Broker: Feeling exposed?

In December last year, the Financial Conduct Authority published a thematic review into brokers’ professional indemnity insurance, revealing practices which gave the watchdog “significant concerns”.

The FCA found that in many cases brokers’ PI policies included exclusion clauses that reduced the scope of cover required by its handbook.

“With the way that some of the wordings had been drafted, even if the broker had been negligent, the policy might not pay out,” says Your Compliance Matters director Mike Hanson. “Clearly, that is not acceptable for a policy that has been designed to cover the broker’s negligence itself.”

Post explores the breadth of the issue, and whether brokers are potentially leaving themselves exposed.

The FCA found insurer insolvency exclusions in 140 of the 186 policies it assessed. PI insurers explained to the regulator that the clauses are included as they don’t want to underwrite the credit risk of the insurers with which the intermediary places policies.

“The PI market cannot be the last guarantor for poorly capitalised unrated insurers with a business plan that can’t work,” says Manchester Underwriting Management CEO Charles Manchester. “So when they inevitably go bust, as they do, then you can’t have the PI market picking up the losses.

“My sense is that the thematic review was published before there was any consultation with the industry on the FCA’s findings. Had there been some consultation, then it would have understood better what the industry’s trying to achieve.

“You now have the Financial Services Compensation Scheme consulting on its future and it’s talking about potentially subrogating against the PI insurers of brokers that have gone bust. So you’ve got the potential for quite a lot of aggregation against insurers, should they be giving cover relating to insolvent insurers.”

The breadth of the exclusions found by the FCA varied widely, however, with the regulator particularly concerned with how closely linked a claim needs to be to the insolvency of an insurer to be excluded.

Concerning clauses

The watchdog said that “in many cases” it was concerned that the exclusion clause would not provide intermediaries with the necessary cover for claims for which they may be liable.

“It is something that the broking community is really concerned about,” says Sarah Naylor, insurance partner at Hill Dickinson.

“Brokers speak to us about this a great deal. There have been court decisions where a broker has had to pay out because an insurer has gone under.

“That’s why we’re in this situation where the PI insurers have for quite some time now put these exclusions in the policy wordings that are going to leave brokers uninsured in certain circumstances.

“You don’t see the half of it because most claims will get settled behind the scenes. But it’s certainly something that brokers are concerned about.

“There has been a case in Australia where a broker was found to be negligent because he’d failed to advise the client that the insurer’s position was tenuous. The Australian case made us a bit concerned that that might be something that brokers might actually need to do.”

Manchester adds: “The FCA has clarified its initial comments by saying it’s more concerned where a broker has been negligent other than in connection to the insolvency of the insurer.

“That should be covered and it shouldn’t be the insolvency of the insurer that gets PI insurers off the hook. Putting that into a clause that works is something that might be harder to do than might at first be thought.

“Is there a big problem lurking there? There have been cases of brokers being found liable for losses arising where an insurer has gone bust. There haven’t been many. The thing is at some point there will be a situation where brokers are found to be at fault.

“If you have a well-rated insurer that goes bust, it’s going to be difficult to pin it on the broker. If you have an insurer where a lot of the market are thinking ‘How the hell are they still existing, writing this kind of product with that kind of a rating without any capital?’ that is something that is a potentially large issue.

“Insurers, of course, write policies without insolvency exclusions. There’s not many of them, and frankly if they stop and think about it, they might change their mind because actually they’re putting their own existence at stake.”

Model clause response

In response to the FCA’s review, in April, the International Underwriting Association of London released two model clauses that could potentially address the issue by more clearly defining what is excluded from a policy.

The first model clause reads: “This policy does not cover liability arising out of the insolvency or bankruptcy of any insurance company, underwriting agent, bank, building society, unit trust or any other business with whom you have arranged any insurance, investment or deposit; or your insolvency or bankruptcy or that of any other business through whom you have arranged any insurance, investment or deposit.”

The second model clause is identical, but includes the sentence: “This exclusion will not apply to any circumstance or claim that may be covered under this policy but for the relevant insolvency or bankruptcy”.

Chris Jones, director of market and legal services at the IUA, says: “When we spoke with the FCA, it had seen some clauses that it thought were ambiguous that it wanted to raise with the market.

“So we sat down with the FCA and said: ‘Let’s go through what your concerns are, and whether we can put in place a model provision that can address those concerns’.”

In addition to taking legal advice, the IUA consulted the members of its PI forum before drafting the clauses.

“Insurers want to avoid being in a position of responsibility for the aggregated, high-severity credit risk of the insolvency of an insurer with which a broker has placed business,” explains Jones.

“From our perspective, it’s absolutely not the role of the PI market to meet those potential liabilities. But obviously, the FCA’s concern was that some policy clauses could be construed very widely, to exclude any claims. And that’s what we agreed with the FCA to address and that’s what we tried to do.

“The FCA can’t rubber-stamp model clauses but indicated that they were addressing the issues that it had raised.”

Mitigating risks

What can brokers do to mitigate the risks posed by broadly drafted insolvency exclusion clauses? Brokerbility chairman Ashwin Mistry believes the answer is simply transparency with the client and proper due diligence into the carriers being used.

“Everybody’s known about this for years, so it’s not new,” he says. “Broker PI doesn’t protect against insurer failure, full stop. That’s been known by every professional broker since day one.

“You’ve got a number of fundamental issues. That puts the onus on the broker in terms of the carrier that it’s recommending to the customer. The obligation is on the broker to highlight to the end customer the financial rating of the carrier.

“If they go for a premium that is market-competitive but the carrier has a low credit rating, then of course the policyholder will be left without any recompense if the carrier goes under. My personal experience is I’ve never had a client that’s accepted an insurer with a rating that has been questioned by us, let alone the markets.”

Naylor says that a broker that takes sensible steps to investigate the solvency of an insurer they place business with will be better able to defend a claim that may be brought against them.

“Brokers in larger networks have security committees that have a system of checking the quality of the security that’s afforded by these insurers,” she adds.

Mistry emphasises, however, that it is not the network’s responsibility to tell brokers “how to behave”. He says that Brokerbility has never had to raise the issue with any of its members.

“It’s not a network responsibility, and if a network does take responsibility for that, then God help them with their own PI!”

Hanson adds: “The majority of our clients use a specialist PI broker to arrange the cover for them. And perhaps they are trusting that those PI brokers are ensuring that they are getting the cover they should have.

“There has been a level of trust by the brokers who are actually buying the PI cover that may have been slightly unwarranted. So they need to look very closely at the wordings for the cover that they’re being provided with.”

Mistry says he has seen examples of brokers limiting their liability with their customers in their Terms of Business Agreements.

“For example, a broker insures a company, and says: ‘The PI for you is only £2m. If my business screws up, I’m only going to cover you for that if we’re liable’. But the client’s exposure could be many times that.

“Some brokers will potentially go down the limited liability partnership route, and that’s another strange thing to do, but again it’s brokers trying to protect their position.

“There’s a whole range of issues in terms of limiting liability, Terms of Business Agreements, the impact of the Insurance Act, the limits of indemnity and obviously the client’s understanding of the capacity of the provider with which they’re placed.

“This is not a new issue, it’s been going on for a very long time. Most people have decided to stick their heads in the sand, and hope it doesn’t really exist because it never impacts on them, but I suggest now with the Insurance Act, it’s somewhat different.”

Hanson says, however, that unless a broker receives a signed document from the client agreeing to liability limitations within a Toba, it is “unclear” how enforceable the limitations would be.

“Although it’s important and it’s embarrassing for the industry when this sort of thing happens, in a way it’s slightly a red herring,” says Manchester.

“What’s arguably more important is that brokers aren’t insuring themselves enough for the sort of things that should be covered.”

Real danger

Manchester believes that the real danger to brokers is failing to buy the right level of cover. “Most brokers have got clients insured well into the millions and sometimes hundreds of millions, yet they buy PI cover at the absolute bare minimum required by the FCA,” he notes.

“Although there is a limit on how much brokers should spend on insurance, the cost of buying £2m PI cover increased to £5m or £10m really isn’t that much. But they’re buying the bare minimum.

“That’s a much bigger issue because every year there are a number of total loss claims on brokers’ errors and omissions insurance policies that are inadequately covered because of the amount of cover that a broker buys.

“You can spend years building up your business and then put it all at risk for the sake of not a lot of money by not buying adequate cover. There is an irony there but it’s not that funny.”