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Three legal and regulatory challenges facing (re)insurance

Insider Engage gets the experts’ views on some of the biggest legal and regulatory challenges facing the (re)insurance sector in 2021 and beyond

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Wordings – BI and beyond

After the UK Supreme Court decision in the case brought by the Financial Conduct Authority (FCA) last year over business interruption (BI) coverage, insurers and reinsurers will be looking closely at their wordings this year.

Underwriters will be keen to ensure that the cover that they are selling is what they think it is, and that, accordingly, their exposure to risk is what they assume it is, argues Clive O’Connell, a partner and head of insurance and reinsurance at McCarthy Denning.

“This does not apply solely to BI business,” he says. “While the recent case threw a spotlight onto BI coverage, the issues that it exposed apply to coverage generally. It is essential for the pricing of cover and for calculation of exposures and reserves, that insurers and reinsurers know exactly what cover they are selling and buying.”

“The current economic climate is difficult and volatile. It is a climate in which disputes could well be incubated. Now is the time to conduct a thorough audit of one’s wordings. Next year might be too late,” he adds.

Gordon Vater, UK business development director at claims services provider Gallagher Bassett, is concerned about the risk of a more stringent regulatory environment.

“The fall-out of the FCA Covid-19 BI test case has left an increasingly aggressive regulator, who’s not afraid to intervene with policyholders,” he says. “The loss sustained from business interruption claims is still playing out for insurers across the UK and this may see the FCA taking actions that are not strictly in their remit.”

The BI case revealed wide-ranging issues for underwriters, O’Connell stresses, with wordings much more inconsistent and less watertight than expected.

“In some cases, individual companies had multiple wordings covering the same type of issue. While those wordings were probably all evaluated in the same way, it is easy to see that different wordings could give rise to very different results."

O’Connell says that, in addition, the wording of reinsurance contracts needs to reflect the cover given under insurance contracts.

“This can only be achieved if there is discipline in relation to the insurance wordings that are used and that the reinsurance wordings are designed to reflect the underlying cover,” he says.

“Twenty years ago, contract certainty was introduced to ensure that contracts existed. Now, it is essential that the meanings of those contracts are also certain.”

Autonomous vehicles – third party liability

No, not a Terminator scenario, but rather a shift in third party liability risk from humans to manufacturers, artificial intelligence firms and software providers.

Autonomous vehicles (AVs) remain relatively rare in Europe, but they are becoming a feature on US roads. Since the death of death of Elaine Herzberg in 2018 – the first pedestrian fatality involving a self-driving car – there has been a sharp legal and regulatory focus on the risks posed by AVs.

In the UK, the government passed some legislation on AVs in 2018, keen to be seen to be ahead of the curve in Europe, and has recently repeated that it wants to see driverless cars on UK roads by the end of this year.

“The issue of motor premium for AVs should be an upcoming challenge,” says Anthony Baker, a partner at Plexus Law. “The 2018 legislation was sparse in detail, because the government wanted to get something on the statute books, so it’s a skeleton that needs to be fleshed out.

“The key for insurers will be how they are going to rate these vehicles. However, there is a huge variance between motor insurers in how mature they are in their thinking towards AVs.”

Insurers already active in the US are among those with a lead in thinking around the issues. Major UK insurers such as Axa XL, Direct Line and RSA are also working intensively on pilots of AVs across the country.

“The insurance industry is 100 per cent committed to supporting the development of automated vehicles, which have the potential to dramatically improve road safety and revolutionise our transport systems,” according toa post by the Association of British Insurers (ABI).

“While car manufacturers are producing innovative hardware and software, insurers are innovating their products to make sure vital questions of safety and liability are answered to make the UK’s autonomous vehicles market a global leader,” the ABI adds.

Motor business is usually a predictable business line, marked by high frequency of relatively low severity claims. However, AVs could change its liability dynamics and make it more litigious, Baker suggests.

“If an AV hits a pedestrian, even if the pedestrian walks out in front of it, the vehicle can be found liable. Motor insurers will be looking to the manufacturers, who will be looking to software providers,” Baker says.

Baker says a whole host of different experts will need to be involved in investigating road traffic accidents.

“Engineers and safety experts are the norm, but now there will be manufacturing and software experts. For insurers, that will require new strategies to deal with claims or to subrogate loss between parties,” he says.

Climate change and the TCFD

Insurance organisations are under increasing scrutiny over their carbon footprint from regulators, as well as other stakeholders, particularly investors focused on environmental, social and corporate governance (ESG) issues. Green credentials are increasingly aligned with reputation and profitability itself, as well as ethics and long-term sustainability risks.

A “Dear CEO” letter from the Prudential Regulation Authority (PRA) on 1 July 2020 called for a strategy, embedded by the end of this year, aligned to the PRA’s Supervisory Statement 319, from April 2019, which asked banks and insurers to consider their approaches to managing financial risks of climate change.

“The original Supervisory Statement set out good practice principles without setting a timeline. The Dear CEO letter has mandated parts of it and set a clear deadline, as well as saying the PRA will be checking that it gets done,” says Richard Weighell, a partner within BDO’s financial services advisory team.

Weighell thinks the more insurers engage with it, the more, potentially, they will realise they still have to do.

“Superficially it seems manageable. However, as soon as you get into it, the issues grow into bigger challenges, as organisations are being asked to take a strategic stance and many are behind the curve,” he says.

Nigel Brook, a partner at Clyde & Co, notes that the EU is particularly active on climate change regulation, as well as other overlapping ESG initiatives, such as the Corporate Due Diligence and Corporate Accountability Directive, a draft of which was adopted by the European Parliament on 10 March 2021.

The directive promises global reach and GDPR-style fines for firms that allow shady practices to exist within not just their own operations but potentially their partners, their supply chains and their customers. Insurers could find their own operations under fire, as well as exposure within lines such as directors’ and officers’ liability (D&O).

“Key elements of the proposed directive include companies having to identify, address and remedy their impact on human rights and the environment throughout their value chain,” says Brook.

“Questions are already being raised about the insurability of fines or whether and to what extent companies might seek recourse from their D&O insurance policies. This is probably the most important ESG issue for companies in Europe.”

More change is coming internationally for the most global of problems. The Task Force on Climate-related Financial Disclosures (TCFD) was created in December 2015 by the G-20’s Financial Stability Board, giving global proportions to reporting requirements.

TCFD typifies the move from voluntary and disparate reporting towards international standards that are harder to shirk or avoid. This was the background behind the PRA’s missive to CEOs last July.

“The UK is the first major economy to start making these rules compulsory,” says Brook. “From January 1 premium listed companies reporting their 2021 accounts will have to adopt TCFD reporting, which can be within annual reports.

“Reporting thus far is patchy, with insurers meeting soft criteria but not the tough ones. More information is needed, because there are criteria but no benchmarks to tell you what’s good and what’s bad. However, the PRA is expecting insurers to start asking questions.”

He notes that while TCFD’s “scope one” reporting requirements, for a company’s own consumption, is fairly straightforward, once “scope three” is attempted, the picture becomes almost immeasurably complex.

“If you’re an energy (re)insurer and underwrite lots of oil and gas companies, it hugely increases your footprint if you acknowledge responsibility for that,” says Brook.

“However, if across global supply chains and risk transfer partnerships, those same emissions get counted several times over, how do you divide up responsibility? These are the details that need to be worked through to make this a way to hold organisations to account in a meaningful way.”

Insurers have an inconsistent record on climate change. Lloyd’s, for example, is backing away from thermal coal and tar sands as the most carbon intensive insureds, but it has announced no plans to pull out of insuring the bulk of conventional natural gas.

Some US insurers are making commitments but these are likewise piecemeal and patchy. Axa has meanwhile announced it is chairing a so-called Glasgow Financial Alliance for Net Zero, with details yet to emerge.

The biggest governments will meet at the COP-26 meeting in Glasgow will provide another global stage for further pronouncements.

Since the Biden Administration took power in the US, the Trump era of wobbly US commitments to climate risk is over. With increasing pressure on and from governments worldwide to hit international targets on curbing carbon emissions, sources agree this can only lead to further tightening of the screws through increasing regulatory requirements on companies.

“Insurers and reinsurers are at the forefront of this,” says O’Connell. “By imposing regulations on insurers and reinsurers relating to the risks that they can cover and the investments that they can make, governments can impose behaviours down the risk chain.”