely certain that it always serves the interests of the other.

Put simply, this isn’t enough.

The FCA has permitted the insurance industry to adopt a business model which is riven by potential conflicts of interest and that seems to use complexity as a weapon with which to beat policyholders.

If the regulator stops short of a thoroughgoing investigation of the entire picture it will not get to the heart of what has truly gone wrong here and it will not answer the essential question of why so many policyholders believe they have cover when so many insurers believe they do not.

The result will be the continued decline of an industry that was once a jewel in the crown of British business.

Rob Smart is the technical director at Mactavish