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Clause and effect

Economic downturns traditionally see an upsurge in claims, or threats of claims, against financial advisers.

Many of these claims may be unfounded or come to nothing but a key issue for any professional is the position of his or her professional indemnity insurer.

Professional indemnity policies are generally “claims-made” policies.

This means that the insurer indemnifies the insured professional against claims intimated against the insured – and notified to the insurer – during the period of the policy, even if the actual payment comes after the policy has ended.

This type of policy contrasts with (and has largely replaced) occurrence-based policies, under which insurers indemnified against losses resulting from the conduct of the insured during the period of the policy even if no claim was made until years later.

Occurrence-based policies caused much uncertainty for insurers because they could be made liable years later for the conduct of their insured of which they had been unaware during the policy period. As a result, liabilities were extremely hard to predict and premiums became inflated; and occasionally – as with the asbestos-related claims – massive and unforeseen claims incurred.

The point of a claims-made policy is that insurers are better able to keep track of the liabilities they are incurring so the policies generally have strict requirements regarding the notification of claims. In many policies, the insurers have the right to reject a claim if they are not told immediately of the claim or if they are not told immediately of circumstances which may give rise to a claim.

To avoid such a Draconian penalty for even a technical breach, IFAs should familiarise themselves with the notification provisions of their particular policies.

Consider the example given at the top of this page. Although this might at first glance appear relatively straightforward, looked at closely, the insured is, by this one sentence, burdened with seven distinct obligations. He is required:

i) to give a “notice”;

ii) to “the Insurer”;

iii) “in writing”;

iv) “as soon as practicable”;

v) “of any circumstance”;

vi) “of which he shall become aware”;

vii) “which may give rise to a loss or claim against him”.

Each of these has the potential to trip up a notification.

Although it may seem perverse, insurers are entitled to insist on strict compliance with the form of notification which they have demanded. It follows that an insured faced with the clause outlined above would have no guarantee of cover if he attempted to notify orally even if, in reality, a written notification would have provided no additional benefit to his insurer.

A difficult judgement for an insured is what amounts to a “circumstancewhich may give rise to a loss or claim”.

A recent High Court case demonstrated that such clauses will be interpreted generously in favour of insurers.

The judge, Gloster J, explained that an insured was required to notify insurers of a circumstance which “creates a reasonable and appreciable possibility” of a loss or claim.

There need not be the certainty of a claim, nor even a probability or likelihood of a claim, merely that the prospect of a claim emerging from a circumstance is “real as opposed to false, fanciful or imaginary”.

Clearly, this implies a wide obligation on an insured.

It should also be remembered that disputes over notifications only occur after a claim has actually been made. Accordingly, an argument that there was only a “fanciful” prospect of a claim emerging from circumstances known to the insured will be a difficult one to win against the backdrop of precisely that having happened.

The next question is how specific such a notification to insurers is required to be.

The answer is that it must be “clear and unambiguous”, leaving a recipient “in no reasonable doubt as to how it is intended to operate”.

It should be noted immediately that the subjective intention of the insured is irrelevant.

How much has been notified to an insurer (and consequently covered under a policy) is an objective question decided by a reasonable interpretation of the words actually used.

What an insured intended to notify, or thought he or she had notified, is of no interest to a court. Again, the recent High Court case referred to above provides a useful illustration.

The claimant company designed and operated tax- avoidance schemes.

In April 2000, a tax manager employed by the company began to raise concerns regarding the validity of certain of the tax-avoidance schemes which it had designed.

By mid-August 2001, these concerns had reached the board. Advice from a QC reinforced the concerns, which rapidly spread to other schemes marketed by the claimant.

By the end of August 2001, a full review had been carried out, which generally provided reassurance as to the validity of the schemes.

Such reassurance, however, proved ill-founded. The schemes marketed by the claimant were successfully challenged by the Inland Revenue. In December 2002, (eight months after expiry of the policy period), the first claim was received. Given that the policy period had expired, the only way that the claimant could secure an indemnity from its insurers was if the claims could be said to have emerged from a circumstance notified to insurers as soon as practicable during the policy period.

The claimant relied primarily on a letter sent to its insurers in August 2001. This letter had stated that: “The Inland Revenue, if minded, could be critical of some procedures followed in certain casesThe Board has taken the view that this might be regarded as material information for insurers. There is no sign of a claim arising at the present time, but the Board feels that it is appropriate in the circumstances to advise what is happening and to take your instructions.”

The judge rejected its claim, describing the letter as “coy in the extreme”, identifying no error, act or omission on the part of the firm, no victim or potential claimant, and no intention to notify under the terms of the policy.

Indeed the judge noted that as this letter was sent to the broker rather than to the claims department of the insurer, the letter was more in keeping with the disclosure of something material to the risk in relation to a new policy rather than a notification of a possible claim.

It was suggested at trial that the form of the letter was explained by the fact that the insured was wary of panicking insurers, lest it adversely affect their renewal premium, particularly in circumstances where the board itself was sceptical of the substance of the concerns which had been raised about the schemes.

Accordingly, in order to avoid problems with notification, all profess- ionals should:

  • Err on the side of caution in assessing whether claims may emerge from problems which become known. If in any doubt, notify;

  • Notify as soon as possible on becoming aware of problems; and

  • Make it clear to an insurer that what is being notified is a circumstance which may give rise to a claim and provide as much detail as possible.
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