Our analysis of key legal developments in the insurance industry over recent months.
In this edition of Insurance focus, Laura Hodgson casts an eye over the Law Commissions’ proposals to reform insurance contract law in the United Kingdom and questions whether they should be of any interest to insurers based in other jurisdictions. In addition, Noleen John focuses on the Retail Distribution Review and its impact on the payment of commission. From our Milan office, Salvatore Iannitti assesses the potential effect of two major packages, aimed at liberalising the Italian economy, on insurers in the region.
This edition also contains two articles considering tax law reform. From our Hamburg office, Uwe Eppler looks at suggested changes to German insurance premium tax law and, from London, Andrew Roycroft reports on the evolution of the controlled foreign company regime.
In our case notes section, we examine several recent cases of interest including Jeremy Paul Egerton Hobbins v Royal Skandia Life Assurance Ltd and others  HKCFI 10, in which the High Court of Hong Kong confirmed that commission paid to an insurance broker by an insurer does not constitute an illegal secret profit unless it is in excess of what is normally paid within the insurance market. We also include updates on regulation and insurance related developments from across our international practice.
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Cutting the Gordian knot - removing the complexities of UK insurance contract law
Many people working in the London insurance market have been keeping an eye on the progress of the Law Commissions’ (of England and Wales and of Scotland) proposals to reform insurance contract law in the United Kingdom. Although obviously a matter of importance to the London market, should these reforms be of any interest to those outside the UK? Laura Hodgson suggests that the proposed changes should not be overlooked in terms of their international significance for the insurance market. Given the size of the London market (the third largest in the world, the largest in Europe and with 28 per cent of UK net premium coming from overseas), understanding the UK changes may be an essential part of legal risk planning for international business.
The current proposals for reform to insurance contract law in the UK (this article will limit its discussion to the law of England and Wales) have in part been prompted by international pressure. It has been argued by proponents of law reform that a modernised insurance contract law will better equip the UK Government in any negotiations held in Europe about the introduction of an optional European insurance contract law. As the law currently stands, the UK may have limited capacity to persuade European colleagues to adopt principles found in our national law. In an increasingly globalised commercial market, the current law with all its complexities and uncertainties can fail to meet the expectations of both policyholders and insurers, potentially damaging the UK’s position as a favoured jurisdiction for insurance disputes.
So, what is wrong with the current law? In short, some argue that it is archaic, overly complex in some areas and can be harsh on the unwary insured. Furthermore, the letter of the law differs considerably from market practice - especially for consumer insurance where regulation by the Financial Services Authority and the decisions of the Financial Ombudsman Service often mitigate the sometimes draconian outcomes of the law.
The progress so far
The Law Commissions began their review of insurance contract law in 2006. The Commissions’ published a series of issues papers to consider the main areas of the current law that were thought to be problematic. Areas included misrepresentation and non-disclosure, the status of intermediaries, warranties, insurable interest, damages for late payment, post-contractual good faith and the requirements contained in statute for a formal marine policy.
The Consumer Insurance (Disclosure and Representation) Bill
Following public consultation on the issues suitable for reform, the first Bill was laid before Parliament in December 2009. This Bill addresses the law of misrepresentation and non-disclosure in consumer insurance policies (the Consumer Insurance (Disclosure and Representation) Bill).
The Bill tackles the long criticised application of the principle of utmost good faith in consumer policies. The Marine Insurance Act 1906 (MIA), which applies in certain areas to non-marine insurance, requires prospective insureds to volunteer information about the risk that they are seeking insurance for. Essentially, MIA requires insureds to disclose those “material circumstances which would influence the judgement of a prudent insurer in fixing the premium, or determining whether he will take the risk”. Failure to do so can allow the insurer to avoid the contract. Similarly, MIA allows the insurer to avoid where the prospective insured has made a material misrepresentation. At present, there is no obligation in law for the insurer to ask for information about facts they wish to know in order to underwrite.
The Bill changes the nature of the parties’ pre-contractual negotiations so that insurers are obliged to ask those questions about the risk they wish to know. In response, consumers will be under a new duty to take reasonable care to answer the questions asked by the insurer fully and accurately.
Where a consumer has made a mistake in answering the insurer’s questions, the Bill makes a distinction between “careless” and “deliberate or reckless” misrepresentations; innocent misrepresentations have no negative consequences for the insured. The remedy which an insurer will have available to him in the event of a misrepresentation will depend upon what the underwriter would have done had they had the information when underwriting the risk.
The Bill received Royal Assent on 8 March 2012, and should come into force in a year’s time.
Consultation on post-contractual duties
In December 2011, the Commissions began the next stage of the reform process by publishing a consultation on post-contractual duties. The consultation covers insureds’ remedies for late payment, insurers’ remedies for fraudulent claims, the nature of insurable interest, and policies and premiums in marine insurance.
Damages for late payment
The normal position in general contract law is that where one party suffers loss because the other party has failed to meet its contractual obligations, the innocent party may claim damages for consequences suffered (Hadley v Baxendale (1854) EWHC J70). The English courts have, however, held that insurance contracts fall outside of this rule. In English law, an insurer is not liable for any loss caused by its delay or failure to pay a valid claim. This is based upon the legal fiction that the insurer’s contractual obligation is to prevent the loss occurring (or to “hold the insured harmless”), rather than to pay out a claim. As a result, claims money is considered to be damages. Where payment is late, there can be no remedy (other than interest on the amount outstanding) as English law does not allow damages for late payment of damages (as decided in The President of India v Lips Maritime Corporation (The Lips)  AC 395).
The Commissions believe that there is a strong case for reform and their main proposal is to re-characterise the insurer’s primary obligation not as a duty to prevent loss but to pay valid claims after a reasonable time. At the same time, the Commissions accept that insurers require enough time to investigate claims fully. For business insurance, an insurer should be able to use a contractual term to limit or exclude its liability to pay damages for late payment, provided that an insurer acts in good faith. Conversely, in consumer insurance, insurers should not be able to exclude liability for failure to pay valid claims within a reasonable time.
Insurers’ remedies for fraudulent claims
Fraudulent claims are a serious and expensive problem and the law is currently unclear as to the penalties for fraud. Since the nineteenth century, the courts have recognised a common law rule that a person who fraudulently exaggerates a claim forfeits the whole claim. The rule is, however, inconsistent with the duty of utmost good faith set out in section 17 of MIA. Section 17 states that the penalty for failing to observe good faith is avoidance of the contract ab initio. This means that, in theory, insurers could require policyholders to repay all claims already paid under the policy, including genuine and legitimate claims paid before the fraud arose.
To address this confusion and to ensure that the UK has a robust and clear approach to insurance fraud, the Commissions propose a number of changes. Statute should clarify that a policyholder who commits fraud should forfeit the whole claim to which the fraud relates. Further, the policyholder should forfeit any claim which arises after the date of the fraud. However, the fraud should not affect any previous valid claim where the loss arises before the fraud takes place, whether or not the claim has been paid. The insurer should also have a right to claim the costs reasonably and actually incurred in investigating the claim, provided that these costs are not offset by savings from legitimate, forfeited claims which have occurred after the fraud.
The Commissions provisionally propose that in commercial contracts, express fraud clauses setting out remedies should be upheld, provided that they are written in clear, unambiguous terms and specifically brought to the attention of the other party.
In English law, contracts of insurance require the insured to have an “insurable interest” in the subject matter of the policy. Put simply, the insured must stand to gain from the preservation of what is insured or suffer a disadvantage from its loss or destruction. For insurance to be valid, the insured must possess an interest capable of being insured. Unfortunately, the English law of insurable interest is not particularly straightforward and has been described as “a confusing and illogical mess” with definitions and requirements scattered across legislation and case law. The nature of the interest, when it must be shown and the consequences of not possessing an interest vary depending upon the type of insurance concerned, whether marine, indemnity or life (and other non-indemnity policies which the Commissions label “contingency”).
A number of commentators now question whether the requirement for insurable interest - originally introduced as a concept to protect against gambling - retains any practical merit. In Australia for example, legislation has removed the need for insurable interest altogether. Nevertheless, a majority of respondents to an earlier issues paper published by the Commissions were in favour of retaining the concept in the UK to ensure against moral hazard, especially in life insurance. There was also strong support for revision of the law as it stands to meet modern commercial expectations.
The Commissions’ proposals for indemnity and “contingency” insurance differ. For indemnity insurance, the Commissions propose to provide a clear statutory basis for the requirement of insurable interest, and clarify that the insured must have an interest at the time of the loss. Further, they propose that a policy will be void unless there is a real probability that a party would acquire some form of insurable interest at some stage during the duration of the policy. The consultation considers whether a statutory definition of insurable interest would be of benefit.
For life and other forms of “contingency” insurance, the Commissions suggest that the current law is unduly restrictive. For example, whilst people can insure the life of their spouse (or civil partner) for an unlimited amount, they cannot insure the life of a cohabitant, child or parent. Policies can also be based on the fact that the insured will suffer financial loss on another’s death, but this is restricted to “a pecuniary loss recognised by law” (and requires a legal right to payment).
The Commissions propose a new statutory requirement for an insurable interest for life policies, which will replace that in the Life Assurance Act 1774. This would state that without an insurable interest, a policy is void but not illegal (as it is at present). The Commissions’ main proposal is to widen the test of economic dependency. They propose that it will be sufficient for there to be a real probability that the proposer will retain an economic benefit on the preservation of the life insured, or incur an economic loss on death. The new test will enable people to insure the lives of family members where they are dependent on them and would suffer a loss if they died.
The Commissions also suggest that parents should be entitled to take out insurance on the life of a child under 18. In addition, cohabitants should be entitled to insure each other’s lives without evidence of economic loss if they have lived in the same household as husband or wife (or as civil partners) for at least five years before the policy is taken out.
The remaining proposals in the Commissions’ latest consultation are on anomalous aspects of the law relating to marine policies. One area is the requirement for all marine insurance contracts to be “embodied in a marine policy”. Without a policy, the insured will have no evidence of the contract and therefore will not be able to make a claim. The requirement, contained in section 22 of MIA, dates from a time when stamp duty was imposed upon all marine policies. This was abolished in 1970 and the formal requirement for a written policy as evidence of the agreement is widely ignored by the market. The Commissions propose removing section 22 and leaving the form of policies to the market and regulation.
In addition, the Commissions propose to reform section 53(1) of MIA which currently makes brokers, rather than policyholders, primarily liable to the insurer for the payment of marine premiums.
Reform in a global context
Reform of English insurance law and the form it will take will be relevant to any commercial business insuring in the UK. London is a major international centre for commercial insurance and reinsurance, not least in terms of marine underwriting. Some elements of insurance contract law in the UK currently fail to meet the demands of the modern market, but the proposals set out in the latest consultation aim to ensure that the UK remains a suitably flexible and commercial jurisdiction for international underwriting.
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Making headway - is it finally time for reform in Italy?
2011 closed with a bang in Italy, both from an economic and political perspective. In the last few weeks of the year, interest rates on Italian bonds rose dramatically and Mario Monti, a well known professor of economics and former member of the European Commission was called in to lead a new Government. Monti stated that his mission as Prime Minister would be to promote the passage of reforms, which he believes necessary to reduce public debt and stimulate growth in the Italian economy. A combination of factors, including pressure from international financial markets and the huge backing which Monti’s Government enjoys from Parliament, has led onlookers to believe that Italy will finally implement reforms which have been on the table for years. Salvatore Iannitti considers the impact of the reforms on the Italian insurance market.
Mario Monti has already demonstrated that he is not going to waste any time in implementing reform. His Government has already finalised two major packages aimed at liberalising the Italian economy (the Liberalisation Decrees). In relation to the insurance sector, the Liberalisation Decrees focus on credit insurance and motor third party liability insurance, two sectors in which consumers are traditionally considered to be in a weakened bargaining position when compared to both banks and insurance companies.
Reforms relating to credit insurance
The Liberalisation Decrees closely follow a number of rules issued by the Italian market regulator (ISVAP) over the past two years, which were primarily aimed at reducing the commission paid to intermediaries. Back in 2010, ISVAP introduced a new rule requiring the disclosure of commission in policy documentation and another establishing the insured’s right to be reimbursed part of the premium upon early redemption of a loan. More recently, having ascertained that the average level of commission is still very high (in certain cases around 80 per cent of the premium) ISVAP enacted stronger measures relating to conflicts of interest. As of 2 April 2012, beneficiaries under a policy cannot, directly or indirectly, through an affiliated company or commercial partner, be intermediaries of the product.
Consumer associations in Italy are supportive of the new ISVAP rules. Monti’s Government, at the suggestion of the antitrust authority, has now decided to push for further reform aimed at increasing competition in the bancassurance market, where it is believed that borrowers may still feel compelled to purchase policies mediated by the lender.
According to the first of the two Liberalisation Decrees, a bank or financial institution will be committing an “unfair commercial practice” if it conditionally agrees to the grant of a loan (including consumer loans and mortgages), which is dependent upon the purchase of credit insurance from the same organisation. Consumers ought to be free to “shop around” for the best price and conditions before purchasing the required policy.
The second of the Liberalisation Decrees introduces a new obligation under which banks and financial intermediaries will have to provide a client with at least three quotations for life insurance, when the policy is prerequisite to the grant of a mortgage or consumer loan. Two of the quotations should be provided by insurers who do not have a contractual relationship with the intermediary and do not belong to the same group. In addition, banks and financial intermediaries will be required to accept an insurance policy procured by the client, provided that it meets certain minimum requirements, which will be set out by ISVAP in a specific regulation. The last rule, in particular, appears to represent a concrete step towards reducing the premium paid by consumers and effectively opens the market for policies connected with loans and mortgages to new players. Whilst many have welcomed the reforms, some have suggested that the rule should be wider in scope. It is currently limited to the sale of life insurance in connection with mortgages and does not, for example, extend to buildings insurance.
Although discussed by Parliament prior to ratification, Italian legislators have, at least for the time being, abandoned plans to follow the United Kingdom in implementing a point of sale prohibition which applies to the sale of payment protection products at the same time as the credit agreement.
Reforms relating to motor third party liability insurance
The Liberalisation Decrees contain a number of measures aimed at: (i) reducing the high premiums for motor third party liability insurance, which are typical in the Italian market, especially in the Southern regions; (ii) increasing competition in the distribution of motor third party liability insurance; and (iii) protecting insurers against fraud.
The measures are as follows:
- When the insured agrees to the installation of a “black box” (at the expense of the insurer) or a pre-contractual inspection of the vehicle, then they will be entitled to a “material” discount on the price of the premium.
- The insurer has the right to suspend payment of the indemnity to the injured party if, applying the guidelines published by ISVAP, there are good reasons to suspect fraud.
- Paper insurance certificates must be converted to electronic documents, which will be registered in the police database so as to allow them to identify vehicles without compulsory public liability insurance cover (estimated at nearly 3.5 million vehicles).
- Insurers must provide ISVAP with an annual report listing fraud committed against them and the measures they have adopted in order to prevent fraud. There is a risk that this measure will be recognised as being in the public interest and, therefore, applicable to European Union insurers operating in Italy.
- An insurance intermediary must provide a client requesting motor third party liability insurance with information on the premiums and conditions applied by at least three different insurers, and if this is not done, any policy sold by the intermediary will be null and void. At present it is unclear whether the provision will be solely applicable to Italian intermediaries or whether it will apply to all insurance intermediaries (including those from the EU). It is also difficult to conclude whether the provision introduces an obligation to submit three different quotations to the client.
- Only physical damage that can be objectively measured by medical equipment (no matter how minor) will be indemnified by the insurer.
Whilst the reforms introduced by the Liberalisation Decrees aim to increase efficiency and competition in the market, they will initially require insurers and intermediaries to review their business model and sustain material costs in order to comply with the new statutory requirements, an exercise which they have been forced to do several times in the past few years.
Only time will tell if the costs relating to this review will be compensated by an actual increase in efficiency and competition.
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Following the trail - where does the RDR leave payment of commission?
In June 2006, the Financial Services Authority (FSA) launched the Retail Distribution Review (RDR). One of its aims was to remove commission bias from the sale of investment products to retail clients. FSA research had found that as commission was paid by the insurer it was not clear to clients that they were paying for advice relating to their investments. The RDR rules will come into effect at the end of 2012. The changes will include a ban on the payment of commission and rules preventing product provider involvement in setting adviser charges. Noleen John discusses the effect of the rules.
The ban on the payment of commission will apply to advised sales (those involving a personal recommendation) of a retail investment product to a retail customer (consumers and relatively small businesses). The ban will cover all life policies aside from pure protection contracts. It will therefore still be possible to pay/receive commission in relation to pure protection products, whether sold under the FSA’s Conduct of Business Sourcebook (COBS) or Insurance: Conduct of Business Sourcebook (ICOBS). Commission can also continue for retail investment products (other than certain group pensions products) sold without advice and for legacy business (ie business issued prior to the implementation of the RDR - which can include new members joining an existing pension scheme). Other consequential effects are that rebates from product providers, factoring or indemnity payments, and soft commission will be banned.
The rules made by the FSA to implement the RDR refer to the fees that will be paid by clients following the ban on commission as “adviser charges” or in the case of group personal pension or stakeholder arrangements (collectively known as GPPs), “consultancy charges”. The adviser firm can set its own adviser charges, provided that they are agreed with the client. A client will still be obliged to pay the charge even if they decide not to accept any of the adviser firm’s recommendations.
Consultancy charges in connection with GPPs are to be agreed with the employer, rather than individual pension scheme members. Notably, they cannot be charged where an employee elects not to join the pension scheme after they have received advice. The employer may pay a fee in relation to GPPs instead of consultancy charges. If no fee is paid, then the employer and the adviser need to agree the consultancy charges in respect of the advice or services which are to be provided.
In determining the level of adviser and consultancy charges, a firm should have regard to the “best interests” of the client or the employer/employees (as appropriate). The FSA’s new rules will require adviser charges for similar (“substitutable”) products to be the same, and going forward ongoing adviser charges must relate to services provided (or to regular premiums) - although there will be an exemption for ongoing trail commission on products sold pre-RDR. The rules also provide that there should be no product bias in favour of products with ongoing charges, unless these products are in the client’s best interest.
The charges must be set out in writing and in good time before the advice or services are provided and the language used must be clear. The total amount of charges payable to the firm (or its associates) must be disclosed in cash terms. The charges may, with the client’s written authority, be deducted by the product providers from the underlying product.
Adviser charging needs to be transparent in order to work. The FSA has specifically stated that advisers recommending their own products, or distributor influenced funds, will not be able to continue to receive other income streams for acting in connection with these products. The FSA will require a clear separation between advice charges and product charges and any cross-subsidisation should not be significant in the long term. As well as avoiding inducements that do not explicitly enhance the service given to customers, firms will need to ensure that their staff remuneration policies do not result in product bias.
Now that the deadline for RDR implementation is approaching, focus has shifted to some of the more practical issues. For example, providers will still need to pay commission on existing business and may be “facilitating” (ie deducting adviser or consultancy charges from new products). There are, however, potential issues where action is taken in relation to existing contracts. The FSA recently issued PS12/3 Distribution of retail investments: RDR Adviser Charging - treatment of legacy assets, which gives an insight into some interesting problem cases. It reminds firms of the basics of the RDR, namely that adviser charging and consultancy charging will only apply where a personal recommendation (or in relation to GPPs, advice/services) is provided after 31 December 2012. Consequently, the RDR will not affect charges not covered by the new regime (eg where there is no advice). The FSA has also stated that where advice is given that will not affect existing commission arrangements, adviser charging will only apply to the new advice. Interestingly there also appears to be a benefit for unit-linked insurance contracts as trail commission can continue where advice in relation to a unit-linked fund switch takes place.
The result appears to be as follows:
Situations where commission can continue to be paid include:
- non-advised sales (other than new GPPs);
- sales of pure protection products (whether under COBS or ICOBS);
- products existing pre-2013 where no new personal recommendations are made;
- trail commission on pre-2013 sales where an ongoing service is provided and there is disclosure to the client; and
- trail commission following advice in relation to fund switching of a pre-RDR unit-linked insurance contract.
Situations in which adviser charging would be required:
- personal recommendations made post-RDR on a pre-RDR product; and
- where a client appoints a new adviser post-RDR (however, trail commission on pre-RDR business may be re-registered and offset against adviser charges provided that it is disclosed and relates to an ongoing service).
Finally, the FSA still appears to be of the view that firms should not renegotiate existing commission and replace it with a similar level of adviser charging - presumably because they do not want historic commission levels to influence adviser charges agreed with clients. This is likely to cause practical difficulties for providers, resulting in the need to run two different systems, potentially in relation to the same product, based on whether or not advice has been given. Hopefully, once the new regime is established the regulator may be prepared to take another look at this aspect of the RDR.
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Taxing offshore profits – the ‘controlled foreign company’ story continues
The current United Kingdom Government has acknowledged the importance of having a corporate tax regime which is competitive with those of other major jurisdictions, or at least one which is not significantly less competitive. It has reduced corporation tax rates, and introduced an exemption from corporation tax on non-UK branch profits. These measures build on the corporation tax exemption for non-UK dividends which was introduced by the previous Government, albeit in part because of concerns about the compatibility of the UK’s pre-2009 regime (which taxed non-UK dividends but exempted dividends from UK companies) with European Union law. These changes left outstanding one aspect of the UK’s regime for taxing so-called ‘foreign profits’ – the controlled foreign companies (CFC) rules. These rules require a UK company to pay corporation tax on the undistributed profits of certain overseas subsidiaries which are based in certain low-tax jurisdictions. Andrew Roycroft discusses the CFC rules, one of the tools which HM Revenue & Customs (HMRC) has historically used to counter arrangements involving offshore captives.
The direction of reform – only taxing “artificially diverted” profits
The CFC rules are one of the more complex parts of the corporation tax regime. They can be arbitrary in their application, and have been the subject of challenge under EU law. The Government’s announcement that it planned to refocus these rules on countering the artificial diversion of profits from the UK was a welcome development. It took initial steps in that direction in the Finance Act 2011, dealing with some of the easier issues such as profits from “foreign to foreign” trading transactions. Those reforms were only ever intended to be a temporary measure, with “full reform” promised for 2012. This provided some breathing space to consider the more difficult issues surrounding how to apply the regime to intangible and financial assets held offshore, which are perceived to pose the greatest risk to the UK tax base.
Behind the scenes, HM Treasury and HMRC have been conducting extensive consultation with interested businesses, particularly those in the insurance, banking and pharmaceutical industries who are most directly affected by the CFC rules. Creating a set of rules which only apply to “artificially diverted” profits has proven to be difficult. Although draft legislation was published in December 2011, with further detail provided in January and February 2012, there is widespread acceptance that a great amount of work remains to be done to meet the deadline for reform. Further detail is expected when the Finance Bill is published on 29 March 2012 and so the new regime continues to evolve. The new rules are expected to come into force in January 2013.
The Insurance industry – captives, reinsurance and offshore insurance companies
For the insurance industry, a key concern is that the rules should not prevent legitimate insurance arrangements with offshore captives or reinsurance arrangements.
As far as captives are concerned, the current proposals are to limit the CFC charge to profits of the offshore captive which arise from insurance contracts with a UK taxpayer. It could be argued that these contracts represent a potential risk to the UK’s tax base, if premiums on the contracts do shift profits outside the scope of UK tax. There are already limits on such profit-shifting, including the transfer-pricing rules. However, HMRC and HM Treasury do not accept the argument that the transfer-pricing rules provide a sufficient safeguard against profit-shifting. Accordingly, the new CFC rules will potentially apply to the captive’s profits from insurance contracts with UK resident companies which are connected with the captive (unless the insurance is for the purposes of a tax-exempt branch). They will also potentially apply to its profits from insuring a UK branch of a non-resident company which is connected with the captive.
Premiums from other UK residents (eg, individuals) will only be taxable if the insurance relates to the provision of goods or services by or to that UK resident. Where the captive is based in a Member State of the EU or the European Economic Area, the CFC rules will only apply to its profits from the contracts if there is no “significant non-tax reason” for entering into the insurance contract in question. This is presumably designed to reinforce HMRC’s belief that the new regime will be compatible with EU law, a point which can be debated at length. A captive’s profits from reinsurance contracts should only be caught by the new CFC rules if the reinsurance is of a contract to (ie, the underlying insurance contract is one to) which the CFC rules would apply.
Although much of the focus has been on captives, there are other issues for the insurance industry, including whether the changes are sufficient to make the UK a more attractive location to establish a holding company of a group which carries on insurance business elsewhere in the world. Whilst a number of insurance groups – notably AON - have announced that they are moving (and, in some cases, returning, to the UK), some aspects of the new regime remain unclear. Perhaps the most significant is how the rules will exclude offshore insurance businesses from the scope of the CFC rules.
The proposal so far is to achieve this by means of a “capitalisation” test, which will limit the CFC charge to those profits of a UK company’s CFC which are attributable to that CFC having “free capital” or “free assets” in excess of the amount which it would be “reasonable to suppose” the CFC would have had if it were not controlled by any person. This test does not discriminate against CFCs which enter into reinsurance contracts, so a CFC should not automatically fail this test in respect of profits from reinsurance transactions. Even if the CFC has such excess free capital or assets, the profits attributable to them will only be subject to a CFC charge if the free capital or assets are attributable to UK ‘connected’ capital contributions – broadly, contributions to the CFC’s capital by UK resident companies which are connected with the CFC. This test may be supplemented by a “safe harbour”, which will entirely exclude from the CFC regime the profits of a CFC which carries out certain types of insurance business. The terms of the safe harbour have not been published, and are the subject of ongoing discussions between HMRC and the insurance industry.
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Increasing the burden - draft legislation on Insurance Premium Tax
The German Ministry of Finance recently published draft legislation proposing changes to German insurance premium tax (IPT) laws. The aim of the changes is to tackle certain structures and products that have a negative impact on German IPT revenues, as well as to broaden the tax basis in relation to non-European insurers covering risks in Germany. Consequently, the proposed new rules will lead to an increase in the burden of German IPT for a number of insurance products. They will also impact co-insurance products. The German Ministry of Finance is aiming to introduce the new rules with effect from 1 January 2013. Uwe Eppler considers the impact of the proposed new rules.
Multinational insurance programmes
Multinational programmes will be affected by the potential application of IPT to policies written by insurance companies resident outside the European Union and the European Economic Area. If the insurance relates to a German entity or a German permanent establishment, liability to German IPT will be triggered. Under the current rules, IPT is only due if the risk insured is located in Germany, or if the policyholder is resident in Germany.
For example, where a non-German policyholder holds liability insurance under a multinational policy with a non-European insurer, the liability insurance will cover the risks of a Germany affiliate or a German permanent establishment. This cover is currently outside the scope of German IPT. Under the new rules, German IPT would be due.
Reinsurance for surety insurances
Reinsurance is not subject to German IPT. The proposed rules introduce a new definition of the term reinsurance, which makes it clear that there has to be a primary insurance policy. This proposed change aims to make reinsurance of so-called surety insurances subject to IPT.
It is not clear whether “surety insurance” qualifies as insurance for IPT law purposes, or as a mere financing transaction. The German Federal Ministry of Finance, as well as the Fiscal Court of Munich, has taken the view that surety insurance is not insurance. Hence, the IPT exemption would not be available for reinsurance of surety insurance as there is no underlying insurance policy. The decision of the Fiscal Court of Munich has been appealed and is currently pending at the German Fiscal Court of Finance.
The proposed legislation implements the view of the German Federal Ministry of Finance, so that reinsurance of surety insurance is subject to IPT.
In the German insurance market, so-called insurance packages are currently offered to customers, which combine IPT exempt insurance with insurance subject to IPT (e.g. travel health and travel cancellation insurance). The German Federal Court of Finance decided on 13 December 2011 that in order for the IPT allocable to the health insurance not to be subject to IPT, this part of the premium has to be expressly shown and allocated to the health insurance element in the policy.
The proposed rules go beyond this decision. Relief from tax will only be available if there are legally separate insurance policies. The proposed rules contain a list of requirements for this to be the case. If implemented, this law will require insurers to un-bundle their existing insurance packages.
Currently, German IPT law allows either one of the co-insurers (usually the leading insurer) on a policy to pay IPT on the total insurance premium, or for each co-insurer to take responsibility for the payment relating to its part of the co-insurance premium. The draft legislation proposes the abolition of this option and obliges one of the co-insurers to be responsible for the payment of the total IPT.
Furthermore, if the responsible co-insurer is not an EU-resident, or does not have a branch office in the EU, it will have to nominate a representative to take care of payment of IPT. This representative must be resident or have its seat or a branch office in the EU or the EEA.
The co-insurer responsible for the payment of IPT, or where applicable, the representative will be liable for IPT relating to the total insurance premium.
Reporting, invoicing and documentation
The draft legislation proposes that IPT returns can be filed electronically with the Federal Central Tax Office as an alternative to filing signed hard copies. This simplification of filing processes will be advantageous for insurance companies.
However, the reduction of bureaucracy is accompanied by increased obligations in relation to invoices and requirements for insurers to maintain adequate internal documentation. There are currently no formal requirements for IPT invoices. In the future, invoices will have to include the following information:
- Amount of IPT.
- IPT rate.
- IPT number.
- Applicable IPT exemption (if any).
The German Insurance Association (GDV) has already published its opinion on the draft legislation, objecting to several of the proposed changes. It remains to be seen to what extent the proposed changes will actually be implemented. Given the GDV’s criticism, it is likely that the draft rules will be submitted to the German legislature in a revised form. A representative of the Federal Ministry of Finance, for example, has already announced that the proposed changes for compulsory motor insurance, which introduced a taxation of deductibles as constructive insurance premiums, will be revised.
More generally, the IPT treatment of multinational policies is a complex issue in that various jurisdictions are currently looking to see if they can tax such arrangements to the extent that they cover domestic risks. Insurance companies looking at such policies should consider carefully whether they will be exposed to IPT and, if so, in which jurisdictions. Where necessary, insurers will need to put in place appropriate arrangements for IPT to be paid.
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Do litigation funders need an Australian Financial Services licence to do business? International Litigation Partners Pte Ltd v Chameleon Mining NL and Anor  276 ALR 138
The New South Wales Court of Appeal has delivered the most recent challenge to the Australian litigation funding industry, finding that a funding agreement was unenforceable on the basis that the litigation funder was dealing in a “financial product” without an Australian Financial Services (AFS) licence.
On 28 October 2008, Chameleon Mining NL (Chameleon) entered into a litigation funding agreement with a Singaporean litigation funder, International Litigation Partners Pte Limited (ILP), in respect of proceedings commenced in the Federal Court of Australia by Chameleon against Murchison Metals Limited and others. ILP was entitled under the funding agreement to the repayment of its legal costs and the payment of a percentage of the proceeds from the litigation. The funding agreement also gave ILP the right to a multi-million dollar Early Termination Fee in the event of termination.
Following a change in control in Chameleon resulting from a merger, Chameleon purported to rescind the funding agreement on the basis that, contrary to the Corporations Act 2001 (Cth), ILP was providing a financial service without an AFS licence. The impact of this challenge was that if this rescission was effective, the contract with ILP would be unenforceable and ILP would not be able to recover the Early Termination Fee or any other benefit under the funding agreement.
Decision at First Instance
Hammerschlag J rejected the proposition that the funding agreement was a “financial product” issued by a non-licensee and concluded that ILP was entitled to the Early Termination Fee.
Court of Appeal
The Court of Appeal, in determining whether the funding agreement was a “financial product”, was required to resolve whether the funding agreement was a facility through which Chameleon “managed financial risk” as required by section 763A(1) of the Corporations Act. At trial, Hammerschlag J had found that while the funding agreement minimised Chameleon’s defence costs enabling it to pursue Murchison, on no realistic view could it be said that the funding agreement was a facility through which Chameleon managed its financial risk.
On appeal, Chameleon submitted that his Honour wrongly confined attention to the payment of Chameleon’s defence costs without reference to the risk of an adverse costs order or the risk that the proceedings could not go ahead without the provision by Chameleon of security for costs, both of which also featured in the funding agreement.
The Court of Appeal unanimously held that the Funding Agreement was a “financial product”. This Court, however, was divided as to whether the exception contained in section 763E of the Corporations Act applied. This exception permits dealing without an AFS licence where managing financial risk was not the main purpose of the “financial product”. The majority concluded that managing risk was the main purpose of the facility while Hodgson JA found that this aspect was incidental to the main purpose, which was the provision of funding.
The result was that ILP was found to have provided “financial services” without an AFS licence contrary to the Corporations Act which meant that the funding agreement could be rescinded by Chameleon.
High Court - special leave
The High Court has granted special leave to ILP to appeal this decision. During the Special Leave Application, Gummow J observed that the question of licensing litigation funders was an important one that needed to be addressed.
The litigation funding industry will be watching closely this High Court appeal which is expected to take place this year. The Australian Securities and Investments Commission (ASIC) has, since the Court of Appeal judgment, issued class order 11/555 which extends class order 10/333 to exempt all litigation funding arrangements, including single member arrangements, from the requirement to hold an AFS licence.
The Federal Government has also released details of a proposed Corporations Amendment Regulation which, amongst other things, seeks to carve out funded class actions from the definition of a “financial product” in the Corporations Act. Thus it appears that whatever the outcome of the High Court appeal, litigation funders will not in future require AFS licences as the issue is being dealt with by ASIC and the Federal Government.
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Ontario Court of Appeal releases judgment on duty to defend. Hector v Piazza 2012 ONCA 26
The Ontario Court of Appeal’s decision in Hector v Piazza, 2012 ONCA 26 reminds insurers that they must pay careful attention to the wording of exclusionary clauses, which will be strictly construed against the insurer even where industry understanding of the purpose of a particular type of policy suggests a different result.
Piazza purchased and renovated an apartment building, then sold it to Hector. Hector later sued Piazza and others for negligent construction. Piazza was insured under a Comprehensive General Liability (CGL) policy that applied to the property. The insurer denied coverage and any duty to defend based on a clause in the policy that excluded:
- property damage to
- property owned or occupied by or rented to the Insured
Piazza named the insurer as a third party and brought a motion for an order against it declaring that it was obliged to defend him. The motions judge held that the wording of the exclusionary clause was ambiguous and, as a result, the insurer’s duty to defend was triggered.
The sole issue on appeal was whether the motions judge correctly interpreted the exclusion in the CGL policy. If the word “owned” referred only to the past tense, the exclusion would apply, since the insured had clearly owned the property in the past. If, however, as held by the motions judge, the word “owned” could refer to the present or to the past tense, the policy could not be said to “clearly and unambiguously” exclude coverage, since the property was no longer owned by the insured at the time the claim arose.
The Court of Appeal held that grammatically, “owned” could refer to property that was currently owned or was previously owned by the insured. As a result, the policy did not clearly and unambiguously exclude coverage, and the duty to defend was triggered.
Although an insurer’s duty to defend is often broader than its duty to indemnify, in that “the mere possibility that a claim falling within the policy may succeed will suffice” to trigger the duty, the decision in Hector v Piazza is relevant to both duties.
In drafting exclusionary clauses for CGL policies, if an insurer wishes to exclude coverage for property that is or has been owned or occupied or rented to the insured either in the present or in the past, it must state so explicitly. Hector v Piazza makes it clear that an insurer cannot rely on the argument that because a CGL policy is intended to insure against third-party liability and it is not intended to respond to first-party claims, an exclusion for property “owned” by the insured only has meaning if interpreted as referring to the past.
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Hobbins v Royal Skandia Life Assurance Ltd  HKCFI 10 in the context of the UK Bribery Act
In Jeremy Paul Egerton Hobbins v Royal Skandia Life Assurance Ltd and others  HKCFI 10, the High Court of Hong Kong confirmed that commission paid to an insurance broker by an insurer does not constitute an illegal secret profit unless it is in excess of what is normally paid within the insurance market. This, according to Reyes J, represents the long-settled common law position and is more than just a customary practice within the insurance brokerage industry. The Hong Kong insurance market has welcomed the judgment, which, amongst other things, removes any doubt as to whether insurance broker commission is akin to a bribe and whether agents have an obligation to fully disclose any commissions received.
Mr Hobbins purchased numerous Investment-Linked Assurance Scheme (ILAS) products from Skandia and other insurers via Clearwater. When the ILAS products did not perform according to Hobbins’ expectation, he took legal action against Skandia and Clearwater, in order to set aside the ILAS contracts and recover his investment. One of Hobbins’ allegations was that the ILAS contracts were illegal by reason of section 9 of the Prevention of Bribery Ordinance (PBO), in that Skandia without lawful authority or reasonable excuse rewarded Clearwater for introducing him as their ILAS product client. On this basis, Hobbins claimed that the ILAS contracts were void or unenforceable. Reyes J stated that according to a long line of judicial pronouncements stretching from the nineteenth century to the present, there is “lawful authority” for the commercial practice, under which an insurance broker acts as an agent of the insured and not of the insurance company, and it has long been settled that commission paid to an insurance broker by an insurer is not illegal unless it exceeds what is normally paid within the market. However, Hobbins’ Counsel sought to argue that the fact that commission payment might be customary is not a defence pursuant to section 19 of the PBO. To that, Reyes J said there was more than just a customary practice within the insurance brokerage industry and the practice of commission payment has been validated by over a century of judicial authority. His Lordship added that the practice of insurers paying commission to insurance brokers may or may not be unsound and ought possibly to be strictly regulated or even prohibited altogether. However, that was a question of policy for the legislature to tackle.
Hobbins v Skandia has caught the attention of insurance market players overseas including the United Kingdom, where the Bribery Act 2010 came into force on 1 July 2011 and applies to anyone who has a “close connection” to the UK. On 9 February 2012, Lloyd’s of London issued a market bulletin (Y4561), which gave further guidance on the disclosure of the remuneration of intermediaries in Hong Kong in the light of the High Court decision.
Under the UK Bribery Act, there are four statutory offences, of which two are general criminal offences covering the act of bribing someone and being bribed. The offence of bribing someone means offering, promising or giving a financial or other advantage to another person with the intention of inducing that person improperly to perform a relevant function or activities, or to reward them for doing so. The offence of being bribed means requesting, agreeing to receive or accepting a financial or other advantage to perform a relevant function or activity improperly (although the function or activity does not necessarily need to be performed by the person taking the bribe). It is in the context of these two general criminal offences that issues regarding the legality of commission payments arise.
As recognised by Reyes J in Hobbins v Skandia, commission is not generally a bribe. However, it automatically creates a potential conflict of interest between the broker and the insured (being its principal) in the sense that the former naturally wishes to obtain the highest commission possible and the latter wishes to obtain the lowest possible premium. It would be less of a problem if the insured is informed that commission is to be paid to the broker and the commission is at the normal market rate. The conflict between the broker and the insured will be more acute if the broker is remunerated by “contingent commission”, in which case the rate of commission increases in line with the amount of business the broker introduces to the insurer. The broker would have a strong incentive to recommend the insurer to its client even if a more suitable policy is available with another insurer. The first-mentioned insurer could be said to be paying a bribe with the intention of inducing the broker to improperly perform their duties to the insured (which include the duty to act in the best interests of the insured) with the broker accepting a bribe for improper performance.
On 22 February 2012, Lloyd’s of London issued another market bulletin (Y4567) to address the issues arising out of commission payments to brokers and the UK Bribery Act. The bulletin confirmed Lloyd’s view that commission at the normal market rate is compliant with the Act. However, commissions linked to the volume or profitability of the business (i.e. contingent commissions) are very high risk, and Lloyd’s insurers must not pay such commissions. The bulletin also addressed additional payments to brokers. It stated that it is important that an insurer agreeing to additional payments satisfies itself that the payment is appropriate rather than relying on the fact that other insurers may have agreed to enter into the same or a similar arrangement. Guidelines were given to assist Lloyd’s insurers in deciding whether they should agree to additional payments.
Whilst the High Court in Hobbs v Skandia confirmed that commission payments to brokers are generally not a bribe, it is important to keep an eye on the evolution of market practice in the UK in light of the UK Bribery Act.
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The due diligence proviso - is simple negligence enough for underwriters? Sealion Shipping Ltd and another v. Valiant Insurance Co (The Toisa Pisces)  EWHC 50 (Comm)
The English Commercial Court recently decided an important marine insurance question relating to the “due diligence” proviso in the Inchmaree clause (found in named perils wordings, including ITC-Hulls (01/10/83)). The Inchmaree perils - including, notably, “negligence of master officers crew or pilots” - are subject to the proviso that the loss “has not resulted from want of due diligence by the Assured, Owners or Managers”.
Toisa Pisces was insured against loss of hire. A claim was brought following a breakdown of the port-stern azimuth thruster in 2009. The claim was for 30 days’ hire, at US$ 70,000 per day. The cover required the operation of an insured peril under ITC-Hulls (01/10/83).
Underwriters argued that the assured had failed to exercise due diligence. They alleged that the assured should (and would) have avoided the 2009 breakdown by inspecting and modifying the port-stern thruster following the breakdown of the starboard-stern thruster in 2004. Underwriters did not dispute that they had the burden of proving a lack of due diligence and causation - this view being supported in the latest edition of Arnould’s Law of Marine Insurance and Average.
The judge noted that the true meaning of the proviso was “an unresolved issue of English law”. He considered two questions: (i) what amounted to a failure of due diligence - recklessness or negligence? and (ii) who must have failed? On the second question, it was common ground that the failure must be the assured’s - someone suitably senior within the assured’s organisation. In the present case, this was the assured’s onshore technical manager.
On the first question, the assured invoked the usual English insurance law position, namely that the contribution of the assured’s negligence to a loss is generally disregarded - negligent accidents being precisely the reason why insurance is purchased. The assured argued that “due diligence” should be treated the same as obligations to take “reasonable precautions” in property policies, the courts having held that the recklessness of the assured is required to breach such clauses.
Underwriters distinguished marine and non-marine insurance, arguing that in the context of the former “want of due diligence” means a lack of reasonable care. The judge agreed, holding that the proviso excludes, narrowly, only the negligence of the assured, with the negligence of others - the master, officers, crew, etc - being expressly covered. The due diligence proviso thereby “defin[ed] the scope of the indemnity”.
Underwriters may welcome this construction, under which, while they may have to prove causative negligence by the assured at a senior level, they do not need to go so far as to establish recklessness.
This article first appeared in Insurance Day
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The implications of China’s more open insurance market
In November 2011, the China Insurance Regulatory Commission (CIRC) published a short note on its website considering the implications of China’s more open insurance market. According to the note, 55 companies supported by foreign investment (with around 1,300 branches) have now been established in China. The insurance companies that are backed by foreign investment are concentrated in large cities including Shanghai, Beijing, Shenzhen and Guangzhou, with a respective market share estimated at between six and 11 per cent.
As well as introducing foreign investment in the Chinese insurance market, CIRC has gradually applied its “going global” strategy to Chinese insurers wishing to enter the international insurance market. At the end of November 2011, eight Chinese insurers had established legal entities overseas in order to engage in international business, with another six Chinese insurers setting up overseas representative offices for the purposes of exploring offshore markets.
In 2000, CIRC joined the International Association of Insurance Supervisors (IAIS). It became a member of the executive committee in 2008 and the audit committee in 2010. These appointments greatly improved CIRC’s international standing. To facilitate its increased role in international supervision, CIRC has signed up to a number of bilateral cooperation agreements with insurance regulators in various jurisdictions, including the United States, the United Kingdom, Hong Kong, and Japan. CIRC has also established an insurance dialogue mechanism with insurance regulators in the US and the UK, with a particular focus on sharing supervisory information and developing the commercial pension insurance market. As a representative of a developing country, CIRC has actively participated in drafting the Supervisory Framework for International Insurance Groups. The active involvement of CIRC has largely mitigated the impact of the overhaul of international supervisory rules on China’s insurance industry.
According to the note, CIRC will continue to open up the Chinese insurance market. It will focus on attracting further foreign investment in the health and pension sectors and increasing the establishment of branches in the Mid-West of mainland China. Conversely, given the existing international financial environment, CIRC requires all insurance companies to regularly assess the risks resulting from the internationalisation of the insurance industry. Companies should take particular care to avoid unnecessary transfer of risk from foreign owners to their Chinese subsidiaries.
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Contracts of insurance and the break-up of the eurozone
The break-up of the eurozone remains a worrying possibility. Companies are preparing for the risk that some or all countries in the eurozone cease to use the euro. It is, therefore, prudent to consider the effect of a break-up on the contractual obligations of insurers and reinsurers.
The economic and monetary union could divide in a variety of ways and the method of separation is important. The eurozone could break-up completely with the euro ceasing to exist, or an individual Member State may withdraw, creating a new national currency. Neither scenario is likely to terminate or frustrate the obligations under a contract of insurance and such contracts should remain valid. The break-up does, however, create the risk of redenomination under which an insurer may be required to make payment in a new currency.
Where an individual Member State unilaterally withdraws from the eurozone, there will be no redenomination. English courts would refuse to give effect to the currency change in the withdrawing Member State as it would have been enacted in breach of a treaty to which the United Kingdom is a party and its recognition would be manifestly incompatible with the public policy of the European Union and, therefore, England.
Redenomination will, however, occur if the euro ceases to exist. Here, the relevant contractual obligations will be redenominated into new national currencies through the application of the lex monetae principle (stating that no party may default on a contract if a government alters its national currency). Alternatively, any existing euro obligations could be converted into a new European currency.
The negotiated withdrawal of an individual Member State will create a conflict under which the applicable currency for those remaining in the economic and monetary union will still be the euro whereas the withdrawing Member State will have a new currency. In determining the currency of obligation in a contract of insurance, reference will be made to the intention of the parties. Consideration of the contractual provisions on jurisdiction, governing law, currency and place of payment will be particularly relevant.
Where the contract is governed by English law under the exclusive jurisdiction of the English courts with payment to be made in euros outside of the withdrawing Member State, redenomination will not occur. Complications arise where the parties have chosen a different route. For example, where the place of performance is the withdrawing Member State, the clause will need to be analysed to determine whether payment was anticipated in the existing currency at the time or whether the currency of obligation was intended to vary to match any changes in the Member State’s legal currency.
During this time of uncertainty, insurers and reinsurers would be well advised to consider these issues.
This article first appeared in Insurance Day
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Official white paper published on the transposition of the Solvency II Directive
The official white paper on the transposition of the Solvency II Directive into the German Insurance Supervisory Act (VAG) has recently been published. After going through the legislative process, the law will come into effect on 31 October 2012. The white paper does not attempt to harmonise the VAG and the Directive. It does, however, seek to avoid the imposition of any additional requirements on top of those provided for in the Directive, unless they already exist in the VAG. The following issues will be of greatest interest:
- The risk-based capital requirements (including enhanced solvency requirements based on an integral risk analysis and new valuation rules based on market value) are transposed in line with Solvency II’s three-pillar approach.
- There will be a greater focus on group supervision. It will be enforced through the establishment of a group supervisor as well as better cooperation between the supervisory authorities of respective Member States.
- The German Federal Financial Supervisory Authority (BaFin) will focus more on the active review of risk profiles of insurance companies and on the quality of their risk management and governance systems. The white paper gives BaFin greater discretion regarding the application of the regulations. As BaFin will increasingly be incorporated into the European system of financial supervision, which is headed by the European Insurance and Occupational Pensions Authority (EIOPA), the VAG will be just one of several levels of legal provisions.
- Any debt financing for insurers (outside of the permitted types of Tier-1 and Tier-2 capital) will continue to qualify as non-insurance business and will not be permitted for German regulated insurers.
- The current system of keeping a register of specific assets covering technical reserves will be maintained.
- Where a cross-border portfolio transfer within the European Union leads to a change in the competent EU supervisory authority, the policyholder will be entitled to terminate their policy.
- Certain transitional provisions do exist under certain circumstances. For example, there are provisions regarding minimum capital requirements (one to two years) and disclosure requirements (five years).
The Association of the German Insurers (GDV) has commented positively on the white paper’s clear and comprehensive structure. However, one of the main objectives was to keep the cost and effort connected with the new requirements as low as possible for the insurance industry. The GDV noted that the white paper could cause enormous practical challenges for insurance companies attempting to comply with the new requirements.
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A new approach to reasonable precautions
The reasonable precautions clause of the wording familiar to readers and used in the industry for the last 70 years or so is not dead but it is on life support. A common wording is “The insured shall take all reasonable steps and precautions to prevent accidents or losses”. It can be saved by appropriate intervention but that necessitates the re-wording of the clause. Successful reliance or use of the current industry reasonable precautions wording is not unheard of but is rare.
In 1965, the Natal High court in Aetna Insurance v Dormer Estates held that if a person charged with the duty of taking reasonable precautions failed to take them, it would be a failure by the insured to comply with the condition, entitling the insurer to reject liability. The insured carried his wallet in the rear back pocket of his trousers, and lost the then magnificent sum of R220.00. The pocket had lost its button. The wallet was a bulky one. In the past, when the insured carried the wallet in the same pocket, he found it on a number of occasions having fallen out whilst he was driving his car. The court said that the insured should have appreciated both that the wallet could fall out whilst sitting without his noticing or that it caused a large bulge in the back of his trousers constituting a temptation to any thief.
In 2002 in Roos v SA Eagle Insurance Company, the insurer successfully raised breach of the policy requirement that the insured take all steps to safeguard the insured vehicle from loss. The insured had entered into an agreement of sale with a third party who had absconded with the vehicle without making payment. The buyer’s cheque, purportedly bank guaranteed and deposited into the insured’s account, was subsequently dishonoured after the insured had allowed the buyer to take possession of the vehicle and disappeared.
However, a number of judgments, culminating in the matter of Santam Limited v CC Designing CC 1999 have explained the reasonable precautions clauses in holding that:
- to construe the condition as an exclusion of liability for the negligence of the insured in a policy covering negligence would in a policy covering negligence be to take away a significant part of cover afforded by the definition of the risk
- taking of reasonable precautions as between insured and insurer is not necessarily the same thing as the absence of negligence in the delictual sense
- for an insurer to be successful in using the clause, it essentially had to show the insured acted recklessly
- the test relates to the reasonable precautions taken by the insured itself as opposed to its employees who are not the directing mind of the insured.
There is, however, no need for an insurer to throw up their hands and abandon the reasonable precautions clause. What insurers do need to do is to review the current reasonable precautions clause wording. The reasonable precautions clause can be resuscitated by:
- ensuring that the definition of the insured in the context of that clause includes, where appropriate, the relevant level of staff or agents of the insured dealing with the insured risk
- avoiding wherever possible the use of a standard reasonable precautions clause and with a proper appreciation of the risks underwritten formulate a reasonable precautions endorsement which specifies the prevention of loss steps which the insured (including its staff) is required to take.
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Lending opportunities for insurance groups in 2012
Irrespective of whether eurozone politicians find a way to limit the impact of the debt crisis in the short term, the United Kingdom and the European real estate industries are facing a serious shortage of commercial property lending in 2012.
Even prior to any debt crisis loan defaults that they may suffer, banks are under renewed and face increased pressure to increase their capital reserves. Such pressure is coming not only from regulators but also from their own management who wish to see a reduction in liabilities brought about by a controlled process of balance sheet shrinkage.
Banks can achieve such liability reduction in any one or more of the following ways:
- by raising new equity or other qualifying capital/securities
- by disposing of peripheral businesses
- by selling surplus performing / unperforming loans or
- by ceasing to make new loans, allowing the existing loans on the balance sheet to be repaid / run off.
2012 will see senior (ie. first mortgage) lending in the UK being in very short supply. Already in 2011, Eurohypo, West Immo and Societe Generale have withdrawn from the market and announced a temporary suspension of all real estate commercial lending. Such suspension may well last until June 2012 when Basle II (with its Tier I capital requirement of nine per cent) is expected to be implemented. These banks are expected to be followed by others. There is likely, therefore, to be a severe shortage of bank loan capital. This situation is exacerbated by the continued closure of the real estate securitisation (CMBS) markets, which in recent years have supplied much of the medium (five year) term capital to the real estate industry.
We therefore believe that there will be an opportunity for insurance groups to enter the UK and European commercial property lending markets. Such entry is likely to be on relatively conservative terms - making loans on quality property of sub 60 per cent loan to value, with a first mortgage on the asset. Given the shortage of bank capital, such loans are anticipated to be at attractive margins (in excess of the equivalent length bond or gilt).
Insurers in the United States have for many years been large participants in the senior real estate lending markets, and there are already some insurers lending on commercial property in the UK, either directly or indirectly (eg. via debt fund). This is an attractive opportunity for insurers, not only in relation to the margin, but also because it enables them to use the loans for liability matching purposes with their existing pension or life insurance liabilities, by making loans of a typical ten year plus duration.
The lending activities envisaged could take one of a number of forms, either a direct entry into the market or an indirect one, by means of joint venture or syndication arrangements with an existing bank or banks.
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Recent publications of interest
Research Handbook on International Insurance Law and Regulation
Edited by Julian Burling and Kevin Lazarus
Norton Rose Group has contributed several chapters to the newly-published Research Handbook on International Insurance Law and Regulation.
Produced in association with Lloyd’s, the handbook draws on the expertise of both academics and practising lawyers to provide much needed coverage of insurance law and regulation in its international context. It contains 30 chapters providing in-depth studies on key areas and jurisdictions.
Norton Rose Group has contributed the following chapters:
- Michael Mendelowitz (Partner) and Rob Merkin (Legal Consultant) in London co-wrote the chapter on Reinsurance.
- David Whear (Partner) and Bob Haken (Senior Associate) in London produced the chapter on Closing Books of Business.
- Wenhao Han (Dispute Resolution Legal Manager) in Hong Kong was responsible for the chapter on Developments in Insurance Law and Regulation in the Peoples' Republic of China.
The handbook has been edited by Julian Burling, Barrister at Serle Court Chambers, Lincoln’s Inn (formerly Counsel to Lloyd’s) and Kevin Lazarus, Solicitor at Lloyd’s, UK and is published by Edward Elgar Publishing.
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