“Adaptability” Or Die – Who Is Paying For The Insurance Market’s Survival?

As with all industries, the unstable financial climate, which has been prevalent over the last few years, has had a major impact on the insurance and reinsurance industry; on the one hand, tighter margins and tougher requirements to utilise capital efficiently and effectively have impacted on insurance companies’ willingness to write risks and the availability of insurance and, on the other, the number of claims has increased and brought along with it, a sharp spike in threats to the market such as fraudulent claims and cyber risks. 
 
Throw into that mix minimal investment income returns on the premium collects, increased regulation, government spending cuts, the Eurozone and sovereign debt crises and a raft of major “insurance” world events, and the London insurance market has had to call on its greatest strength to survive: adaptability.
 
So what, says the consumer or the business that buys insurance, it’s a sign of the times and not my problem.  Except, it becomes your problem when you have to pay for it. 
 
The demand for the market's adaptability is essentially driven by cost; and never has the market seen so much increased cost with so little scope for preserving its margins.  As we shall see below, this is not good news for insurers and reinsurers and purchasers of insurance alike.
 
So Where Are These Cost Drivers?
 
Step forward regulation.  Costly and time consuming steps have to be taken to implement procedures to handle increased regulation both from the UK Financial Services Authority (the FSA) and the European Insurance and Occupational Pensions Authority (EIOPA).  These costs will only increase insurance premiums and therefore impact on us all.  This regulatory drive is an even bigger issue for the Lloyd’s market, which, in addition to the FSA and EIOPA, has its own internal regulator, the Council of Lloyd’s.  To add to the regulatory burden, there is concern as to whether the new regulatory landscape that will be implemented in the near future will simply result in a convoluted and costly regulatory regime for the insurance and reinsurance industry, imposed by the banking fraternity rather than those familiar with the insurance market.
 
One of the current key criticisms of the London insurance market is the speed and settlement of claim payments.  There has long been a perception that claims are taking longer for insurance companies to resolve.  The English and Scottish Law Commissions have now taken up the mantle as part of their review of insurance contract law that began in January 2006. 
 
Step forward another increased cost for insurers, that of preparing for and adapting to a potential new legal regime. 
 
In their most recent consultation paper, the Law Commissions considered the current law on late payment of insurance claims and found that the position was in need of reform.  They look to be moving towards the US approach of penalising insurers for late payment; they have proposed a new statutory duty be imposed on insurers forcing them to pay valid insurance claims once a reasonable period of time to investigate the claim has passed.  Thus providing the insured with a means of redress if the insurer fails to comply with this duty.  Under these proposals, assuming they are implemented, not only would an insurer be in breach of their duty for rejecting a valid claim but also for any unreasonable delay in making the claim payment. 
 
If, going forward, insurers are to be penalised for concluding that there is cover where they have investigated a claim within a reasonable time period, will they just pay more claims and do so within a short time period?  While this might seem like good news, if claim payments increase, premiums will rise.  To make matters worse, claims costs are inexorably increasing in any case.
 
Our perception, since the start of the credit crunch, is that there is now more of a US style approach to litigation in England, especially when professionals are sued.  In particular, this includes joining all possible parties into litigation.  This complicates the making or defending of claims in the early stages, particularly in respect of assessing quantum and each party’s respective liabilities.  By “complicates” we mean that it increases insurers’ claim costs, which – now a broken record in this article – ultimately translates into higher premiums. 
 
To compound the felony, another claims development coinciding with the pressures upon insurers arising out of the credit crunch, is the increase in the use of conditional fee agreements (CFAs) in pursuing claims; again this is particularly prevalent in cases against professionals who insurers will defend under their professional indemnity policies. 
 
While CFAs give cost security to a claimant, especially if after the event insurance (ATE insurance) is taken out alongside the CFA to cover the other party’s costs, they have contributed to the mushrooming of insurers’ defence costs; first, with the financial risks of pursuing litigation removed, there becomes no litigation inhibition for claimants and, secondly, the success fee payable can magnify the costs payout – a classic "double whammy" for insurers.  Yet another increased cost that will inflate premiums.  
 
It remains to be seen what impact the Lord Justice Jackson costs reforms will have on the frequency of CFAs when the reforms are implemented in 2013.  The key reforms in respect of CFAs are, first, that success fees will no longer be recoverable from the other party (although CFAs themselves will still be permitted) and, secondly, that ATE insurance premiums will no longer be recoverable.  This will impact on the claimant’s rationale for using a CFA as it will remain liable both for the success fee and any ATE premium.  Conversely, under the current regime, the claimant may not have to dip into their pockets at all if they are successful. 
 
But do not necessarily expect claims costs to fall with the demise of success fee and ATE premium recovery: we suspect there may be a spike in CFA initiated litigation in advance of April 2013 when the reforms are introduced (the changes will only impact on litigation commenced after April 2013 and matters already operating under a CFA will be allowed to continue); and do not underestimate the ability of claimant lawyers and the claims funding industry to adapt themselves to a world of damages based agreements; we do not expect to see claimant litigation falling off a cliff. 
 
So raise a glass to the resilience and adaptability of the insurance market and, in the current difficult time, to survival.  But remember, we are all bearing their burden and sharing in their pain.
 
Stephen Netherway is a partner and Insurance Sector Head, and Alaina Wadsworth is an associate in CMS Cameron McKenna LLP’s Commercial, Regulatory and Dispute Resolution Group.  CMS is the largest European Law firm. 
 
Stephen can be contacted via email at stephen.netherway@cms-cmck.com or alternatively by calling +44 (0)20 7367 3015.
 
Alaina can be contacted via email at alaina.wadsworth@cms-cmck.com or alternatively by calling +44 (0)20 7367 2722.