Whilst at first glance the industry appears well on course to meeting and even exceeding the FSA’s timetable, it is clear that it is going to become incrementally more difficult to achieve future targets

David Hall, director of client and broker relationships at Allianz Global Risks UK, believes the insurance industry must continue to commit to involve the positive adoption of tripartite relationships if it is to realise the benefits that lie behind contract certainty.

The Financial Services Authority (FSA) became the regulator for the general insurance industry towards the end of 2004. One of the first challenges it set the industry was to achieve contract certainty across all insurance lines by January 2007. A timetable for voluntary compliance was agreed and just over one year into the programme the FSA published its mid-term stocktake report on the delivery of contract certainty.

The London Market Principles’ Contract Certainty Code of Practice defines contract certainty as having the complete and final agreement of all terms, including signed lines, between the insured and insurers before inception. The wording chosen makes it clear that the FSA is determined to bring an end to the “deal now, detail later” culture that has been prevalent throughout the insurance industry.

The initial response from the industry has been positive. The FSA’s report confirms that the industry has already met its interim target of 65 percent contract certainty. However it is important to look beyond the headline rate and examine the figures in more detail in order to gain a more accurate measure of the industry’s progress.

A recent survey conducted by AIRMIC shows that the rate of contract certainty for some lines of business, such as Employer’s Liability and Property, was as low as 35-37 percent. From this it is clear that some areas of the market have a great deal of work to do if a consistent rate of contract certainty across all insurance lines is to be achieved. Even within lines of business that performed well above the average there is the feeling that much of the progress has been achieved through the picking of low-hanging fruit. So whilst at first glance the industry appears well on course to meeting and even exceeding the FSA’s timetable, it is clear that it is going to become incrementally more difficult to achieve future targets.

The FSA is progressing with contract certainty on a voluntary basis. To date this has worked well, with the benefits to the industry far out weighing the time and effort spent on compliance. The question still remains over how the industry will achieve the next 20 percent and then the last 15 percent. The industry is aware that FSA has the option to switch to a mandatory compliance regime should the voluntary programme not deliver all that it requires. However progress to date augers well enough for the businesses involved to keep the voluntary momentum going.

The significant change that will signal real development within the industry is when matters move beyond mere procedural compliance and become culturally adopted. To succeed requires a cohesive approach from clients, brokers and insurers alike. A contract certainty partnership, based on open tripartite dialogue and full disclosure has to become central to the way the industry works.

The long term understanding of a client’s risks lies at the heart of true tripartite relationships. This is important not only to deliver mechanical compliance with the FSA’s requirements, but also to ensure that all parties involved can benefit from the advantages that lie behind the concept.

More informed underwriting and thereby certainty of insurance transactions will be provided by adopting a tripartite approach. Clients will be clearer on exactly what cover they have purchased and experience a more straightforward claims process. In tandem, insurers will fully understand a client’s risk exposure, allowing more efficient allocation of capital to risk profile. This will lead to better control of costs and thereby help to avoid mis-pricing. Whilst the focus of the regulator is primarily on the insured and insurer, brokers will also benefit from contract certainty, as both their fiduciary risks and operational costs are reduced.

There is a great deal of international support for contract certainty and the UK market is seen as one of the pioneers of the concept. Provided that interpretation issues are tackled effectively, the UK is in an ideal position to realise the significant commercial advantages of a contract certain market. By offering overseas buyers and brokers a greater level of control and reduced risks, the UK market will become a more attractive place to conduct business.

Dialogue between all parties needs to be an ongoing process throughout the period of cover and not just take place at renewal or after a claim. This is essential to avoid gaps in cover or the policy only reflecting the risk profile of a client at key pivotal points. Such a situation could lead to a major dispute between insurer and insured if any claim were to arise, resulting in increased costs and a delay to starting the recovery process. With client, broker and insurer working together throughout the period of cover to keep the business risk profile as accurate as possible, any claims can be settled quickly and the potentially terminal effects of business interruption minimised.

It is equally important that the issue of price is put into its proper context. To do so requires clients to think in terms of cost and not price. Clients need to be looking beyond the figure at the bottom of the contract and asking themselves what are the costs to their business of poor risk management and inadequate risk transfer?

The costs of disputed claims and the resultant delays to the recovery process should also be of prime importance. From a board level and stakeholder’s perspective, is a nominal reduction in premium really worth as much as the ability for the business to have risk transfer certainty so it can quickly get back on its feet at a time of crisis?

The issue of claims is central to contract certainty and the ability to settle claims quickly is just as important to insurers as it is to clients. With contract certainty in place any claim will be experienced in sectors that the insurer is expecting, meaning surprises are avoided. By expediting the one service they deliver to clients directly, transactional costs can be minimised and positive relationships built.

The ultimate goal for any insurance transaction is that the policy issued best reflects the client’s needs. Creating a stronger tripartite alignment will help to achieve this as the more insurers know about the client the more equitable and certain the business link becomes. This will lead to policies becoming better defined and more accurately priced. Insurers will also be able to build longer-term relationships with both brokers and clients, and avoid purely transactional business.

Far from being the FSA’s final challenge, achieving contract certainty is more likely to be the first step. The successful completion of a documentary process is only going to answer the underlying concerns of the FSA if it involves the full articulation and accurate understanding of a client’s business risk. It will be intimately tied up with the ability to create successful tripartite disclosure via open dialogue and listening based relationships. Contract certainty is not an end goal for the insurance industry, but is instead the foundation for its future.

This Special item appeared in issue 106 of JTW News - June 2006

Author: David Hall - Allianz Global Risks UK