TAKING THE BIND OUT OF BINDERS: A REVIEW OF PROBLEM AREAS. A lecture by Tim Goodger and Andrew Stevenson

Transcription

1 Elborne Mitchell TAKING THE BIND OUT OF BINDERS: A REVIEW OF PROBLEM AREAS A lecture by Tim Goodger and Andrew Stevenson These notes are derived from a talk by Timothy Goodger, partner, and Andrew Stevenson, Solicitor, of Elborne Mitchell, given at Lloyd's Old Library on Thursday 16 September 2010 relating to some problem areas for binding authority agreements. Where specific reference is made to the law it is to English law as at 16 September For specific advice, you should please contact Timothy Goodger, Andrew Stevenson or the partner with whom you usually deal at Elborne Mitchell. Disclaimer: These Notes are for information only and nothing in them constitutes legal or professional advice. They should not be considered a substitute for legal advice in individual cases; always consult a suitably qualified lawyer on any specific legal problem or matter. Elborne Mitchell assumes no responsibility to recipients of these Notes. Elborne Mitchell Solicitors One America Square Crosswall London EC3N 2PR Tel: Elborne Mitchell Solicitors, September 2010 Elborne Mitchell is regulated by the Solicitors Regulation Authority. Registered Number

2 TAKING THE BIND OUT OF BINDERS: A REVIEW OF PROBLEM AREAS A Introduction Lloyd s most recent published information show the numbers of coverholders has increased steadily in recent years such that, as at mid-2010, there are now around 2,500 coverholders producing an impressive 30% of Lloyd s market premium income annually. That accounts for over 5 billion for The reasons for entering into a binder differ, but ultimately on both sides it is to make a profit. There are obvious mutual attractions for both insurer and coverholder from the arrangement. For the insurer, these include: Cost-effective access to new or niche markets. There is no need to set up a costly infrastructure or deal with potentially costly local legal, staffing, administrative issues although there may be compliance issues; it is an alternative way of increasing market share; Potentially a stable core income; The benefit of a coverholder s specialist local knowledge, relationships, expertise, experience. A ready network to access ; and Ceasing to write that business should be relatively straightforward. 1 For the coverholder, these include: Access to the insurer s brand and, in the case of Lloyd s, the Lloyd s brand. The benefit of excellent security and ratings. The ability to operate the business from a relatively low costs base without having to meet certain capital requirements, to have all of the back-office roles of the insurer and the need to maintain reserves and incur the associated costs of capital. The opportunity to work with experienced London market underwriters and brokers. Potential downsides:- Inherent risk of issuing cover that will lead to claims. Control of undertaking to a different organisation, potentially giving rise to a lack of daily oversight. 1 See issues relating to Transfer of Undertakings (Protection of Employment) Regulations Elborne Mitchell

3 The key to it from the insurer s perspective is twofold: 1. Choosing the right coverholder. 2. Ensuring that the terms on which both parties are to participate are as clear and unambiguous as they can be. Problems commonly arise out of the following: Insufficient due diligence Gather information about the business and the coverholder, including the losses suffered in the sector generally or by the particular coverholder. A mismatch of the parties expectations What does each stakeholder wish to achieve and what is their time frame to achieve their goal? Lloyd s emphasises, managing agencies should have a strategy, including business rationale and roadmap. Poor training or no education programme Insufficient knowledge Relevant personnel within the insurer and coverholder should have knowledge of the actual duties and obligations arising under the binder. All those that are concerned with the binder, from those named in the binder through to those dealing with claims, need to understand the relevant obligations. This is a top to toe process including acquaintance with systems and controls as well as limits of authority. Unclear communication It should be clear if there is either an indication, a quotation or a bound risk. Avoid ambiguous statements. Failure to follow up communications B. General observations A binder is simply a commercial agreement. It is not a contract of insurance and nor is it a contract of utmost good faith. It is however the document that sets out the fundamental duties and obligations between the parties and therefore it is of crucial importance that the terms reflect what the parties understand the other is required to do in the context of the overall relationship. There s no industry standard wording for underwriting authority or binding authority agreements although the Lloyd s/lma standard binding authority wordings are generally treated as a London market standard. Those standard terms may be revised and replacement clauses inserted at the point of negotiation of the binder. Some companies have devised their own bespoke wording and these tend to be more detailed that the LMA wordings, although they usually follow roughly the same format. The amendments depend upon the negotiating positions of each of the parties, but it s common for there to be variations. 3 Elborne Mitchell

4 Ensure the terms of a binding authority agreement and Terms of Business Agreements (TOBAs) and any other relevant agreements compliment each other. There should be consistency between any slip contract and the form of wording for the binding authority. If the slip contract provides for a particular form of words, it is practically more difficult to negotiate a different form of words. The insurer needs to carry through and implement the rights that the agreement gives him. The parties should take care to ensure that the definitions are relevant to the business to be bound. The wording in a binder needs to reflect or be consistent with the wording in TOBAs. The parties need to be satisfied that the agreement conforms to any other agreements and also the actual processes that the coverholder intends to implement. There are risks if the parties use short-hand to summarise or incorporate terms or rely on the wording of the slip but do not finalise the actual agreement. Each party needs to be aware of the general duties but express contractual duties should be inserted if the insurer expects the coverholder to assume any additional duties or stipulate how the broker/coverholder should deal with a particular situation. These likely will vary between business types and differ between underwriters; each requiring the coverholder to perform in a particular way. If each party and their staff are aware of the duties I have outlined, then that should assist in the smooth operation of the binder. C. Legal Principles Duties and Obligations The relationship between the insurer and the coverholder is one of agency. At its simplest, the insurer acts as principal and the coverholder is agent. Contractual relationships Coverholder Insurer Coverholder Broker placing the binder Accounting for premium 2 Premium payment chain Coverholder Broker of record Insurer 2 Note: there are conflicting authorities regarding obligations of the broker of record and the duty to account. Ordinarily, the broker of record acts as agent of the coverholder. 4 Elborne Mitchell

5 1. Duties and obligations Duties and obligations on the coverholder are: Contract - Express - Implied Tortious Fiduciary (as agent) Obligations on the underwriter are: Contractual - Express - Implied 2. Contractual obligations The basic obligations on both parties will commonly be set out in the binding authority agreement. These will customarily include the following aspects: Binding Authority limits; Payment of premium and accounting; Payment of commission; Claims handling/payment of claims; Auditing/performance review/inspection of records; Termination of the binder; Jurisdiction and choice of law. The binder may be subject to change over time and it is common for the parties to want to amend the terms. In doing so, care needs to be taken to ensure that the new terms do not conflict with the old ones or cause ambiguity. Similarly, given the increasing ubiquity of TOBAs it is perfectly possible for the duties and obligations between the parties to be set out in two or more different documents, and consequently there is a risk of conflict between them. It is important to supplement the common law duties and implied terms with additional express terms setting out any additional duties and requirements that the insurer thinks is appropriate to impose upon the coverholder, and this is the case particularly if the coverholder has authority to further delegate. Ideally, the underwriter needs to ensure that problems can be identified early, rectification sought, and if necessary termination and runoff of the binder be pursued, and any damage controlled. 5 Elborne Mitchell

6 3. Common law/statute a. Obligations on the Coverholder i. An implied duty to act with reasonable skill and care: this is an implied term but ideally should be an express term. ii. Implied fiduciary duties. Since the relationship under a binder is based on a great deal of trust bestowed by the insurer on the coverholder, the law imposes strict obligations on the coverholder to act as a fiduciary. See Bristol and West Building Society v Mothew [1998] Ch.1 at p.18 Millett LJ: "A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal. This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of fiduciary obligations Named persons in the binder are sub-agents and owe duties to the underwriters. These are not limited to the coverholder entity. Where a coverholder may have binding authorities with a number of agents, and indeed with the same business type, it runs the risk of conflicts of interest between those of different principals. The broker should consider making clear to his principals that the binder is not an exclusive arrangement (which should be acknowledged by the underwriter). There is also an inherent conflict where a coverholder is also an insurance intermediary and advises its customer (potential policyholders) on insurance contracts and security suitable for that customer. Treating customers fairly and in line with the TCF principles should avoid conflicts of interest. Although it is not strictly necessary, creating a new division within the broker to deal with binders alone can assist in managing conflicts. Customers can be advised that the broker has a specialist division of facility available and some brokers have used this model to create a profit centre and to encourage better controls. b. Obligations on the Insurer i. To pay remuneration/commission. ii. To indemnify the agent for sums reasonably incurred by him on behalf of the principal. 6 Elborne Mitchell

7 4. Lloyd s The Intermediaries Byelaw sets out the relevant rules for delegation of authority to enter into contracts of insurance. 3 In the Lloyd s market a managing agent is able to delegate to an approved coverholder or restricted coverholder. The approved coverholder can only underwrite in accordance with the terms of a registered binding authority or a restricted binding authority. And the restricted coverholder can only bind in accordance with the terms of a restricted binder. A managing agent can also delegate to a service company coverholder as well, which in turn may delegate authority. The issue of documents evidencing the contracts of insurance is also permitted on similar basis only. These rules have become stricter over the years because of incidences where delegated authority has been abused. Lloyd s approves coverholders and its approval can be revoked. 5. FSA The coverholder must be regulated either as an authorised intermediary or registered as appointed representative. C Authority One of the central aspects of the operation of the binder is the way that English law treats the concept of authority. There are two types: actual authority and ostensible authority Actual authority Conferred on the agent by the principal. Ostensible Authority This is the usual authority that someone in the position of an agent coverholder would be expected to have. Delegation of authority The binder sets out the parameters of the coverholder s authority and may allow the coverholder to delegate the authority further. Sub-delegation potentially dilutes the strength of the original underwriting. The extent to which authority can be delegated and to whom it is actually being delegated are important aspects to establish both at the outset of the binder and on audits so that the Insurer can be as comfortable as he can be that the person who has his pen is the person he wants to have his pen. This should be addressed properly in the binding authority agreement. 3 See also Lloyd's Code of Practice Delegated Underwriting 21 December 2009 and Service Companies Code of Practice 08 September Elborne Mitchell

8 Ratification An act performed by an agent outside his authority may be ratified by the principal, effectively (retrospectively) validating the agent s act. Awareness by and a positive act of the insurer is required. D The role of the placing broker The placing broker acts as agent of the coverholder and logically therefore a sub-agent of the insurer. However, this does not ordinarily give rise to any obligations on the broker to the insurer either in contract or tort. But there are certain exceptions; - Assumption of duty: see Pryke v Gibbs Hartley Cooper [1991] LLR Vol Dishonest placement of the binder: see Sphere Drake Insurance v Euro International Underwriting [2003] EWHC 1636 (Comm) 4. - Markel and QBE/Amalfi vs Surety Guarantee Consultants and Others [2008] EWHC 3087 (Comm) 5. Although not a contract of good faith, the broker is required to disclose unusual or unexpected features of the coverholder. The broker therefore needs to consider the proposed coverholder s standing. The cases of Markel and Sphere Drake in particular make clear that contributory negligence of the underwriter is difficult to assert. However, equally both make clear that knowledge of the underwriter could have an impact on the outcome of matters. Fraud makes it virtually impossible for contributory negligence to be asserted against the underwriter, but failure of the underwriter to act can lead to a different result. The placing broker is not there to police the coverholder for the insurer. However, it is possible for the broker to assume that role and where it does so, the broker needs to take care that it has the ability to do so. E Specific Aspects of the Contractual Relationship This section reviews some drafting issues and potential problem areas. As said, Lloyd s and others have done a lot to standardise and improve agreements, however problems can and do arise from time to time. The parties need to consider at the outset particular aspects including not only the amount of authority to be delegated, but also the expected outcome on termination of the binding authority. 4 See Appendix 5 See Appendix 8 Elborne Mitchell

9 (i) General observations Due diligence Due diligence carried out on the following assists in the drafting of the agreement: The book of business; The coverholder entity; The named coverholders; The broker of record; Senior management of the entity (its directors and key employees). The extent of delegation Where the coverholder is named and additional coverholders are identified, the insurer should take care if it is to then go further and include wording such as any such additional coverholders as may be agreed by the Coverholder. This is fraught with danger unless the insurer is satisfied as to the integrity of the principal coverholder. Premium rates The agreement of premium rates by the coverholder rather than the insurer also is a further loss of control, and without insurer approval the coverholder may run amock with the insurer s pen before the damage is realised. The use of restricted binding authorities in the Lloyds market reduces this risk and means the coverholder can only deal with insureds and on prescribed terms. There should be comprehensive terms for the determination of the premium to be charged in respect of each contract of insurance to be entered into under the binding authority such that the coverholder does not have significant discretion to calculate premium or make adjustments to it. Therefore the use of a rating schedule or matrix is required or the use of a prior submit system, such that the coverholder refers to proposed contract of insurance. Also a lack of control over the gross premium income can lead to problems. There are various cases where the authority was exceeded, but went unchecked. Although there is usually a term in the binder that that the coverholder monitor the total gross premium income and to notify the underwriters if it is apparent that it will be exceeded, the underwriter (and the broker of record) needs also to be alert to what is authorised and expected. Care needs to be taken with premium income estimates and that they are rigidly adhered. Effective Date The standard LMA Binding Authority Agreement comes into effect when Underwriters acknowledge in writing receipt of a signed copy of the agreement from the Coverholder. Consequently, the binder is confirmed as being valid on compliance with this term. Problems arise however where different parties sign different versions of the binder, or different copies. Where one party signs, but the other does not, returning the document to the placing broker without signature, then potentially there is no valid agreement. 9 Elborne Mitchell

10 See also: Syndicate 1242 at Lloyd s v Morgan Read & Sharman [2003] LLR Authorisation The general prohibition set out in Section 19 of the Financial Services and Markets Act 2000 (FSMA) states that no person may carry out a regulated activity in the United Kingdom unless he is authorised or lawfully exempt. As a consequence those dealing with underwriting must have the adequate authorisation to do so. As highlighted from the fall out of the CIC Insurance Company AVV of Costa Rica and CIC Insurance Company of Greece 7, intermediaries are under an obligation to consider whether the relevant firm with which it deals is authorised by the FSA to carry on insurance business and, if it is not, to take appropriate action. In respect of CIC, two entities had acted contrary to general prohibition - operating illegally by writing insurance in the UK without being authorised by the FSA to carry out regulated insurance business. The FSA took action against one director of a UK-based intermediary which issued CIC policies to UK businesses, while knowing (or whilst it ought to have known) that CIC Greece and CIC Costa Rica were not authorised. (ii) Exclusivity A binder may include terms of exclusivity in the dealings between the insurer and the coverholder, placing an obligation on the coverholder to offer the insurer a right of first refusal basis and that the coverholder may only seek alternative quotations from other insurers if that business is declined by the insurer or if it does not fall within the scope of the Binding Authority. What happens when the coverholder sets up another facility to deal with the renewals that otherwise would have been declared to the binder? For example, the coverholder may decide that it has had enough of the insurer and has decided to set up its own captive operation and divert the renewals to that captive and the coverholder provide quotations for the relevant classes of business. The comments of the Judge in Hiscox v Dickson Manchester [2004] LLR 2, 439 suggest that any coverholder who diverts business from a binding authority without offering the renewal to their principal does so at the risk of being found in breach of their fiduciary duties. (iii) Proprietary Rights The Intellectual Property Rights in respect of the Insurance Documentation and Marketing Material need to be detailed in the binder so that there is no misunderstanding or later dispute (should the agreement be terminated). Much depends of course upon the way in which the binder has come about and whether the coverholder is the driver for the business, or whether 6 See Appendix 7 See Appendix 10 Elborne Mitchell

11 the underwriter is using the binder as part of a distribution network. The main point for negotiation is who has the right to what? Some books of business owe their success not to the security, but the way in which the coverholder / underwriting agency has developed the book, such as establishing a brand and also a network of brokers with which it deals. Non-solicit The underwriter may be using the binder as a means to increase its understanding of the market. There may come a point in time therefore where the underwriter has the confidence to embark on the business itself without the involvement of the coverholder, but still retains the binding authority for the time being but, where there are renewals, uses the information that it has to try and make direct approaches to the insureds via its own vehicle (such as a service company). In those instances the coverholder is exposed. This is where exclusivity needs to be two-way. The parties may consider using non-solicit and non-compete style clauses. (iv) Claims The coverholder not only has duties to the underwriter for the underwriting, but also may have the claims function. Underwriters need to ensure therefore that this aspect is dealt with properly in accordance with its requirements. Many binders provide for the coverholder to handle claims themselves up to a certain level. Thereafter, they must be referred to the insurer s claims department. Although the London market wordings seem to operate on that basis, there is no express requirement that the coverholder deal with claims. It is not uncommon to separate the two out into a separate function and agreement. The coverholder may have an interest in dealing with claims because it may receive a profit commission if the claims are low. However, claims settlement needs to be within the terms of the delegated authority and if settled outside the terms of the delegated authority, then there is a prima facie cause of action against the coverholder for breach of its obligations. If it is found to be outside the terms of the authority, then action need to be taken to ensure that recourse against the coverholder and its PII can be taken. If the coverholder is to deal with claims, then it is wise to have a detailed framework and build in a proper reporting structure such that the claims handling follows the protocol that the insurer has decided to adopt across the whole of its business. These of course vary and therefore those operating the binder and the claims need to ensure that their systems and controls are such that they are able to differentiate clearly between the procedures and processes required by the different underwriters. Service levels tend to be increasingly more detailed and response times prescribed by the FSA and those by the underwriter need to tie in and the agreements need to include the underwriters own service levels. The insurer will often require that all decisions to decline claims or avoid cover are dealt with by them. However, the insurer s rights to handle claims in the way that it normally would, 11 Elborne Mitchell

12 have been compromised due to the authority given to the coverholder. The following are areas where potential problems can arise:- Internet Sales Where the coverholder is permitted to bind insurances via an internet site or portal, the underwriter needs to be fully familiar with the way the site operates, and the process adopted to bind cover. Clearly the coverholder will seek confidentiality and to protect its interests, but the insurer needs to have full control of the site; in this regard the LMA wording provides for inspection at any time and the ability to require the coverholder to cease underwriting. The insurer needs to review the site to satisfy itself that answers given by the potential assureds do not restrict its ability to consider arguments of misrepresentation and/or non-disclosure. Consider the retention of records and screen grabs. Premiums paid via a finance company Although, under the LMA non-marine terms the coverholder is not to enter into the terms of a premium finance arrangement in the name of the underwriter, it may do so for its own account. Problems can arise where an insured makes a claim under a policy where it has stopped paying monthly premium to the finance company that had funded the annual premium up front. It is not uncommon for finance companies to seek to cancel the policy because of an assured s non-payment and ask the coverholder to issue a notice of cancellation of the policy. Consider the authority to cancel in these circumstances. Suitable Claims-Underwriting Feedback mechanisms These are useful since there is an inability of the coverholder otherwise to learn of problem accounts or problems with its wordings/terms of policies. (v) Money Issues By whatever means the insurer wishes the coverholder to collect and hold premium, it should ensure that this is done in accordance with the terms of the binding authority and the coverholder s regulatory status. As agent of the underwriter, the coverholder holds monies as its agent and risk transfer will operate. There needs to be consistency between the TOBAs and the binders in respect of the way the coverholder accounts for premium and how monies are to be held. If the account is intended to be a trust account, then this needs to comply with the relevant laws for the jurisdiction to ensure that the account is properly classified and that the underwriters position is best protected in the event of insolvency. See: Lloyd s/lma new model wordings (October 2009). 12 Elborne Mitchell

13 An insurer runs the risk of being exposed if it permits a coverholder that is not an FSA authorised insurance intermediary to run an old styled IBA, as monies in that account are not ring-fenced from the coverholder s general estate on insolvency. (vi) Policing the binder In order to know when the binder should be terminated, the binder should be adequately monitored. This requires someone within the underwriter s organisation having an understanding of the business to be bound, mindful of the level of premium income being written and whether that conforms to the proposal that the coverholder advanced at the outset of the relationship. Attention to bordereaux, making considered decisions, records being made and retained of conversations (either notes or documents to record them), and following internal controls and inspection of audit are key. Although a coverholder may be a FSA authorised entity and/or have been approved by the coverholder department at Lloyd s, this does not mean that less due diligence is required on the coverholder. The placing broker merely acts as agent of the coverholder in placing the binder and is not there to police the coverholder for the insurer. However, it is possible for the broker of record to assume duties to or roles for the insurer either expressly or by way of an assumption of responsibility. Where it does so, the broker needs to take care that it has the ability to do so and is not in breach of its duties to the coverholder. Audit/Inspection Audit or Inspection is a tool. Regular inspection with full instruction of the areas to be reviewed is fundamental. The FSA s view is that it is not enough for firms to use audit in isolation. In 2005 the FSA fined Goshawk 220,000 for failing to operate sufficient controls over some of its coverholders. 8 The underwriter needs to consider what information it requires from an audit report. Standardised reporting templates and a panel of approved auditors may be useful. The cost of inspection needs to be built in to the cost of the business, in the same way as costing the marketing materials. (vii) Terminating the Binder Plan for termination Consider: the logistics of termination; 8 General Insurance Newsletter: A regulatory update from the Insurance Sector Team Issue No.10 September Elborne Mitchell

14 the transfer of relevant data and files, who will oversee it; and if another organisation should handle all the run-off or merely the claims aspects. The underwriter needs to take an early decision on how serious a breach of authority or a breach of a term of the binding authority is and how to resolve it. Certain breaches are minor, and can be dealt with through close liaison between the parties representatives, but there are others that require proper notice being given seeking the matter to be rectified within a given period and which otherwise, if not rectified, will lead to an actionable breach of the binder. There are other breaches that are so fundamental that they go to the heart of the contract and may enable the party to assert that the binder has come to an immediate end without the need for a notice period. Consider the risk of waiver of a breach and affirmation of the binder. That may result in the insurer losing any right to pursue the coverholder for a remedy for the coverholder s breach of obligations. If there is an inkling of a problem, then exercise of inspection and review is essential. And prompt action to be taken thereafter if there is an adverse report. If there is to be an inspection of records, and a report is to be compiled, it is important for the insurer to provide proper and full instruction such that it is able to glean the information that it requires to establish if the binder is being operated properly. This will also provide an invaluable source of information in order to control the termination and ensure that all matters are properly addressed. Termination Notices It is a fundamental point that a notice should be properly drafted: Identify all the relevant binders; Make clear the effective date of cancellation; and What authority is curtailed, e.g. new business, state the obligations of the coverholder. Notices must be served in accordance with the terms of the binder:- Correct method of service; Sent to the right person at the right location; Correct notice period; Obtain an acknowledgement. Consider termination in the context of the renewals of the policies that have been issued. There are circumstances (such as where there are automatic renewals) when it is appropriate to ensure that assureds are told that policies will not be renewed. Retrieve the underwriter s paper. Underwriters should be clear and unequivocal about what is required. The coverholder should be required to deliver up promptly to the insurer or their appointed representative all unused certificates of insurance or documents and materials which the coverholder possess in connection with the agreement. The coverholder needs to account for all the certificates that have been issued and those that remain unused. If there is not immediate compliance then the insurer should consider taking immediate steps (such as obtaining an injunction) to prevent the issue of policies without authority. 14 Elborne Mitchell

15 (viii) Issues on termination Ownership and the rights over the renewals of the business can become an issue, and so a term addressing this at the outset is helpful. The coverholder may need to consider nonsolicit clauses in respect of policyholders and its broker network which it may have developed at great cost, and effort. A specific provision makes clear the parties obligations. The Insurer has the right to inspect and copy documents held by an agent with delegated underwriting authority. This is an implied right but underwriters should ensure it is included in the binder terms. Hiscox v Dickson Manchester Co Ltd [2004] LLR 2, 439 confirms the insurers' rights in this regard. The insurer was successful in obtaining access to documents for the purpose of effecting renewals which otherwise had been denied by the coverholder who sought to transfer the business to different security. The court also held that the insurance business was "owned" by the insurer. This was in circumstances where there was no express term and the insurer was keen to continue to write the renewal business. Notification to policyholders that there will be no renewal of policies by the coverholder as agent for the insurer on the following year of account is a prudent step, particularly if there is no other security in place. There has to be clear understanding how to deal with direct debit/standing order arrangements in respect of premium relating to renewals. Where the coverholder s broker has sought to replace the security then the fresh documentation showing the changes in security must be issued and the coverholder needs to make sure of that. Handling the run-off The parties should try as best they can to set out their rights and the cost of run-off. It is not unusual for the underwriter to want to take back the claims handling element such that it retains some control on its exposure to the business that has been written. There are potential difficulties for the coverholder in securing the claims handling if the authority has been withdrawn. Consider: Temple Legal Protection Ltd v QBE Insurance (Europe) Ltd [2008] EWHC In so doing, the underwriter needs to take care to appoint the right person to run-off the book of business i.e. an entity with resource and know-how, which understands the business. It is unlikely that it has its own team to do so and therefore will need to outsource. 10 The insurer will want the run-off handled in such a way that any irregularities in underwriting are picked up. For example, there may be instances where the underwriting agent either exceeded its authority in underwriting or settling claims or settled claims that did not fall within the indemnity afforded under the wording etc. 9 See Appendix 10 This paper does not cover the intricacies of outsourcing agreements: the reader is referred to Elborne Mitchell s 2006 seminar: Issues for the Run-Off Market (Timothy Goodger and Alexandra Booth). 15 Elborne Mitchell

16 The Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246) There is an interesting issue arising out of The Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246) 11 (commonly known as the TUPE 2006) and whether those involved with the binder may be deemed under the employment legislation to become employees of the insurer. TUPE 2006 is the main piece of employment legislation governing the transfer of an undertaking, or part of one, to another undertaking. The regulations are designed to protect the rights of employees in a transfer situation enabling them to enjoy the same terms and conditions, with continuity of employment, as formerly. It is now common therefore for the binder to have specific wording to address this and the potential transfer. Brokers will see these clauses more and more as insurers tend to use them and they usually address the situation where a new/replacement coverholder binds business on behalf of an insurer where another agent had dealt with that business previously; and second, where the binding authority agreement is terminated and the business is undertaken by another contractor for the insurer, say the run-off element of the business. Each of these events may constitute a potential transfer of undertaking under TUPE Equally, undertakings that contract out business can sometimes be held to have transferred the employment of their employees to the outside contractor under TUPE. It is not uncommon now to see insurers seeking indemnities in respect of transfers that arise automatically. Lloyd s delegated authorities department have produced a useful outline of the issues and also various draft clauses contained in their September 2009 bulletin. Legal advice should be sought on these aspects, however. Non-renewal of the binder Problems arise where there are changes in the binding authority. If a binder is being terminated then it follows that many of the risks under it will come up for renewal and will do so after the binder has terminated. Where required, the underwriter should actively consider whether a notice of non-renewal of the contract of insurance needs to be served before it ends so as to avoid automatic renewal. From the underwriter s perspective, there may also need to be agreement that any quotations for insurance for potential new assureds or for renewals of insurance business with which the coverholder has been concerned be referred to the insurer. Consequences for the coverholder in default (a) (b) (c) FSA sanction: loss of authorisation; fines. See the FSA s decision in July 2010 to ban three individuals from working in regulated financial services having been involved in a scheme which defrauded Markel International Insurance Company, QBE Insurance (Europe) and Amalfi Underwriting over an extended period of time, exposing underwriters to significant losses. Sanction by Lloyd s (if a Lloyd s binder) and/or loss of its Lloyd s recognition. E&O claim by the insurer: claims for damages, an account or tracing. 11 TUPE 2006 replaces the Transfer of Undertakings (Protection of Employment) Regulations 1981 (SI 1981/1794). 16 Elborne Mitchell

17 Professional indemnity Insurance Underwriters need to ensure that when an issue arises the coverholder s PI insurers are properly notified and also that the matter is dealt with effectively. The underwriter needs to take care with what it alleges so as to not vitiate the cover that exists and upon which the insurer will wish to rely. Equally, the coverholder should ensure that if it is necessary to notify a circumstance that it does so properly and promptly. It may be better for the insurer to notify the insurer himself or have written confirmation that the matter has been notified. G Conclusion In view of the coverholder s commercial need to preserve the business it has created and therefore preserve the interface with those with whom it deals, greater attention needs to be given when binders are drafted to the rights of the parties, including those on administration post termination, and the protection of their respective business interests. Elborne Mitchell Solicitors 16 September Elborne Mitchell

18 Appendix to Taking the Bind out of Binders Cases referred to Liability of named coverholder Sphere Drake Insurance Ltd v Odysssey Re [2003] EWHC 1636 (Comm) This concerned a binding authority by which the coverholder accepted 35 separate programmes of reinsurance relating to US Workers Compensation (carve out business) essentially loss-making business addressed the extent of the duties of the fiduciary duties owed by the coverholders. The Judge examined whether there was knowing assistance by the brokers and what would have been the effect of knowledge by the reinsurer. Briefly the facts were that a binder was granted to an individual through Horace Holman and then transferred to Euro International Underwriting. Before inception of the binder and business being written, certain brokers made clear that they would offer loss making business to the person writing the business under the binder. Much of the business was known to be carve out business and was part of the PA spiral, where workers compensation carve out business was treated as an accident policy and reinsured on that basis notwithstanding that it was in effect a liability insurance. Premiums for this business were far less than claims and the business was written deliberately knowing there would be a gross loss. The business was reinsured for lesser premium but a greater element of the losses, but in turn that was subject of further retrocession. Sphere Drake asserted that acceptance of the business under the binder was dishonest on the basis that it had not been authorised and it had no knowledge of it. It was alleged that the coverholder knew acceptance of the business to be dishonest and in breach of its duties. The Court ruled that the practice of arbitrage or net underwriting was unobjectionable provided each participant knew it was participating and there was a fair presentation of the risk and full disclosure given, and writing or placing such business was not dishonest. The Court found that the nature of the business was fraudulently misrepresented to the Sphere Drake director who granted the binder, and that he was not told of the programmes were gross loss-making business. That was concealed. The Judge concluded that if Sphere Drake had been told of it, it would not have agreed to it. Further there had been deception by the broker and the coverholder inducing insurers to become involved in a business which, properly explained, they would not have entered into. Notwithstanding the Court concluded that the underwriter had acted with gross negligence and dereliction of duty, which would have discovered the dishonesty of the coverholder, and the matter would have been investigated, the Judge concluded Sphere Drake were entitled to recover. The Court held that contributory negligence was not a defence to an intentional tort to cause damage, deliberate disregard of the fiduciary duties owed. This led to personal liability of those involved. 18 Elborne Mitchell

19 Dishonesty Markel and QBE/Amalfi vs Surety Guarantee Consultants and Others [2008] EWHC 3087 (Comm). Mr Higgins, an experienced surety bond underwriter was regarded as a leading figure in the field, writing surety bonds for small and medium sized construction companies in the UK and Ireland. Surety bonds are commonly used in the construction industry and operate on the basis that the surety (usually an insurer or bank) agrees to pay a third party beneficiary in the event of a failure by the client construction company to discharge its obligations to the beneficiary. In 2004, Mr Higgins joined three others to form Surety Guarantee Consultants Ltd (SGC). SGC persuaded Markel, through Markel s speciality underwriter, Mr Smith, to grant it a binding authority. The Markel binder commenced on 1 January It contained a number of restrictions on SGC s authority including, most importantly limits of 1m on any one bond and 2.5m on any one contractor, unless Mr Smith had agreed otherwise in advance. The binder also identified three authorised individuals at SGC who would manage the account, one of these was a Mr Felstead. Unbeknownst to Markel, Mr Felstead had a prior conviction for fraud and SGC had already been advised that the FSA would not approve of Mr Felstead carrying out controlled functions for SGC. SGC began writing bonds under the binding authority straight away. Some were within the terms of the binder but a significant number were not. In one case, SGC wrote a bond for 10 million, ie 10 times the authorised limit. Bordereaux were produced on a monthly basis and Mr Smith visited SGC monthly to review them and check that SGC was writing within its authority. Unfortunately for him, SGC were producing falsified bordereaux that said that they were only writing within the agreed terms. Mr Smith then left Markel to join a new venture, Amalfi, which underwrite for QBE. He took the SGC account with him. He was given permission by QBE to offer similar terms as between SGC and Markel and the QBE binder commenced on 1 October Notification of the cancellation of the Markel binder was given on 1 November 2005 and SGC was told to stop issuing bonds. After its binder had been cancelled Markel audited SGC. However, copies of the actual bonds in the files were replaced with dummy bonds that showed they were within the underwriting limits. Shortly after inception of its binder, QBE appear to have learned about Mr Felstead s fraud conviction. Mr Smith asked SGC/Mr Felstead directly about it and it was denied. It doesn t appear that Mr Smith took it any further. During 2006 QBE also audited SGC and the same thing happened - dummy bonds were placed in the files and managed to fool both Markel and QBE. By August 2006 QBE were unhappy about the standard of record keeping at SGC generally and cancelled the binder from September They then did a further audit and finally discovered one of the bonds written exceeding the authority. Markel were also told about the unauthorised bonds. Somewhat inevitably, claims were made on some of the bonds written in breach of the binder. Both Markel and QBE felt that they had no option but to honour them. 19 Elborne Mitchell

20 QBE and Markel then set about trying to recover their losses. It transpired that the excess premium (ie that earned from writing bonds over and above the authorised limits) had been siphoned off into a British Virgin Islands registered company owned by three of the four promoters of SGC. However, unravelling exactly what bonds had been written legitmately/illegitimately and what premium was owing was a mammoth task because SGC had obviously tried to disguise the true position and cover their tracks wherever possible. SGC predictably went into insolvent liquidation. The principals therefore pursued the individuals concerned suing them for fraud and breach of fiduciary duty (amongst other things) in order to claim the secret profits that had been made. Notwithstanding that the evidence of fraud seems to have been pretty overwhelming, the Defendant s still forced QBE and Markel to go to trial. For the most part, the defendants declared themselves too ill to attend court or unable to pay for lawyers and so defended themselves in person. Their first line of defence was to challenge their personal liability; they argued that it was not they who owed fiduciary duties to Markel and QBE, but SGC. The court rejected this. The three individuals named on the binder plainly owed fiduciary duties personally to Markel and QBE and had breached those duties by perpetrating a fraud. They also committed various other breaches Ultimately, the defendants were ordered to pay Markel about 3m in terms of the claims they had had to settle and 800,000 in premium. QBE s combined losses were about 1 million. Binding agreement Syndicate 1242 at Lloyd s v Morgan Read & Sharman [2003] LLR 412 In 1998, Syndicate 1242 had subscribed to the binding authority with Ace in respect of business written travel insurance schemes by a company enigmatically called The Management Company (TMC). TMC operated schemes placed with various Lloyd s syndicates and arranged travel insurance for the public through a series of sub-agents and other intermediaries and through various tour operators. For the 1999 year, the following year of account, Ace took a 100% line, Syndicate 1242 deciding not to participate. However Ace decided in July 1999 to give notice to terminate the binder because of poor performance for the prior year. The individual broker responsible for placing the TMC business (by way of a binder) moved broking houses and joined MRS in The broker having failed to persuade Ace to change its position approached syndicate 1242, and the active underwriter - rather than syndicate 1242 s class underwriter for that business who had previously refused the business in with a view to having a binder commencing 1 August Various meetings followed, and a draft binder was produced upon which in February 2000 the active underwriter penciled the words H/C [Held covered] 100% to Income no more that 750,000 - SN requirements met - Advise signing 20 Elborne Mitchell

21 In fact prior to this the broker had met with SN, with certain figures and had been told that they were inadequate. The initials of the syndicate were added in pencil but the syndicate stamp was not appended. The issue was whether there was a binding contract. The Court found that syndicate 1242 never became party to the binding authority for the prior period commencing 1 August The request for information to be presented to the class underwriter was a condition that had to be met, and the Judge concluded that it would have been irresponsible and reckless for any underwriter to commit his syndicate without the requisite underwriting information. It seems however that the business nonetheless had been written by TMC, and the Judge concluded that the reason why the broker did not return to the underwriter was because the condition could not be satisfied. Authorisation CIC Insurance Company AVV of Costa Rica and CIC Insurance Company of Greece In respect of CIC Insurance Company AVV of Costa Rica and CIC Insurance Company of Greece, those two entities had acted contrary to general prohibition - operating illegally by writing insurance in the UK without being authorised by the FSA to carry out regulated insurance business. CIC Greece and CIC Costa Rica CIC Greece were never actually established or licensed as an insurance company in Greece and therefore could not have been validly passported into the UK to write business. Having dealt with those companies, the FSA turned its attention to certain underwriting agents sold invalid policies on behalf of CIC Greece and CIC Costa Rica in the UK and the FSA took action against persons who encouraged various UK insurance underwriting agents and intermediaries involved. The FSA took action against the director of UK-based intermediary, Insureyourshop.com Limited (IYS), which issued CIC policies to UK businesses, while knowing (or whilst it ought to have known) that CIC Greece and CIC Costa Rica were not authorised. There was an agreement by IYS to accept insurance business on behalf of CIC Costa Rica and a further binding authority agreement whereby IYS was empowered by CIC Greece to bind insurance contracts in the UK. The FSA issued prohibition orders. These are powerful tools and can be wide ranging and may include the banning of the individual from carrying out any controlled function involving the exercise of "significant influence" as set out in the table of controlled functions at SUP R in the FSA Handbook. The run-off of claims Temple Legal Protection Ltd v QBE Insurance (Europe) Ltd [2008] EWHC 843 This case addressed whether an underwriting agent had an entitlement to conduct the run-off of the business it had bound under the binding authority. This was an appeal from an arbitration decision. Temple underwrote legal expenses insurance on behalf of QBE under a binding authority which had specific terms dealing with the administration of the claims following termination of the binder (the run-off). It stated that, unless otherwise agreed in writing by QBE, Temple would remain liable to conduct the run-off of the insurances bound until their expiry or termination. This is a common provision in binding authority agreements. In this instance 21 Elborne Mitchell