Contract certainty: Choosing your words more carefully

Insurance Day invited a group of top UK insurance lawyers round a table to discuss how the legal profession can help the insurance industry gain greater contract certainty particularly in the light of the Financial Services Authority's stated desire to see change come about quickly.

MC: Maxine Cupitt, CMS Cameron McKenna
DW: David Webster, Eversheds
AS: Ali Sallaway, Freshfields
CC: Colin Croly, Barlow Lyde Gilbert
NM: Nicholas Munday, Clifford Chance
PT: Peter Taylor, Lovells

CC: What [the Financial Services Authority] was emphasising is the timing, and we all know that wordings are never drawn up on time. But the other aspect is the quality, because unfortunately, the way wordings have been drawn up in the past, they have been completed by a back-room person who does not place risk.

PT: I've seen slips that are a damn sight clearer than wordings. I'd much rather work with some slips than with some wordings and then you have some wordings that subordinate themselves to the slip and you are left with a complete dog's breakfast.

AS: I can't think of many situations where you have this two-stage contractual process, and I think some insurers, and possibly some insureds, have come to regard policy wordings almost as a second bite at the contract.

CC: Brokers very often have liked to leave it vague in the good interests of their clients because, if the wordings are not that precise, then when the claim comes along, they have more of an argument for payment.

MC: An immediate issue with producing wordings in a timely fashion is the rebalancing of resources. Brokers, who create wordings, may be saying to themselves "I have to front-load all of this work and actually I might not get anything out of it in the end". My experience is also that, traditionally, the underwriting side frequently does not get a budget for wordings work, which is one reason why you get clauses added to a policy without a review of the knock-on effect.

DW: The claims manager's cry is often "how could my underwriters have agreed that slip, or that clause, on that basis?". In other words, the complaint often is that not enough thought has been given to make sure the terms were understood.

PT: The aroma of premium outweighs the stench of the wordings. I think it does go in cycles. You get some underwriters who make their money on a mixture of premium and layoff and reinsurance arbitrage. Or there are underwriters who come into a market where they are the only person in the market, their terms are the only ones available. You look at what is covered and the answer is "not a lot" but the market is made. Three years later, out they go, and everyone else piles in because it is a great loss ratio, but they forget that it was all because of the wordings.

NM: I don't think we should generalise too much because there are a lot of insurance products out there where there is contract certainty: motor, household, most property. And, of course, many of the reinsurers dealing with each other directly negotiate contract wordings at the time the contract is placed.

ID: So how does the market in the context of legal services make the best use of lawyers?

NM: We are all agreed that insurance companies and underwriters cannot be expected to outsource the drafting of all of their wordings to independent law firms. They need to have in-house people.

MC: Wordings people will have to be involved in the sales process as well. Previously, they have often been compartmentalised, but they will need to be involved with meeting deadlines and interfacing with clients so that they understand what is needed.

PT: What lawyers often forget is that you are selling a product or risk. It is a commercial market and that is why you will never get legal certainty, because the more certain it gets, the more likely that the commercial flavour will go. I have an old precedent document that I sometimes go to. It has the most perfect clauses in the world but no-one sold a single policy with it it was so stacked in favour of one party.

NM: That's right. Your idea of perfection is always going to be from one side of the equation. Perfection is going to stop you from making the deal. You need to have give and take. The final wording should be a reflection of the agreed commercial position rather than the imposition of terms by one party.

CC: Can we agree that the market has not really tried hard enough to get that certainty within a commercial context?

DW: It is a very interesting question. Is it the market's fault? Is it the responsibility of the market to impose a standard clause, or is it better to let each insurance entity do their own thing and set up their own procedures?

CC: Standardisation can be a dangerous thing. We all know the dangers of trying to pigeon-hole. If you have a standard clause, people say "Ah, I must use the standard clause", but it may not be the right one to use.

MC: I think there is another issue, a really important one, which is that people should not set too much store on contract certainty as a panacea because if people think the FSA's vision of contract certainty will put paid to disputes, it won't. There is always going to be a particular set of facts against which a clause will be viewed when a claim is made. Disputes will still arise from that.

ID: What part does jurisdiction play?

CC: We all know that one of the first things is "which law should apply?". Now, to laypeople the choice of law or jurisdiction is not the first thing that comes to mind, but we lawyers all know that you cannot interpret a contract without knowing the law.

NM: The role of lawyers is a crucial one. We will see a structural change in our organisations because our insurance teams are very heavily biased towards litigation and dispute resolution. Law firms should be very aware of the gradual transition towards involvement at the front-end and regulatory stages of a transaction.

CC: Until Tiner, there has been reluctance by companies to spend money on wordings and advice. I cannot tell you how many times I've been asked how much it will cost to look at wordings, but they do not like the answer. Also, people are surprised when you want to see background documents they do not understand that you cannot develop wordings without having a context.

AS: Isn't that reflective of the different training and mindset of industry? We are in the legal profession and have to be concerned about issues, but we can find ourselves being a bit neurotic about the impact of something. I think insurers fear the process will grind to a halt if lawyers are involved at the front end.

MC: My firm is already frequently involved with non-contentious and wordings issues. The onus is firmly on us, as lawyers, to show the industry that we understand the commercial issues.

NM: If there is to be a significant volume of work for outsourced lawyers and we used technology, we might be able to develop a database of wordings. We could develop a much more streamlined way of providing services.

DW: The first job is to identify for each particular organisation which particular clauses they want to have in standard form and which they want to have ready to be used on a bespoke basis. This is a broad consultancy role that we provide either for in-house lawyers or to the underwriters directly.

PT: You could do a "tyre-kicking" exercise, where you take the wording in and simply mark up the things that are meaningless, inconsistent or you do not understand. That is something you could do in two to three hours and then send it back to the client to deal with.

CC: A big question is how much can be done in-house there are enormous pressures on them commercially. In-house counsel get things landed on their desk that they have to deal with very quickly. Outside counsel are listened to, as they can be more dispassionate. And there is another important thing about outside firms: we see a wider spectrum. Frankly, we see most of the [wordings] that go wrong and that is what you need.

PT: You need a pathologist somewhere. I do not understand, though, why the insureds do not demand more contract certainty.

DW: Sadly, it is because they believe the cover note is the contract ...

CC: Brokers are always the first ones brought into issues like this by the FSA, because they see them as key. But will they want to take on the extra expense?

AS: Brokers have always had problems with pricing they traditionally underpriced to keep clients happy. They need to price more appropriately so they can undertake some of these duties on behalf of their clients.

NM: Brokers need to be much more aware of the true cost of the services they provide and, in the same way as lawyers, be able to itemise and cost out the work they do on behalf of clients.

CC: I do believe there needs to be a legal input into legal certainty. Good quality wording is good risk management. If you look at the banking industry, they pay a fortune to the lawyers to produce the documentation. The insurance industry has to realise that it is a worthwhile expense.

AS: I wonder if we are confusing contract certainty as seen by the regulators, which lawyers would regard as a pretty low standard, with contract clarity. There will still be disputes even if you have contract certainty the arguments will just have to be that bit more inventive.

MC: Good relationships between the market and lawyers are key to understanding what someone wants to achieve.

DW: It is training underwriters to understand exactly what the clauses are. This also involves a different approach by lawyers to provide a service that is cost-effective and proportionate. We do not want underwriters to be put off coming to us for advice. We need to encourage them to do so.

MC: I understand that the CII will be including a wordings module in its syllabus.

PT: The CII is one of the worst offenders. If you read one of their exam questions with a choice of three answers, a lawyer would say "Depending on the wording, the answer is...". People should be taught to think like that as they arrive fresh out of school.

AS: The trouble is that underwriters and brokers have used certain clauses for years, considering that such a clause means "x" because they believe that is the custom and practice of the market. When a dispute arises, it turns out that such a meaning is not ascribed to it by custom and practice of "the market" necessarily, but rather their own or their company's custom and practice. Even in the same market, not everybody speaks the same language. Lawyers have to be alive to that.

CC: The problem is that courts or arbitrators look at loose wordings and find them to be a "dog's breakfast". So an investment upfront must be a worthwhile investment. In commercial markets, you bring in people to provide a service who are more capable than you are at a price that is how good business operates. I think that as standards improve the people running businesses will realise they do need to get proper advice.

NM: There is also growing pressure internally. People at the top of large organisations want to retain control.

CC: And when things go wrong, they get involved and want to know what went wrong to make sure it doesn't happen again.

NM: Companies are going to have to involve lawyers more in the commercial process and those companies will have to adjust their approach to remuneration. While external law firms do their best to provide a cost-effective service, excessive use of external lawyers will produce unjustified expense.

ID: Why is contract certainty suddenly so desirable?

PT: I think this has received a profile more because of the World Trade Center (WTC) attacks than anything that Spitzer or Tiner have done I think they are responding to events.

AS: [The disputes surrounding lack of contract wording in connection with] WTC may have surprised or shocked people external to the industry, but it certainly was no surprise to anyone in it.

CC: I think it got the message through to the top. The amazing thing was that there were two different decisions [on WTC] and how much money was riding on those. I think that has got through to the boardrooms.

ID: What about arbitration?

CC: The real problem is that we are getting some certainty in interpretation of wordings but, because of the confidential nature of arbitration, we do not know what they are. But there is a sort of international reinsurance law developing which I think will possibly bring about contract certainty. In countries where they have little juridical commentary, it is being reported back that it is likely an arbitration panel or court would look to English law, which I think is good for an international industry because one of the biggest problems with certainty is that you get excellent wording, but if your retrocession contract is on a different legal system, then you might have a different result.

DW: It is extraordinary that we are still seeing this constant mismatch between aggregation of the insurance and the reinsurance and I think the reason we do is because of the way the courts have interpreted these terms. It's not due to anything the market has done.

AS: It is not a jurisdictional or extraterritorial issue, it is often the same jurisdiction London market but the difference between the commercial court and arbitration. That's a problem.

CC: I wonder whether in the long run arbitration might not bring more certainty. It is one way in which everyone could apply similar principles without the rigidity of courts.

DW: It all comes back to the same point: underwriters have to take responsibility for making sure that wordings are the wordings they want, and the investment has to change from the back end, after claims have occurred, to the front end.

MC: The market over which the FSA can exert control is in turn dealing with a much wider market, some parts of which the FSA cannot control. That wider market has trends that our market will need to follow so there is going to be a tension between the FSA's agenda and the wider marketplace. I wonder how much thought the FSA has given to this?

This article appeared in Insurance Day (http://www.insuranceday.com/) on 23 May 2005.