Directors face legal action if they don't get a grip on Insurance Act duties

The problem is severe enough that companies could be exposed to outcomes where directors could be open to suits brought by shareholders.

The study found 45% of larger commercial claims are disputed by insurers, and that when the claims are eventually settled, which on average takes three years, companies receive settlements of around 60% of what was initially estimated.

Mactavish warn that with the advent of new regulation – the most significant being the Insurance Act 2015, which came into effect over two years ago – boards have a duties have increased but engagement with insurance at the boardroom level is found wanting.

Speaking to Post, Mactavish’s technical director, Rob Smart, said: “There’s two main developments pushing the focus towards how well the board governs risk and insurance.

“One of those is the Insurance Act [2015], which is a new set of specific, codified duties that didn’t exist until 2016 on what the board needs to do to understand and explain its risk for the purposes of arranging insurance. That simply didn’t exist a statutory requirement before.

“In addition to that, there’s a general onward march of corporate governance regulation, which has created more guidelines around how companies need to monitor the risks to which they’re exposed and report those both internally within the company and externally to shareholders.”

Under the act, when arranging insurance, businesses have a ‘duty of fair presentation’, meaning they must disclose “every material circumstance which the insured knows or ought to know”, or failing that make a “disclosure which gives the insurer sufficient information to put a prudent insurer on notice that it needs to make further enquiries for the purpose of revealing those material circumstances.”

In the event of claims where an insurer feels a fair presentation of a business’s risk has not been made, it can reduce the amount paid proportionately to the premium it would have charged had all the risks been presented at the outset.

In extreme situations, if an insurer can prove it wouldn’t have entered into a policy if it had been made aware of all the risks, it can avoid paying out altogether.

Commenting on Mactavish’s findings to Post, John Ludlow, CEO of the Association of Insurance and Risk Managers, said: “The Insurance Act means if a company takes its risks seriously and explains those risks to the insurer then the insurer is fundamentally on the hook to pay out against those risks. If you don’t explain your risks and you don’t have higher level of transparency, then the insurer isn’t obliged to pay.

“Companies should be using risk and insurance professionals to work together to look at their likely large losses and run scenario practices to help with their crisis management and also to understand the impacts of a major loss. Then they’ll see how their policy would respond.

“With insurance and risk management, you get out what you put in and if you’re not prepared to invest in it, and if you’re looking to buy cheap insurance, then you’ll get the insurance that you deserve.”

The board-level problem may run deeper, however, with Mactavish saying there is a worrying attitude towards insurance pervasive through corporate culture.

Bruce Hepburn, pictured, CEO of Mactavish said: “Generally speaking there is low board engagement in insurance, which is out of line with their focus on other capital instruments. 

All chief financial officers, for example would know about their banking covenant conditions but very few would have knowledge about the limitations of their insurance cover.”

Smart explained: “We know insurance buyers and risk managers in companies who say they have a once-a-year presentation to the board. They’re asked to come along to present, told to wait outside for five hours and then told they’re not needed.

“The board will spend two minutes approving the level of insurance spend and the cost but won’t get into more detail – that’s quite a common picture.”

Smart also said that the lack of understanding of risks was particularly pronounced in areas of new and emerging risks, but that there was also general complacency across all classes of risks.

“Everyone arranges their own car insurance or their own home contents insurance, and it’s relatively simple. That creeps into the way people view corporate insurances, even though the reality is that the risks are more complex and getting increasingly complicated every day, and the contracts that cover these reflect this.

“If you look at areas like cyber insurance – it’s a new type of risk, it’s changing daily, and the level of risk that companies are facing is increasing rapidly, but that’s an area where most companies probably aren’t aware of the extent to which their insurance cover would protect them.”