When the owner of the Newfoundland Explorer pledged to its insurer that the 157-foot motor yacht would be kept fully crewed, they could not know that the precise wording of the policy would come back to bite them.
While berthed at a Florida marina, the $3m vessel was damaged by a fire sparked by an overheated generator.
The London-based insurer later declined to pay out on the grounds that no crew were aboard at the time – even though it had been laid up when the misfortune struck.
A legal battle in the English admiralty court ensued, but the insurer won. The policy contained the phrase “at all times”, which the courts interpreted as meaning literally “what it says – the whole time, not some of the time”.
The case is one of several highlighted by the Law Commission, which has proposed changes to the legal regime in England and Wales governing commercial insurance. Its Scottish counterpart has proposed the same reforms north of the border.
As it stands the law allows insurers to avoid paying out if policyholders fail either to meet commitments they have made – such as in the Newfoundland Explorer case – or to disclose information to underwriters.
Companies are required to supply material information they think insurers ought to know, even if they have not been asked for it.
John Hurrell, chief executive of Airmic, an association of corporate risk managers that comprises 450 of Britain’s biggest companies, argues the rules often place “an impossible burden on buyers”.
The increasing complexity of global supply chains – highlighted by natural catastrophes such as last year’s flooding in Thailand – has exacerbated the difficulty for companies in disclosing all material facts to their insurers.
After the disastrous Thai floods, companies – particularly in the car and electronics industries – needed to make insurance claims for disruption at subcontractors based thousands of miles away.
Critics say the legal requirements are draconian, giving insurers plenty of scope to dodge justifiable claims for trivial or irrelevant reasons. In practice, insurers only rarely enforce their legal rights.
“The insurers know that in the end, if they rely on their rights all the way, the industry wouldn’t exist – because nobody would buy insurance,” says Bruce Hepburn, chief executive of Mactavish, an insurance research boutique that has long argued for reform.
“Insurers tend to pay more in claims than they need to legally – but less than the customers are expecting.”
The Lloyd’s Market Association, which represents underwriters at the London insurance market, says the Law Commission, in its research, found only about 25 relevant high court cases in the past 10 years relating to non-disclosure.
Kees van der Klugt, director of Legal & Compliance at the LMA, argues much of the planned reforms risk making the system more complex and having unintended consequences.
“It’s a highly competitive market,” he adds, which encourages insurers to avoid recourse to the law.
Still, while the vast majority of disputes do not end up in the courts, insurers can use the threat of nullifying entire policies for supposed breaches by policyholders – even if relatively minor – as a negotiating tactic to reach settlements.
Moreover, corporate insurance buyers say they can no longer rely on the goodwill of insurers, which have become increasingly willing to enforce their legal rights.
This has been partly driven by regulatory pressure to formalise relationships between insurers, brokers and policyholders, which at Lloyd’s have historically have been characterised by unofficial “gentleman’s agreements”.
Now, a third of claims that are challenged are done so on the grounds of inadequate information disclosure – the biggest single reason why claims are rejected – according to a survey of Airmic members.
The Law Commission has proposed that the law be changed so that insurers can void entire claims only if policyholders have been dishonest. In other cases, remedies for shortcomings in disclosure should be proportionate.
The commission also says insurers and policyholders should be allowed to negotiate individual agreements, with different terms, if they so wish.
While acknowledging that legal changes are essential, Mr Hepburn says that these alone will not solve the problem. Company boards must take more responsibility for managing their insurance contracts, he says.
“It is breathtaking how little governance is applied to the insurance arrangements by the boards of British businesses,” he adds.
“As a result of this lack of scrutiny and subsequent poor procedures, a significant number of organisations fail to put in place valid policies for their most business critical risks.”
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