Episodios
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Catherine Lewis and Emma Shafton team up to discuss the UK's Economic Crime and Corporate Transparency Act of 2023 and its potential impact on directors and officers (D&O) insurance coverage. Both based in London, the lawyers discuss important steps that policyholders can take to mitigate risks.
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Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Catherine: Welcome back to Insured Success. My name is Catherine Lewis. I'm a senior associate in our London office. I am joined today by my colleague Emma Shafton, who is a senior associate in our global regulatory enforcement group who specializes in white collar crime and investigations. Today, Emma is going to talk to us about the two new corporate criminal offenses contained in the Economic Crime and Corporate Transparency Act 2023 which came into force in the UK at the end of 2023. And we are going to share our insights on what this means for policyholders operating in the UK. The potential impact on your directors and officers and other insurance cover and some of the steps that policyholders can take to mitigate risks. Emma, could you give us an overview of this new legislation?
Emma: Sure. So the Act, ECCTA I'll refer to it as, came about as part of the UK government's response to Russia's invasion of Ukraine in February 2022. By this time, there was an increasing understanding that London had become um a dumping ground really for dirty money by foreign elites, Kleptocrats and other bad actors and that the UK's economy was being abused. So the act represents a complete overhaul of the UK government's framework for tackling economic crime. The act itself covers a very broad range of issues. You know, beyond the scope of this podcast, including companies house reforms, but today, we're going to focus on two significant changes to corporate criminal law. The first is the new senior manager's offense and the second is the new failure to prevent fraud offense. So let's deal with the first offense first. So that's the senior manager's offense and that's under section 196 of ECCTA. Uh This came into force very quietly on boxing day last year actually. Um and a lot of Corporates have been caught by surprise by it and it's worth flagging at the outset that this is completely separate to the FCA's existing senior managers and certification regime. These are different things. It's perhaps unfortunate that the draftsman of a decided to use the same language because the definitions unhelpfully do not correlate. Um So I just wanted to flag that at the beginning, we're dealing with a completely new corporate criminal offense here. What the offense means basically for corporates is that if a senior manager of the organization acting within the actual or apparent scope of their authority commits a relevant criminal offense and those offenses are economic crimes. So things like theft, bribery, fraud, false accounting money laundering, and also certain tax offenses. If that senior manager commits one of those specified offenses, the corporate can be criminally liable. Now, what the repercussions of that would be, is a very large fine. Essentially. Now, this offense um can apply to senior managers of a body corporate or partnership and there's no size criteria or threshold. So that means that all organizations um of any size could be liable so long as the jurisdictional requirements are met, you know, this is a UK act and we'll come on to that um, Later.
Catherine: Interesting, this seems like a really big shift from the previous regime. Is, is that right?
Emma: It is. So the new senior manager's offense is one of the biggest changes really in corporate criminal liability in over 100 years. So under previous law, uh which was, you know, Victorian law, um, corporates could only be prosecuted and criminally liable for the offenses of its employees if it could be shown that that individual was acting as the directing mind or will of the corporate and you know, they had the necessary state of mind for the offense in question. So with a lot of the economic crimes, usually that involves dishonesty. So historically, this made it very challenging for authorities to prosecute corporate successfully. Um because there's just a very small group of people who would meet that criteria of directing mind and will. And this is particularly so in large corporates, with complex management systems became very difficult to identify whether an individual belonged to that group. So that was the sort of historic position. This new offense essentially makes it much easier for corporates to become criminally liable for the actions of its senior managers now.
Catherine: So, I mean, who are these uh new senior managers that have been identified?
Emma: So, um this we foresee is going to be one of the issues with this legislation and for corporates in actually identifying who their senior managers are, and it's not entirely clear from the legislation. Um there's no guidance. The government are not required to publish guidance for this offense uh about this point so that the act defines a senior manager as an individual who has a significant role in the decision making of the whole or a substantial part of the corporate and someone who is involved in the actual management of the whole or part of the corporate. So it's somebody who's making decisions, really somebody who is making decisions at a high level. Um Apart from directors who are perhaps a sort of obvious class of people who would fall within this definition, other roles could include a regional manager, for example. Uh but you know, as, as I've already said, it's not clearly defined who senior managers are. And it may be difficult in practice for corporates to identify who their senior managers are because depending on the sector and the business, this may be a fluid category of individuals. We also foresee that one of the biggest challenges for prosecutors is going to be proving apparent authority. So actual authority, perhaps you might look at a job's description or somebody's responsibilities to determine what is within someone's actual authority. But what does apparent authority mean? It sort of implies that that person doesn't have authority to do um the act in question. So we think there's going to be substantial debate on this topic. And um it'll be very interesting to see. The SFO have indicated, the Serious Fraud Office that they may publish some guidance about how this new offense will be enforced. So it will be very interesting to see in due course, what they say about this. So, um yeah, that sort of is broadly um the position on the definition of senior managers.
Catherine: That's really helpful. Thank you. And so is the senior manager events limited to individuals within the UK?
Emma: So the definition of a body corporate or partnership in, in the act includes um those incorporated outside of the UK, so um it's not limited to the UK, and what this means is that a non-UK company could be liable under this act where um an offense is committed by a UK national senior manager, for example, or by a foreign national senior manager when the offense is committed in the UK. So there is certainly a degree of extra territoriality.
Catherine: Really interesting. So it seems to me that policyholders will need to be carefully considering their directors and officers insurance as well as their liability policy wording to take into account these pretty serious and significant changes. Directors of offices or D&O policy is one that a policyholder would typically look to respond if it's faced with an investigation or a potential investigation by a regulator or an authority um, in respect of the conduct of its senior management and clearly an important point for policyholders is to, as you said, Emma consider who their senior managers are and to ensure that those individuals are falling within any applicable policy definitions of individual insured or insured persons. Are we expecting to see a significant number of investigations or prosecutions or penalties being levied as a result of this legislation?
Emma: Yes, we think so. So on paper, the offense is astonishingly wide. The group of individuals whose conduct can lead to the prosecution of their company for their actions, their criminal actions has, it's really expanded the pool of people is much bigger now. And therefore, um the new offense significantly increases the risk of criminal liability for corporates but of course, um, you know, these offenses are only as good as the enforcement agencies, um, who might use them. So this offense is only going to be a game changer and is only going to see more prosecutions and so on if the agencies actually use them. So at the moment, we, we understand that the serious fraud office are, are quite excited about this new legislation. Um, yesterday, I, I heard a senior person from the serious fraud office describe it as a game changer this offense and said, you know, where appropriate obviously, they will use this offense where they can. They've had um a very bad track record of securing convictions against individuals in relation to corporate settlements and have lobbied very hard to change the law in this area. So, you know, we certainly um would expect to see them using this relatively soon in an appropriate case. And as I highlighted earlier, they've hinted that they are going to publish some corporate guidance in relation to this. So we, we await that with interest. There's definitely a sense though that the office is buoyed by this new offense. It's got a new director in place and are doing things differently. It seems so we, we can expect the SFO certainly to be looking at this offense very closely. And then from an FCA perspective, they've recently published their 24/25 business plan and commitment number one is reducing and preventing financial crime. So we would expect, you know, the FCA to be looking very closely at this new tool available to them as well. Another point to highlight in relation to, you know, whether this is going to see a significant number of or an increase in prosecutions and investigations is that there is no defense, there's no defense of having reasonable procedures in place. Uh, which is very interesting. So, um, yeah, we, I think we can expect to see more investigations and prosecutions. The penalty is an unlimited fine for the corporate.
Catherine: Wow, that's pretty, pretty significant for, for anyone doing business that touches the UK. So what can companies and businesses do to mitigate and, and reduce their risk? What steps should they be taking now?
Emma: Policyholders should identify their senior managers as, as the first port of call. And we've already explained that this may be challenging to do in practice, but that's the first point. And, and once you've identified that group of individuals, you need to consider the risks really that those individuals might do something that results um, in criminal liability for the corporate. So introducing comprehensive training relating to economic crime, money laundering for senior managers is going to be key and I've referred to money laundering and that's because it's very important to note that in addition to bribery fraud, theft and so on, there are some money laundering offenses, um, that are caught under this act, in particular in relation to the AML mandatory reporting regime, suspicious activity reports. It's a criminal offense under the process of Crime Act when a relevant person in the regulated sector fails to notify the authorities about suspicion of money laundering and under this act. Now, if that substantive offense could be made out, the corporate could also be liable which wasn't the position before. So, very significant changes here.
Catherine: Yeah, absolutely. So, moving on a little bit, then can you tell us about the new failure to prevent fraud events?
Emma: Yes, sure. This is under section 199 of ECCTA. It follows the failure to prevent model that our listeners are probably quite familiar with now. So section seven of the Bribery Act um was the first offense of this nature and subsequently, we've had failure to prevent tax evasion. The, the key difference though, in relation to this new offense and the Bribery Act, however, is that it only applies to large organizations. Section seven of the Bribery Act applies to all organizations irregardless of size. So it's a smaller pool of corporates who will be affected by this. But the definition of large organizations for the purposes of this new offense is the organization must have a turnover of more than £36 million a balance sheet total of on aggregate more than £80 million in assets or more than 250 employees. And it has to meet two of those criteria.
Catherine: Thanks, and so how does the offense work?
Emma: So if you're a relevant body, so as defined, meeting two of those three criteria, that relevant body will be criminally liable when an associate of it commits a specified fraud offense. So there are four requirements of the offense. The first is there must be a specified fraud offense. Um Those are all listed, but you know, it would be offenses under the fraud act and false accounting, fraudulent trading. The second requirement is the offense is committed by an associated person to that corporate. So associated person is a term we're very familiar with from the Bribery Act, but it's an employee, an employee of a subsidiary agent that those are the sorts of people who are associated persons. It's apparent that the SFO is taking quite an expansive view of who falls within, into associated persons and recently indicated that it's looking at whether social media companies could be liable for failing to prevent investment fraud perpetrated on their platforms, for example. So that just gives you an idea of how expensively they are looking at it. The third requirement is that the offense um is intended to be for benefit of the organization. The fraud doesn't have to be successful, uh doesn't have to 100% be for the benefit of the organization. But it's important to note that if a corporate is the victim of an employee or associated persons fraud, they will not be liable under this offense. So that's an important carve out. And then the last requirement, the fourth requirement is that no reasonable fraud prevention procedures are in place if they are. It, it's a defense. The offense itself is actually not in force yet. Um And that is because there is a requirement for the government, the home office in this case to publish guidance and, and that has not been finalized yet. There's draft guidance in circulation and the final guidance is said to be expected imminently. The offense is meant to come into force six months after the final guidance has been achieved. So um could be this year we're waiting to see um in our view though, that six month period isn't enough time for corporates to get ready.
Catherine: Yeah, I agree. That seems like a pretty, pretty short amount of time to get ready for some fairly significant potential offenses there. I asked this question regarding the senior manager offense, but does this offense apply just to UK companies?
Emma: So there's also scope for um extra territoriality in relation to this offense. It depends really on where the specific underlying fraud offenses take place. So a non-UK organization could be caught by this offense where say an employee or agent commits fraud under UK law or targeting UK victims. So the key thing is where the fraud is taking place, not necessarily where the person is, who's committing it.
Catherine: Right, That makes sense. Are we expecting then to see a significant number of investigations and prosecutions once this element of the legislation comes into force?
Emma: Given the offense only applies to very large companies. We're not expecting as many prosecutions or a significant uptick as we are with the senior manager offense. But we are definitely expecting prosecuting authorities will look to use this new tool where they can and it is possible to see joint charging because the way the legislation for the senior manager offense is drafted, it's not the case that a senior manager has to be taken to a court convicted. And only then once that conviction is, you know, confirmed, the prosecutor would then go on to prosecute the corporate. It, there's no requirement for that. So what we might see is joint charging of senior managers and corporates for the failure to prevent offense. At the same time as with the senior manager's offense, the penalty is an unlimited fine again. So it's essential that large companies are prepared for this legislation.
Catherine: Yeah, fully agree with that. Um Let's go on to about what what steps they can do to prepare. We talked about it a little bit earlier about the senior managers events, but what steps should uh policyholders be taking taking here?
Emma: The critical thing to do is risk assess so specifically focused on fraud, risk and the risk of other economic crime. And if a corporate has already undertaken a fraud risk assessment, that should be reviewed to make sure that it remains fit for purpose. As part of that risk assessment, you should be assessing your geographies, sectors, clients and suppliers. So the second thing is once you've done that risk assessment, ensure that you have proportionate policies and procedures in place to cover those risks, um identify who your most at risk employees, subsidiaries and associated persons are as part of that risk assessment, consider introducing comprehensive training for your employees, subsidiaries and associated persons in relation to financial crime risks and monitor and incentivize compliance. Those are the key things that policyholders can be doing to prepare for this legislation.
Catherine: This all sounds really critical for policyholders and I expect that it's these are the sort of questions that insurers will be asking policyholders when it comes to renewing insurance policies. I certainly think we can expect questions about the identification of senior managers as well as copies of risk assessments and reporting procedures. So any potential concerns are raised and addressed appropriately within the organization?
Emma: Yeah, I totally agree. Are there any other final points from an insurance perspective that you think policyholders should be aware of when considering the impact of the two new offenses?
Catherine: There are Emma, and I've been thinking a lot about all the really helpful analysis and explanation you've done of these pretty significant offenses and some of the key considerations I think that policyholders should have in mind entering into a renewal process since the introduction of the legislation and the two offenses are, is there sufficient investigatory costs cover? So will the policy respond to an investigation being instigated by any of the authorities? And what is the trigger for any investigation or pre-investigation costs? So at what point does the policy step in and help uh a policyholder cover any of its legal costs or investigation costs in looking into the facts and events that the authorities are also looking at. And is there an extension for any specific pre-investigation or mitigation costs? It's also worth bearing in mind what the notification requirements are under the policy in the event that there is an issue down the line when faced with an investigation or request for information from an authority that often requires a really quick response from the business. And the priority obviously will be engaging with the authorities and insurance may not always be front and center of everyone's mind in that context. It's incredibly important that any notification requirements are not unduly onerous to making sure that the policy allows for plenty of days for a notification to be made and avoiding any conditions precedent to cover in case notification isn't made as promptly as everyone would like. When it comes to D&O policies as well as having side A and side B cover protecting individuals, as corporate entities as well as natural persons can be liable under these offenses, I think businesses should be considering whether they want any side C cover as well and having a discussion with their broker about the benefits of having sort of this additional D&O cover. And a basic point but nevertheless important one checking an overall limit of indemnity, making sure that the limits of liability continue to provide adequate protection for the business, particularly in light of what you've been saying about expecting an increase in investigations as a result of the senior managers, events in particular. In my experience when there's an investigation or inquiries are being made by a regulator or other authority clients, customers, investors all tend to get pretty nervous if things lead to a prosecution or a threat of prosecution. A policyholder might also start to see some civil claims coming from allegedly injured parties trying to seek compensation, whether that's investors and shareholders or customers and clients. I think in those circumstances, policyholders should also ensure that any civil liability policies provide the right level of cover for their businesses. So that's it from Emma and I today. Emma, thank you for sharing all your insights on this important new legislation and your tips for mitigating and managing some of the risks. Don't forget to tune in to our next episode.
Emma: Yeah, thanks for having me, Catherine. It was great to chat about these new offenses and yeah, please do everyone feel free to, to reach out if you have any queries about them.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, Opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
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David Cummings and Lauren Gubricky are joined by Jeff Buzen of McGill and Partners to discuss representations and warranties insurance, best practices for making claims and trends in the industry.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
David: Hello and welcome to another episode of Insured Success. Thanks for joining us. My name is David Cummings. I'm a partner at Reed Smith in our insurance recovery group. A way of just a little bit of background. My practice focuses on navigating insurance coverage, disputes, litigation, mediation and arbitration for our corporate policyholder clients, as well as helping those clients navigate insurance placements, renewals claims and the like all with their insurers. An ever growing part of that practice involves a product called representations and warranties insurance or reps and warranties insurance. That's a topic of our discussion today. So before we get started, I have a few introductions are in order. Uh I'm joined today by my colleague, Lauren Gubricky, an associate in Reed Smith's insurance recovery group. Hi, Lauren.
Lauren: Hi, Dave. Thanks for having me.
David: I’m also joined by our guest, Jeff Buzen, a partner in financial lines at McGill and Partners. Hi, Jeff. And thanks for joining us today.
Jeff: Thanks Dave. Great to be here.
David:So, between the three of us, we're gonna cover a few topics today. So I'm gonna start and provide a high level overview of reps and warranties insurance, what it is and how it's used. Then I'm gonna pass it to Lauren who's going to focus on reps and warranties claims and a few best practices. And along the way, we're gonna talk with Jeff to provide us with some insights and trends with respect to the reps and warranties market. So with that, let's get started. So let's start with a quick overview, reps and warranties insurance. What even is it? At at a very high level in a private equity deal, we have company A, the buyer purchasing company, B, the seller. So as part of that purchase and as a result of information borne out through due diligence, the seller makes certain reps and warranties regarding its business. Those can include ongoing risks, contingent liabilities, reps related to financial statements and so on. Traditionally, to hedge against the risks of inaccurate or incomplete information, the asset purchase agreement would provide recourse to the buyer in the form of an indemnity provision and the way that works is a seller would have to back that obligation with funds in the form of a hold back or escrow uh and keep those funds in place for a negotiated survival period, often for several years. Now, the issue is that these indemnity provisions can be the source of extensive negotiations in and of themselves negotiations that could add layers of unwanted complexity to a deal. Um And that may result in delays and disagreements. And in some cases, historically, the deal could collapse entirely over, over these disagreements and these negotiations. So insteps reps and warranties insurance. This product was developed to at least in part to avoid these issues and speed up deals by shifting the risk to a third party insurance company. This allows for higher indemnity limits and survival periods without material increasing seller exposure all while being able to keep up deal pays to close quickly and not be bogged down by extensive disagreements or negotiations between the buyer and the seller. So what do these policies look like? So they can be purchased by the buyer as first party coverage or the seller as third party coverage in practice though the overwhelming of them are buyer side. The actual scope of coverage is determined by those specific reps and warranties in the asset purchase agreement and that agreement is generally incorporated into the policy itself. It's a very general matter. Although these, these policies can differ from deal to deal and insurer to insurer. The insurance covers inaccuracies or gaps in the reps and warranties that cause loss or liability to the buyer and although the exclusions too can vary depending on the specifics of that deal and the industry and the reps and warranties at issue. There are a few common exclusions that we see across policies. One of those is an exclusion related to known issues. This type of exclusion is common, not just in reps and warranties, insurance, but really across the full range of insurance coverage. It excludes coverage for losses attributable to issues that the parties were aware of at the time of placing coverage under the general theory that you, you just, you cannot purchase insurance for existing or known loss. A second, common exclusion is purchase price adjustments. Often the asset purchase agreement allows for a post closing purchase price adjustment based on financial metrics calculated as of that closing date. And so reps and warranties policies generally exclude losses deemed attributable to the that adjustment mechanism. Another one is uninsurable, criminal fines and penalties. This is also a common exclusion, not just in reps and warranties, but across policies of all types and in many cases tracks state law providing that such fines and penalties simply are not insurable. The rationale here is that such fines are attributable to willful or intentional and therefore uninsurable activities or emissions. And then there are just traditionally a few itemized coverage carve outs. Two common ones, for example, are asbestos and underfunded pension liability rationale here with, with these carve outs as well as others. Is that other types of insurance are intended to be responsive to claims of this nature. So with that background and overview, I'd like to turn it over to Jeff to talk a bit more about his perspective as a broker in the reps and warranties insurance market. But first a little bit more about Jeff. Jeff Buzen is a partner in McGill and Partners mergers and acquisitions group where he focuses on structuring marketing, negotiation, and broking representations and warranties insurance, as well as tax liability insurance and other bespoke contingent liability insurance solutions. Jeff works on transactions spanning the entire mergers and acquisitions market. However, he has extensive experience in the financial services, food and beverage and life sciences sector. So Jeff, thank you again for joining us today.
Jeff: Thanks Dave.
David: And so we're recording this right about at the end of 2023. So I'd first be interested in your thoughts. Looking back on this past year. Have you seen any noteworthy trends or items of interest this past year or even further down the road that, that has impacted the placement or negotiation of these policies or, or really anything else?
David: Yeah, definitely. And I think you provided a great overview of reps and warranties insurance and what it is, but a little bit about the history of the industry, right? It it really insurance solution started taking off a little less than a decade ago. Um And then, you know, into 2021 and 2022 you know, the kind of busiest times of of the M&A market in recent history actually of all time, right, utilization of reps and warranties insurance was very, very, very hot. Ok? And the utilization rate of reps And warranties insurance across M&A transactions continues to be high and perhaps even higher this year than it was in in recent years. But the M&A market itself is much slower than it was certainly in 2021 and into the first half of 2022. And so what that means is there are more insurers, more underwriters in the market, but because there are fewer deals getting done, there's this mismatch between the demand for reps and warranties insurance and the supply side, right, the insurance capacity available to underwrite transactions. And so that means it's a, it's a very insured favorable market at the moment. Pricing retention have come down a lot. There are a lot of new coverage enhancements that insurers are offering that weren't readily available even a couple of years ago. And so overall, I'd say it's been a good time, a good year to be a buyer of reps and warranties insurance for, for all of these factors.
David: Thank you. That's, that's an interesting outlook. And, and so, you know, at this time of the year, a lot of clients are looking towards their deal activity for 2024. I'm sure the insurance market is also looking into what the next year in the, in the coming years might bring. Uh, do you expect any of these trends to continue into 2024 or what are, what are you seeing, uh, from a market perspective that might be the same might change or, or really just might be interesting?
Jeff: Yeah, I mean, ultimately, my view is we're going to continue to have been an insured, favorable market so long as the M&A market remains at the current activity levels and or until insurers start to start to leave the reps and warranties market, whether that's because of claims or just because they feel they aren't making sufficient premium to justify being in the business. And so, you know, we closely, you know, obviously monitor M&A activity broadly. And I think, you know, I don't, I don't have a crystal ball, but there are some positive signs in recent weeks that suggest that 2024 should be a busier M and a year than 2023 certainly with inflation numbers coming down and the fed indicating that there could be, there should be rate cuts coming soon. Um So, you know, from that perspective, I think there will be more reps and warranties, uh demand for reps and warranties insurance next year. As it relates to the insurer side, you know, a lot of insurance and reinsurance renewals are ongoing as we speak. And so we're in close communication with our insurance carrier partners to make sure, you know, we want to hear how those renewal meetings are going and making sure they really are committed and going to be able to continue to provide reps and warranties insurance capacity for the long term. Because ultimately, when there, if and when there is a claim for our insured clients, we want to make sure, you know, it's a insurer that's still in the industry and is going to have the motivation to act commercially in a claim scenario and handle that, that claim in a, in a good way that won't harm their reputation in the market. And so, you know, so far early indications are, you know that these reinsurance renewals are going in some ways better than expected, right? And so some insurer insurance carriers are actually going to have more, a higher limit, more capacity in 2024 than in 2023 which is surprising to some because we are in this kind of depressed rate environment at the moment. But I think it's, it's a good sign that insurance carriers and reinsurance carriers are committed to this space for the long term.
David: Thank you, Jeff, I appreciate your insight. And so with that, I think we should transition a bit to talk about reps and warranty's claims. And for that, I'd like to turn it over to my colleague Lauren Gubricky. As mentioned, Lauren is an associate in Reed Smith's insurance recovery group. She works on insurance coverage disputes for corporate policyholders of all types and industries. Many of are an increasing number of which are related to representations and warranties insurance issues and disputes. Lauren, thank you again for being here.
Lauren: Thanks, Dave. Happy to be here and happy to talk about the claims process and best practices, at least from the policyholder perspective. So, you know, Jeff touched on this already, but when a buyer asserts that a seller has breached a representation or warranty or at least has breached multiple reps and warranties, these breaches can have a serious financial impact on the company. And we've seen this impact be upwards of tens or hundreds of millions of dollars and the claim process is really where it all gets sorted out. So in the past few years, I've been able to handle a number of these claims and in our world, they range from, you know, relatively small amounts around $50,000 or so to many millions of dollars and regardless of the amount that's in dispute for these claims, there are certain procedures and best practices that policyholders should remember as they go through this process. So some of these, we all are probably familiar with just from claims handling under more traditional lines of insurance. Um And some of these are a little bit more unique to reps and warranties claims. So what is not unique to reps and warranties claims but is especially important for these types of claims is that the policyholder really needs to conduct a robust factual investigation before submitting anything to the insurance company. So typically after closing, the buyer discovers um a particular issue that really should have been disclosed prior to closing. Um obviously, that's not a great situation to be in. But the good part is that now that the deal has closed, the buyer now has access to the information and people and can really just start conducting an investigation from the beginning and see the buyer might know that there's a problem and think that the reps and warranties policy will cover them. But without knowing the specific details of the breach and the loss, the buyer can't really know like which representations or warranties were actually breached. So this is really the time that the buyer is to determine, you know, what is the loss or at least, do you have a reasonable estimate of the loss? What caused the loss? Um Does the loss involve negligence or does it rise to the level of fraud? And importantly, what was known about the loss prior to closing and who knew about it? Reps and warranties policies are usually pretty specific as to whose knowledge triggers a breach. And the policy and the purchase agreement will usually identify certain people by name or at least identify people like by title. Um And so this whole factual investigation process is the most time intensive part of the claim and many times, you know, the the deal has closed, people are moving on, you're running with the business making good money, but then uh we have to deal with the threats of warranties claim. But it is so important that everybody gets together and has all of the information that you can possibly get on the claim before submitting an actual claim to the insurance company. The next part of the claim process is really just at least from the policyholder side is really just taking a look at the transaction agreement itself and the policy with the purchase agreement like Jeff and Dave were talking about, you're really just looking at the specific representations and warranties. You know, Dave touched on a few of these, but most of them have typical reps and warranties like compliance with certain laws and compliance with taxes. Um but some transaction agreements may have industry uh specific representations and it's often the case that one breach or one loss will implicate multiple representations and warranties. With the policy itself, you're looking to see if any exclusions apply and also taking a look at the really practical things like limits the retention, things like that. And finally, once we've done this big investigation and we know what the policy says, we know what the purchase agreement says, you're ready to start drafting and submitting the claim. So most policies are really specific on what needs to be included in an actual claim. It typically requires a narrative of what has happened. An identification of specific representations and warranties that were breached, or potentially breached, or likely to be breached, and a reasonable estimate of the loss as you know it at the time of submitting the claim. And this is what kick start the claim process. Um The insurer has a set amount of time that they're required to at least respond to the claim. And like in other claims under more traditional lines of insurance, um they'll probably issue like a preliminary coverage letter broker is often involved in this process. Um And there's a further exchange of information and that's when the policyholder will start to see any coverage issues that might arise. And so, you know, I recently dealt with a pretty large representations and warranties claim just a couple months ago. What happened in this claim was that there was an undisclosed change in the law that severely affected the buyer's profits. And so one issue that the insurer raised was how this particular change in law affected our company individually versus other quote similarly situated companies. And that's sort of a term of art. And we had done this robust factual investigation like I mentioned, and so as soon as that coverage issue was raised by the insurer, we already had good information on these other, you know, similarly situated companies and were able to very quickly respond to the insurance company’s coverage issues and request for more information and ultimately successfully resolve the claim through mediation. So I won't continue to bore everybody with this claims process. But that's sort of an overview of how these reps and warranties claims happen and how a policyholder can best position themselves for coverage under the policy. So, Jeff, I know you talked a little bit earlier about some trends in the market with respect to your placement and pricing and so on, but transitioning to claims a little bit, are there any claims activity that you think is having sort of an outsized impact on the market right now?
Jeff: Yeah, I think so, Lauren, I mean, when you look at most claim studies that are out there and you know, our own data internally at McGill and Partners, you know, it's, it's pretty consistent that about one in five policies will have claim notices submitted on them. Um But the the vast majority of those fall within the retention or are precautionary in nature. Um But so really, it's 5 to 7% of policies, give or take, have an actual loss paid out on it for the insurers come out of pocket, paying the insured for loss that's in excess of their retention or deductible under the policy. And that's, that's been pretty consistent year over year. But what's interesting is that since, as I mentioned earlier, 2021 was the busiest year on record for reps and warranties insurance that means right now in 2023 and 2022 insurers are getting more claims and claim notices than ever before because there's a kind of natural 6 to 18 month lag between when a deal closes and when a breach is actually discovered and submitted to the insurance carrier. And so insurers are getting more claim notices and more data on claims than they've ever gotten before as a result of that. And there are a lot of, I think interesting takeaways from all, all of these new claims that are coming up. And it's definitely impacting how insurers are approaching underwriting on the front end, right, when they're actually placing policies today. So, I mean, in particular, you know, where one area where we tend to see the most severe claims are whenever it's a claim that is impacting how the buyer valued the business at closing. Right. And so whether that's based on a theory of multiply damages or diminution in value, those tend to be the most severe claims. And importantly, insurers in the industry are paying out claims on that basis and recognizing for certain types of breaches that is the appropriate measure of damages. And let's say you have a, a $1 million issue, but you paid 15 times a multiple of EBITDA to value the business and this is a recurring $1 million impact on the business that's going to impair earnings, uh, in perpetuity, then the appropriate measure of damages might be $15 million instead of that $1 million. And so oftentimes these types of these breaches might relate to financial statements reps, but it also could relate to other types of reps as well such as material contracts. And so insurers are very focused on the due diligence that buyers are conducting. Not only on the the financial statements, that's kind of been the case for years and years and that will continue, but especially on those key customer and key supplier relationships. They want, they want kind of independent um diligence and verification that those relationships are strong and aren't going to go away post closing, that's going to result in some large loss, post closing. Uh Another area that's kind of emerging where we've see seeing more and more claims and particularly more and more severe claims relates to condition of assets and uh on condition of assets. There's actually a $1 billion, that's with a B, rep and warranty claim that's percolating in the market at the moment and for based on that claim alone, but also, you know, other claims and in relating to breaches of the condition of assets rep, you know, that's a rep that says that the physical assets of the target company are in good working condition, subject to ordinary wear and tear, right? And so now, insurers for asset intensive target companies are increasingly focused on um buyers conducting technical due diligence, reviewing maintenance logs, really you know, getting under the hood, so to speak and getting comfortable in getting the insurers therefore comfortable that, um, you know, there are the physical assets of the target are in good working condition and that, you know, you're not going to have some, some big surprise post closing when the buyer actually takes control of the business and turns out actually now all these, all this machinery, all this equipment needs to be completely overhauled because it isn't functioning properly. So, yes, there are lots of, lots of claims, many have been resolved successfully, many are ongoing and it's definitely having a big impact on, on how underwriting is, is being conducted. Um But ultimately, I think, you know, it's, it's for the best, right? We want we as the broker, right, we want to be in a position where we can advise our clients to make sure that they're scoping the due diligence in a, you know, what a customary buyer would do or a commercially reasonable buyer would do such that they can get coverage for all of these broad but really important reps and warranties that they're negotiating into their transaction agreements.
David: Thank you, Jeff, again, very insightful and appreciate your advice and, and insight into the claims process that concludes our conversation today about all things, reps and warranties, insurance. Again, I'm David Cummings and I'd like to once more thank Lauren and Jeff for their time and insight today. This has been Insured Success. Thanks very much for listening and we hope you tune in again for our future episodes.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcasts, PodBean and reedsmith.com. To learn more about Reed Smith's insurance recovery group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
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Laura-May Scott and Margaret Campbell analyze the ABN AMRO Bank N.V. v. RSA et al case in detail and also cover what should be included in a marine cargo policy.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Margaret: Hello, welcome back to the Insured Success IRG podcast. I'm Margaret Campbell, a partner at Reed Smith and this is my partner, Laura-May Scott. We are both insurance recovery specialists. Today we're going to present to you a case analysis on a very important case that we worked on during the pandemic. In this case, we represented ABN AMRO who was suing a group of 14 insurers in the company and the Lloyds Market and ABN’s broker, Edge, for losses it thought it should have been covered for under its marine cargo insurance policy.
Laura-May: And it's worth setting the scene here a bit and reminding listeners what a marine cargo policy typically covers. A marine cargo policy does not just provide cover for marine transit. It's capable of being extended to cover transport by air, rail, road and storage. So marine cargo cover can ensure the entire movement irrespective of the means of transport of the underlying goods. Now, under a standard insurance policy, it's only the physical loss or damage to the goods which is generally the subject matter of the insurance.
Margaret: So going back to the ABN case, the case there concerned losses of £35 million suffered by the bank when two of its customers Transmar and Euromar defaulted under a series of repo financing deals over cocoa and cocoa products. And a significant fraud was uncovered in relation to the defaulted transactions. Not only had the same goods been pledged to various banks, but the quality of the goods was absolutely terrible. Following their defaults, the bank was left holding large quantities of cocoa and cocoa products worth only a fraction of the loan repayments due to the bank. During the course of this case, Laura-May and I learned a lot about cocoa and cocoa products, much more than the man on the street ever knows. And we would issue a warning to everyone listening to this podcast to avoid cheap chocolate.
Laura-May: Yes, indeed. Initially, we worked with the bank and the broker to seek to persuade the insurers to actually pay out under the policy. We gave presentations to them on the underlying goods and the steps that were being taken by the bank to recoup losses. Thereafter, we entered into formal correspondence where the bank formally claimed an indemnity for the shortfall under an all risks policy of marine cargo insurance, which as Margaret says was placed with 14 cargo insurers in the London market by Edge brokers. However, the insurers formally rejected the claim after five long months of discussion.
Margaret: So this claim was actually made for financial losses arising from the defaulted transactions. The problem was the cargo was valued at 35 million and when it came to be sold, it was worth, you know, just a couple of million. Uh There had been no physical loss or doubt with just a question of quality. For those of you familiar with marine cargo insurance, there have been many legal authorities in England that say that in order to trigger a marine cargo policy, you must have physical loss or damage to the cargo. So what was different here? Well, in this case, this was precisely the risk that the bank was, was concerned about and they talked about it internally, they took legal advice from outside lawyers, they talked to their brokers, they went backwards and forwards for months saying in this scenario, what would happen in that scenario, what would happen? They wanted to make sure that their insurance would respond to them in the event that there were any problems. So this was the risk they were concerned about and they negotiated or thought they'd negotiated a bespoke clause in the policy which is called the Transaction Premium Clause. And this provided, the bank was covered for amounts that the insured would otherwise have received and or earned in the absence of a default by a customer. The bank and the broker contended that the effect of this clause was to add a form of credit risk or financial default insurance to the cargo policy. This had been written into the contract after, as I said, all the advice they've taken from everybody and they had instructed their brokers to negotiate it with the underwriters. The brokers had confirmed, they discussed it with the lead underwriter. And as far as the bank was concerned, they had this cover and no problem.
Laura-May: And it's worth noting there that the marine cargo policy in question had various add ons, didn't it? So it wasn't a standard marine cargo insurance policy. Uh It had add ons such as confiscation, expropriation, fraudulent bills of lading. So this was really a very bespoke policy that the client had created over a course of many years. And the crux of the dispute with the insurers really was that those various add-ons needed to still be tied to the underlying physical loss or damage. So the Transaction Premium Clause in and of itself did not provide stand alone credit risk type cover.
Margaret: So how the case unwound with the uh the losses have been suffered? The bank thinking they were covered, said to the brokers, can you please notify the insurers? Uh the brokers notified the insurers but without actually consulting the bank at all. They just notified a small claim and put a value of $50,000 on which was completely inadequate. The brokers also notified under the wrong clause of the policy and it turned out many months later that we discovered they were looking at the wrong version of the policy. Um So that was not particularly helpful in dealing with the insurers. However, uh to begin with, the insurers didn't take any points defending the claim. They just acknowledged the claim. They reserved their rights generally. And uh we invited them to meetings to discuss the claim and gave them presentations on what was involved. And at that point when they realized that it was not a $50,000 claim, but it was potentially a 35 million claim, they actually changed their position and formally declined the claim.
Laura-May: So in their defense insurers argued many different things. They argued primarily that the underwriters would never have agreed to underwrite credit risk. And that the clause in question was only concerned with the basis of valuation. So they were trying to link it to another valuation clause that did require physical loss or damage and their explanation exactly of how that basis evaluation clause linked with the transaction premium clause was never entirely clear. Um They also raised arguments around the ability of the marine insurers to actually write the credit risk. They said that they weren't entitled to do so under Lloyd's regulations. They argued that the policy had been induced by misrepresentation or non disclosure and they purported to avoid it by a late amendment to their defense.
Margaret: Basically, threw the kitchen sink at it and every single point they could raise, they did raise and they continued to change their position as they went along every time they thought of a different defense. Now, normally in the commercial court, which is the court we were in, in um, in London, it's a rule that prior to trial parties have to try and mediate the claim. And uh the reason for that is uh the courts take the view that it's not in anybody's interest to go through lengthy trials and costs and expense. And if a settlement could be reached, that's in everybody's interest. Our mediation in this case was unsuccessful and a large part as to why it was unsuccessful is that it was hybrid. Certain parties were present in the room with the mediator and other parties were on the screen and we were in the midst of the pandemic. So various people just were not prepared to come into London and attend the mediation. But I think this really brings home how important in any mediation it is to have people in the room. Only by being in the room, can they become properly part of the process and be persuaded to settle. Uh And by way of a side, you know, definition of a successful mediation is one where both parties go away feeling they haven't got a good deal. In this event, both parties, all parties went away and there was no deal. So there we were off to court.
Laura-May: And the case went to the commercial court as Margaret says, and we were still in the midst of a pandemic. And therefore, the trial had to be conducted on a hybrid basis, which was a logistical feat. when you think that we had over 20 factual witnesses, over eight expert witnesses and some days we were in the courtroom other days we were on the video. I mean, it really was quite an exciting new case to run in that the, this new way adapting to the circumstances of the pandemic.
Margaret: Yeah, I think it was one of the first commercial court cases to be run in that way. And in fact, on the first day, we were all, you know, in our own homes uh trying to do the case uh from there and we just found it didn't work because by the time you've emailed or messaged the barristers, the cases, you know, the points have moved on and all credit to the clerks to our barristers because we phoned up and said this isn't working. They arranged for a room which we sat in for five weeks with the barristers dealing with the case. Us down one end, we had a separate entry entry, uh all COVID rules and regulations were complied with that there, we were kind of not in court but kind of four screens and all all remote but able to communicate.
Laura-May: And then on to a lengthy judgment.
Margaret: All the witnesses gave their evidence remotely, but we were in court for the final submissions with the barristers, uh which included last minute applications by the insurers for adjournments and retrials. So that was all very dramatic. More evidence was sort of provided at the last moment. And uh they said that they wanted the opportunity to cross examine all the witnesses again on this new evidence. Anyhow, that was rejected by the judge and he proceeded to issue his judgment shortly after the six week trial, the bank was successful and uh they obtained full recourse from insurers and from the broker, Mr. Justice Jacobs accepted the banks submissions on the meaning and effect of the Transaction Premium Clause and he entirely rejected the insurer's attempts to avoid the policy. He agreed with the bank's argument that as a matter of construction, the Transaction Premium Clause provided cover for credit risk and or financial losses regardless of physical loss of or damage to the goods.
Laura-May: A great win for the client. The, you know, the Transaction Premium Clause that they had worked hard to create and put into the bespoke policy was carefully drafted. And the court found that the language was clear and they held that the bank's claims for the difference between the repo prices for the commodities and the amounts recovered by the bank through exercising its rights of sale were covered by the policy and due to be paid by the insurers and those sales were difficult. Those sales of the cargo when, when the bank was left holding the cocoa were difficult due to the underlying quality of the goods.
Margaret: I mean, some at the end of the day, just have to be sold for animal feed and some had to be scrapped. I mean, for example, some of the goods had already, we found out being treated for salmonella some years ago in Malaysia and we're now many years old, so not very attractive uh uh to buy on paper. Anyhow, the detailed judgment clarifies and elucidates many areas of law and is extremely helpful reading for insurance practitioners on the law of insurance in London. It covers many points, but I'll just pick out a few. First of all the interpretation of insurance contracts and the weight to be given to factual matrix considerations rather than just the words that were there in the policy. Secondly, the effect of a non avoidance clause in the policy of insurance and whether underwriters can circumvent such a provision by arguing that the clause itself should specifically have been disclosed when the policy was placed. And just as an aside on the non avoidance clause, I would say that if you have a negotiation in relation to your policy wording, if you can get a non avoidance clause in there, do try and get one because it really does help as Laura-May will explain later.
Laura-May: And the doctrine of affirmation, especially with regard to underwriters affirming a policy by pleading in a that was quite a key point raised in the judgment. The judgment also looked at the precise formulation and application of the test for inducement following a misrepresentation. Quite a large part of the judgment covers that.
Margaret: It also looked at the meaning of a reasonable endeavors obligation imposed on the insured during the currency of the risk and whether it can be breached by any conduct falling short of recklessness and it's quite difficult, quite difficult before that and to find uh actually evidence of what reasonable endeavors were, it was all very subjective in relation to, you know, every transaction. So it was, you know, very helpful, I think for any insurer to know that, you know, this can't be breached if you're not reckless. Finally, they looked at the duties of insurance brokers in detail and in particular, the nature and effect of the broker's duty to procure, cover that clearly and indisputably meets the insurance requirements and protects it against an unnecessary risk of litigation. Our expert witnesses were key in particular, our broking expert witness was marvelous and the judge was really impressed by him. Attempts by the other side to say that he was taking too rigid position were rejected by the judge.
Laura-May: So a full recovery for the bank mostly from the insurers and a little from the broker. This was an exciting case to be part of and a great result for the client. It's not the end of the chapter for certain of the other parties that are involved in the case.
Margaret: No, both the insurers and the brokers appealed against the decision. However, the insurers dropped their appeal against the bank after a day in court. The appeal continued solely between the insurers and the brokers. Case is now on appeal to the Supreme Court in relation to a dispute between the insurers and the broker on the question of estoppel. The appeal concerns the high court judge's finding that the bank was a stop by convention from relying upon the transaction premium clause against two of the 14 insurers. Mr. Justice Jacobs had rejected an avoidance case based upon a misrepresentation that the policy was as expiry, in part because the policy contained a non avoidance clause which prohibited avoidance save in a case of fraud. He nonetheless found that the as expiry misrepresentation created estoppel by convention because edge acquiesced in the underwriters assumption that the policy was as expiry. Consequently, edge was liable to the bank for the shares of those two insurers. Edge had appealed against this estoppel finding on the basis inter alia that the non avoidance clause not only prohibited avoidance, but also the rejection of a claim on the grounds of any non fraudulent misrepresentation. The court of appeal allowed the appeal on that basis. This will be a really interesting case when it comes to uh the Supreme Court as a question of estoppel is not being considered by the Supreme Court for many years. Originally, this was meant to be heard in July 2023 but it's been delayed by other more urgent cases which are going to the Supreme Court. We expect it to be heard early next year and we're certainly going to follow up on this in our next podcast and we'll explain the intricacies of that case further.
Laura-May: Great. Well, thanks for listening and we'll speak to you soon. In the meantime, don't forget to check out some of our other podcasts.
Outro: Insured success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean and reedsmith.com. To learn more about Reed Smith's insurance recovery group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and it is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
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Mark Pring, Catherine Lewis, and Tom Morgan break down the three pillars of ESG (Environmental, Social, and Governance), and discuss current risks that policyholders are facing and how they should go about mitigating certain risks.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Mark: Welcome back, everyone to our podcast series, Insured Success. My name is Mark Pring. I'm delighted to be joined by my insurance colleagues, Catherine Lewis and Tom Morgan to talk about some topical issues relating to ESG risks and how policyholders can try and mitigate such risks. I know you've both written quite a bit on ESG risks on our Policyholder Perspectives blog. Tom, starting with you and focusing first on the E in ESG what are some of the key risks facing Corporates at the moment?
Tom: Yeah, sure. So climate related litigation is the obvious one. So climate related disputes in the UK traditionally have focused on, you know, challenges to government decision making and policy through the judicial review mechanism. But I do think we're now seeing a change of approach focusing instead on corporate actors as, as the strategic target. I think this is in part because of increased transparency and disclosure requirements placed on corporate entities which produces more actual information and gives claimants greater scope to target claims based on, you know, embedded international standards and settled climate knowledge.
Mark: Ok. And what types of claims are we talking about here?
Tom: Yeah, it's a pretty wide array really. Challenges are coming from investors, consumers, activists, regulators and also litigation funders are increasingly looking to back some of these claims. Strategic climate change claims like the recent client Earth action, for example, targeting off directive notably failed to get off the ground, but it's unlikely to be the end of these types of claims in the UK. This exposure is arguably higher since the UK became the first G20 country to put into practice the goals of the task force on climate-related financial disclosures by making it mandatory for the UK's largest companies and financial institutions to report on their climate change risks. Activist claimants in the UK therefore often supported by institutional investors potentially have greater ability than in other jurisdictions to hold corporates to account. They can closely scrutinize disclosed metrics and net zero transition plans with reference to the impacts on agreed international standards.
Mark: Thanks Tom. So this, this seems to be a sort of information paradox, if I can call it that. On the one hand, you have inadequate disclosure of information which may give rise to corporate liability. Yet, publication of the same data may provide a foot in the door for strategic litigation against those same corporates.
Tom: Yes, exactly. So this risk is obviously at its highest for high emitting corporates. However, prospective claimants could target any sector, particularly those directly or indirectly financing carbon intensive companies, but also a wider array of industries including for example, financial services, retail, agriculture, and transport. Many of these you know, companies in these industries will also have set 2030 reduction targets and obviously 2050 beyond that. So we could start to see the claims rack up uh in the near future.
Mark: Understood. So what about the more traditional types of claim those seeking loss and damage?
Tom: Yeah, there haven't really been many breakthroughs in the English Court yet. However, outside of the UK, there has been a growing trend of claims seeking compensatory damages, the indirect impacts of climate change. One claim I'm following particularly closely has been brought by a Peruvian farmer against RWE in Germany. He said for the cost of constructing flood protection measures in his village in Peru which he claims that emissions released by RWE in Germany contributed to. The case is ongoing. But importantly, a uh a German court of appeal has already found that in principle, a polluter can be liable for the impact of climate change.
Catherine: And we should also note that loss and damage were also again a headline issue at cop 28 with the agreement to support developing countries suffering the impacts of climate change. And I think the acknowledgement that high emitters have a responsibility to compensate the damage caused to developing countries that are disproportionately impacted by climate change seems to align with this type of claim.
Mark: I completely agree. And um it's fair to say the English courts have always been a popular forum for international litigants assuming claimants can establish jurisdiction in the first instance. If the actions are successfully elsewhere, they may set a powerful incentive for more claims in the English courts.
Tom: Yes, completely agree. This may also be bolstered by the rapidly outstanding field of attribution science which by seeking to accurately measure the causative connection between climate change and individual environmental events will likely provide a further evidentiary basis for claimants against corporate actors. Furthermore, English courses are already dealing with complex group actions for loss and damage in relation to other environmental issues. And the overall trend is favorable towards complex actions involving questions of science attribution and quantum. So, you know, for example, last year, the court of appeal decided that the group action against BHP in relation to the Mariana dam collapse should continue despite its complexity and multijurisdictional nature. Surviving BHP's attempted strikeouts. You also have the vast Dieselgate claims going through the courts at the moment.
Mark: Yeah, I think we're we're all in agreement that class actions are likely to be a real growth area uh in terms of the types of claims that, that we're seeing in the near future around ESG. Insurers uh, will have to stay on top of, uh, what is a changing and, and growing risk profile for them. So, just shifting across and focusing now on the topical area of greenwashing, this is another risk area. If you like that we're starting to hear a lot about again with that wider access to company information and related disclosure requirements, as well as increased consumer pressure, companies appear to be at more risk than ever of greenwashing claims. Tom, did you have any thoughts?
Tom: Yeah, definitely. So, actions related to greenwashing in the UK typically require the claim to bring a claim for misrepresentation which requires reliance on misleading statements which can often be difficult to prove. However, increasing sustainability disclosure obligations for public companies as we've just discussed, offer an alternative route as claims for misstatement or publication of misleading disclosures can be brought against companies by investors.
Catherine: Absolutely right. I think it's also important to add here that whilst there have not been any notable greenwashing legal cases in the UK, regulators are wrapping up their focus on misleading and unsubstantiated claims made by companies about their environmental impact. So most recently, the CMA, the Competition and Markets Authority, has started an investigation into whether Unilever has overstated the sustainability of some of its products. And there will undoubtedly be more regulatory scrutiny of similar marketing endeavors by other companies who make climate related statements and advertisements. I'm sure you'll have seen adverts for certain international airlines have recently been banned for making misleading statements to consumers about those airlines environmental impact.
Mark: Absolutely, Catherine, we've all seen it. Just pausing here for a moment, we've been talking particularly about environmental risks and of course, this is an insurance podcast. So just for the moment, let's let's focus on uh the application of all of this to, to the insurance context. And obviously one means of mitigating the risk of direct corporate claims is through tailored insurance programs. But the sting in the tail is that the same growth in the risk of exposure to climate litigation has also resulted in increased demands for insurance coverage for such risks, then limited available capacity in terms of uh insurer appetite and also greater scrutiny from those insurers of placement and renewal of the risks. The result of all this being the further risk if you like of policy coverage disputes as and when uh a claim may arise. Catherine, do you, do you have any thoughts on this?
Catherine: Yeah. Um I completely agree with that and I think uh what we will see is that insurers will increasingly expect their insured to accurately disclose the risks that they face from climate change. And this seems to be particularly the case in light of climate litigation trends, which are expected to focus on the liability of Corporates to assess manage and disclose their vulnerability to a changing environment, changing economy and and changing customer expectations. And that is in addition to the traditional risk exposures.
Mark: I agree. And I think my personal view is that insurers are likely to focus on some key points. So first of all, the increased likelihood of insured claiming on liability policies as a consequence of claims relating to climate change. Secondly, management and governance claims in respect of climate change, where directors and officers could be held personally liable uh for failing to consider climate impacts in their decision making. And then finally, failure to properly measure and report company exposures to climate related risks as required by the TCFD that Tom mentioned earlier. For directors and officers, the new reporting obligations here in the UK and elsewhere could lead to personal accountability. So just moving on, we've talked about E, are we losing sight of uh the S and the G? Catherine, any thoughts on that?
Catherine: Absolutely right. So, whilst climate change and environmental issues are quite rightly very high on the agenda of all corporations as governments and individuals um take steps to mitigate the impact of climate change. I think it's really important that corporations don't lose sight of their obligations and consequent risks under what we call the social and governance elements of ESG.
Mark: Again, I completely agree. This is, this is obviously a rapidly developing area and insurers are gonna be under pressure to keep up with the range of judicial decisions and regulatory intervention in this context as well as the potential implications for coverage under their liability policies that they're writing. I think above all, we expect to see insurers probe policy holders at renewal in order to understand uh better uh their ESG related risks and liability policies, particularly directors. And officers liability policies even now we're seeing increased claims.
Catherine: I completely agree with that Mark. So shall we move on then to the, the S, social aspects? And this involves a corporation's interaction with its employees, customers and its stakeholders. And I think diversity and inclusion will continue to be a huge focus for various key stakeholders. In particular investors, customers and employees, businesses are ever increasingly being held to account by stakeholders to do more than simply pay lip service to DEI policies or risk litigation, regulatory action and reputational damage. I think in the same way that greenwashing is considered a litigation and regulatory risk companies may also increasingly find themselves at risk of social washing claims if they mislead about the positive social impact they claim to have. And so, for example, I think multinational sports brands have more recently come under fire in the media for making public statements to combat racism whilst facing reports of allegations of racial discrimination by their own employees. And I think it's only there for a matter of time before we start seeing the first of these so called social washing uh legal actions to to follow.
Tom: Yeah, sure if I can jump in there as well, I think another key theme in merging in the social limit of ESG is health and safety and working conditions. One of the key pillars of ESG related policies is transparency and that's not just the transparency of the business itself but also how it operates on the international stage. A number of claims have reached the English Courts in recent years. The UK Supreme Court, for example, found that a parent company could over duty uh get in respect of operations carried out uh by an overseas subsidiary, particularly in I'm thinking of the Vedanta case. And as I mentioned earlier, the Mariana Dam case relates to BHP subsidiary company which is also being sued in Brazil.
Catherine: These are really interesting developments, Tom and I think these cases demonstrate that the English courts at least are potentially willing to acknowledge the responsibility of an apparent company towards its workers in countries where its subsidiaries operate.
Mark: Yeah, and while it's easier said than done risk in this area can be mitigated by having clear policies in place as well as fostering a culture of transparency in order to allow for incidents such as those to be investigated and and managed appropriately. Policyholders in that context should also seek be able to seek, I should say to demonstrate to insurers that they have appropriate oversight of uh not just their domestic operations but but overseas operations as well. So conscious of time. Should we then focus on the G and ESG, governance, and Catherine, do you have any initial thoughts?
Catherine: Yeah, thanks, Mark. So this aspect encompasses a business's ethical and legal management, how a company governs itself. And this is a very broad topic and it's developing in many, many areas. And currently, um I think there's a clear focus on transparency and this ties into points we've been discussing already that customers and shareholders are rightly holding businesses to account. So in terms of a business’s leadership, in mid-2022 the FCA issued policy statement 22/3, which introduced changes to the UK listing rules and imposed a new comply or explain obligation to seek to improve the diversity of the board and executive management of listed companies. Great news. A key concern for businesses as a result of these comply or explain requirements will be the extent to which claims under section 98 of this, the Financial Services and Markets Act follow alleging for example, misleading disclosures in things like the annual reports produced. So a lot to think about and I don't think it's likely to be the end of de and I policies implemented by UK regulators. I'm sure we can expect both the FCA and the PRA to continue to focus on the diversity of businesses listed in the UK. And in addition to the makeup of a company's leadership, we are seeing increased scrutiny of supply change. It's no longer sufficient to ignore or profit from bad practices or illegal activity happening elsewhere around the globe. Um What do you think, Tom?
Tom: Yeah, I mean, I'd say that the key elements of this risk have actually existed for some time. So the modern slavery act requires companies to produce a slavery and human trafficking statement for each financial year. Assessing the modern slavery risk and supply chains in the business And looking at the bribery act, which also applies where an offensive an offense is committed overseas by a person connected with the UK. We have the EU's new deforestation regulation which came into force in June 2023 which requires companies to conduct extensive due diligence on their supply chains when dealing with certain products. I'm thinking, you know, cattle, cocoa, coffee, palm oil, soya, wood. So implementing robust policies, regular training and clear reporting lines will enable the risk to be monitored in incidents when they do arise to be managed appropriately.
Mark: That's all very practical and just thinking sweeping all of this up in terms of mitigating ESG associated risks. It's gonna appear daunting for many insured, but it is, I think possible to navigate the positive changes brought about by an increased ESG focus through implementing in particular as we've discussed already robust policies and procedures. Uh Insurers expect to be informed about a company's ESG awareness and related programs as well as the implementation of those programs and policies and indeed their monitoring. In particular I and others have noted that D&O underwriters have been eager to understand what disclosures and commitments insured have made to the public and whether there are any underlying claims relating to such disclosures. For example, whether the directors have made claims about the diversity of the company's board of directors or the company's climate change statistics. Catherine any, any sweep up thoughts here.
Catherine: Yeah, I have a few. And we've all been thinking about the steps that policyholder can be taking in this environment and I'll just run through a few that, that we've been talking about. So one of the things that um a policy holder can be doing is to implement clear sustainability and ESG frameworks that cut across all business stakeholders. So in this regard, they can also produce um environmental and social impact assessment and just as importantly as producing the original assessment, have processes in place to monitor and update any impact assessments so the risks remain relevant. A policyholder should also be starting to really ensure that controls and processes are in place internally to ensure early identification of specific threats facing the business. So specifically, for example, ensuring that the money laundering reporting officer, MLRO, and other reporting and compliance functions are connected to the areas of the business where risks might arise to ensure that there's prompt notification to the insurance and legal teams. In addition, it's helpful for all parts of the business to engage proactively with legal teams to stay abreast of rapidly changing legislative and regulatory frameworks. And we've discussed this in some detail already and it's no longer acceptable or even possible to turn a blind eye to what's happening overseas. It's also helpful for policyholders to start thinking about having dedicated ESG managers whose role it is to collect relevant data and monitor risk. Finally, from me, an organization should start putting into place clear plans for implementing targets, whether these are climate based targets or DE&I based. And these plans should have concrete steps that can be demonstrated to insurers and regulators.
Tom: Great, thanks Catherine. And just one more point from me, policyholders should really engage with insurers and or their brokers early ahead of a policy renewal. They should when doing so expect questions in proposal forms and in discussions with the insurers about what steps are actually being taken to mitigate the risks associated with ESG.
Mark: Great points at the end there from both of you. Thank you and thank you everyone for listening to Insured success. We absolutely look forward to joining you again for another episode. Bye bye.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
Transcript is auto-generated.
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In this episode, Ellie Ruiz and Kelly Knight discuss the ins and outs of non-payment insurance policies. They address the non-negotiables and other key issues that policyholders should be aware of when purchasing non-payment insurance.----more----
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Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's Insurance Recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected] We'll be happy to assist.
Ellie: Hello and welcome to the Insured Success podcast. My name's Ellie Ruiz and I'm a senior associate in the insurance recovery group at Reed Smith. Today for this episode, I'll be speaking with Kelly Knight from the Reed Smith Structured Finance team and discussing the ins the outs and the non-negotiables of non-payment insurance policies. We're aiming to refresh the key issues for clients you're aware of when they're purchasing non-payment cover. And then Kelly has very kindly rounded up some common queries she sees from clients including this type of cover to mitigate credit risk in financing transactions with a particular focus on receivables financing.
Kelly: Thanks, Ellie, you and I have worked together on a receivables financing which raised a number of questions about the nature and scope of non payment insurance. And I've had clients raise similar questions on other deals which include credit insurance as a former credit support. We both know how important the insurance cover can be to our clients as policy holders when putting together receivables, financing transactions. So I'm looking forward to going over the fundamentals with you and discussing what we should be looking out for. So I think the best place to start might be a quick overview of what non payment insurance is exactly and when clients might want to consider taking it out.
Ellie: Perfect. Ok, so starting from the beginning, non-payment insurance, also known as trade credit insurance, it's a form of credit protection that protects a client from a payment default by the other party in a deal i.e. when there's a failure to make a payment on a scheduled due date. So there's a really nice degree of simplicity to non-payment insurance in that all that you require is a simple failure to make a scheduled payment. And that reason for failure to make the payment can be either an inability to pay, for example, due to change of financial circumstances or it can be a deliberate refusal to pay due to a dispute between the parties. These kind of policies do have the ability to be tailored to the specifics of each transaction, given the complexities, the underlying deals that you would be working on or that we're talking about. So it's particularly advantageous to have that level of flexibility between insurer and insured?
Kelly: Ok. Understood. And when considering how to take out non-payment insurance for receivables financing, what are the advantages or disadvantages to structuring cover as either two separate policies held by each of the seller and the purchaser or alternatively taking a single policy with the seller and the purchaser both named as co insured.
Ellie: So they're both interesting options. The advantage of being co-insured on one single policy be that either party. So the purchaser or seller could make a claim and be indemnified under just one policy, albeit you have two separate contracts. The idea is that one policy can still reflect different interests of two parties. But then there's no need for two policies to be purchased covering the same risk, the interests and rights of the purchaser and seller remains separate, which is critical, but subject to policy wording, an insured would be able to recover under the policy even if the other co insured has breached any of its terms because it's only breaching its own contract with the insurer. On the other hand, the disadvantages to being co-insured. A. there's a single policy limit which can be eroded by a claim from either party which might not be so agreeable to both parties on the deal. And B. there's less clear delineation between which insured is covered in respect of which receivables at any one time. And as you and I both know, it's always the gray area where you end up having the disputes; either between the parties or with insurers. In addition, sometimes insurers might reject the idea of co-insuring a seller and a buyer in a deal of this nature on the basis that insurers then can't pursue a subrogate recovery against one insured for an insured loss suffered by the other insured. So if it is a loss that is being caused by either seller or purchaser, then the insurer can't make a subrogate recovery because logically, there's no purpose in bringing a subrogate claim when the insurer would be liable to indemnify the claim once it had to be met.
Kelly: Ok. Got that. Um Now, to complicate matters further in many of our receivables financing deals, a purchaser will be receiving funding from one or more investors who typically will want any claim under a credit insurance policy to be paid to them directly. In your experience. Can insurance coverage be structured to achieve this. For example, can an investor or a security agent acting on behalf of investors also be a co-insured?
Ellie: It certainly it's possible. This kind of arrangement is - it's a policy by policy decision. But if we're looking at it from a very high level, there is the option to either add as a co-insured or alternatively, you can name an investor or a security agent here potentially as a loss payee. So as we've just been discussing, there are some clear disadvantages to being co insured And in addition to those that I just mentioned, when you're talking about investors, it's also worth noting that by becoming an insured, those investors would then have disclosure and other obligations to the insurers which can be hard to satisfied given their proximity to the deal and how much information they would have. Alternatively, a loss payee is just identified as having first rights over any payment out that's made by insurers. So that would address your initial query regarding any claim being paid out directly to investors. It also voids the need for a separate contract between insurers and investors. However, a loss pay lacks the authority of an insured under a policy. So they can't, for example, make a claim under the policy and absent any express language, clear evidence of a separate agreement, they wouldn't be able to enforce directly any lost payment rights against the insurer. So in that situation, realistically, the relationship between the purchaser and the investors in terms of how they treat that insurance policy would probably still need to be governed by separate documentation between them which the insurer then isn't a party to.
Kelly: Ok. Sort of. So lots to think about there. So when clients are going to insurers to put together a non-payment policy for complex financing deals like the ones we we deal with in our structure, finance team, will they be expected to have a complete picture of the deal structure in place or or final documentation to share with the insurer?
Ellie: Not initially, I I mean, I've seen when we've worked together how many iterations some of these documents go through. And I think at the stage where we're just trying to talk to insurers and put a policy in place at the beginning, a client would just be having to complete a proposal form of some sort or other. So you're applying for the non-payment insurance and you're just aiming to give sufficient information to offer the policy. In that context, the transaction would need to be described in some level of detail in the proposal form. And then ultimately, it's usually closer to when the policy contract is about to sign. The insurers are likely to want to see final form or very near to final form documentation. It's probably a timing issue there and what gets signed first and who requires what? But in particular, the receivable sale and purchase agreement is something that insurers are likely to want to see and understand. There's also on top of that and a much more general nature, there is a duty of fair presentation in accordance with our 2015 Insurance Act, which an insured is obliged to comply with. And that includes providing information, ensuring material representations are correct and also that no material information is withheld or misstated. So on a higher level, that kind of covers not being able to hide anything or change anything at the last minute that the insurers weren't aware of.
Kelly: Oh, well, thanks Ellie. That's, that's been really helpful just thinking about sort of specifics. What would be the key date that clients should be aware of in a non-payment policy?
Ellie: Hm, um Go to the obvious one first, policy period sounds almost too obvious. There's a start date and an end date, but in particular, the policy end date should ideally be very closely tied to the underlying transactional documentation And those related definitions just want to be very clear. There's no gap between when the deal itself has come to an end and when the insurance itself stops providing cover. Secondly, there's often a lot of definitions surrounding due date, date of loss. Due date is usually that scheduled date for payment of the debt, which goes back to that original description of what exactly non-payment insurance is. And then there's likely to be a very specifically defined date of loss, which is closely linked to the due date. And this is all about just ensuring the insurer and insured are clear about when a loss has actually been suffered. And in addition to that, I think it's always worth looking at the waiting period, which is often found in policies like these, it’s generally a period following that date of loss before the insured loss is payable. This is one that can be negotiated between insurer and insured and potentially it can vary depending on the circumstances of the loss. For example, if the loss is as a result of insolvency or deliberate refusal to pay those might be different specific time periods.
Kelly: Ok. Thanks Ellie. A term that we often see bandied about is, is insured percentage. Uh So, you know, as, as you can imagine, our, our clients are quite keen to understand what would leave uninsured, what would be an uninsured percentage.
Ellie: Yeah, I can see they might have some concerns there. Um What it means is just this policy is gonna pay out a percentage of the outstanding debt, but it won't be paying out 100%. Usually we find that insured percentage is anywhere between 75 and 95%. Depends on what's been purchased. The reason for this is an insurer will want to ensure that the client retains significant skin in the game and that just ensures their commitment to the deal and they're not using the insurance like a like a parachute. “Oh, well, never mind. No payment. We've got insurance.”
Kelly: Ok. That, that's interesting. I know some of our clients when they take out a non payment insurance policy, they, they view it as almost like a silver bullet that's going to cover all non payment risk in their deals. Is this correct or are sort of non payments uh such as, I don't know, non payment by a customer as a result of a dispute that might not be covered under insurance policy?
Ellie: Well, in theory, it is probably possible to have a policy which covers all nonpayments, but I have never seen one. In reality, it's unlikely. The place you're looking in a policy for the answer to that kind of question is the exclusion section. And that tells you what losses or nonpayments aren't going to be covered. The common ones that we would almost expect to see are non payments that are caused by the policyholder themselves or a deliberate breach or default under deal, documentation, failure to comply with material laws or regulations. The policyholder becoming insolvent or the policyholder engaging in fraudulent or criminal behavior that's relevant to the deal. So take your, you know, traffic issues to one side. In the case of non-payment by a customer as a result of a dispute. The key point tonight is there can be payment out but if that dispute is ultimately resolved and it's resolved in favor of the policy holder after the insurer has paid the claim out, there's an overriding rule against double recovery. So the policyholder can't take the money from the insurer and from succeeding in the dispute. So the policy will generally provide that that money has then be paid directly back to the insurer.
Kelly: right, ok. So in in respect of the uninsured percentage, so our clients sort of risk exposure would a client be allowed to look to mitigate that credit risk through other forms of credit support, you know, for example, like parent guarantee or something similar?
Ellie: It, it would vary policy to policy, but it's definitely, you're absolutely right. It's something that our clients should be aware of and it's something to consider really carefully. It's not at all uncommon as you say that a policyholder client like this might be wanting to benefit from a contractual guarantee or an indemnity. Some insurers will require that any other insurance or indemnities or guarantees which might cover the same losses should be called upon first. So they'll just put themselves in a ranking and say your parent company, if they've still got money, they pay out first and we all pay when you don't have any other options. Alternatively, it might be a requirement that just any recovery is made under the other insurances or guarantees indemnities are applied first before the non-payment policy steps in. In particular, in relation to that uninsured percentage. You remember, as I mentioned before, insurers preference for the client to keep some skin in the game. The policy might require that this particular percentage remains completely uninsured and that no other insurance cover or guarantee can be taken out in respect of that amount that may or may not be the case. We're talking about a company very closely related to the policyholder, but they're not going to want it to free up that sense of risk and being a little bit cautious mitigating any potential risk.
Kelly: Ok. Well, that's, that's definitely something that, you know, we ought to be taking into consideration when when structuring the transaction. Um just, just kind of going back to our discussion earlier about whether insurers would be expecting to see complete documentation of the proposal form stage. What about amendments that are made to deal documents after the credit insurance policy has been taken out, will insurers want to see that or want some sort of input?
Ellie: It's a very valid point because of course, just given the complexity of those deals that we've been looking at, it's obviously it's not uncommon for some changes to be needed in respect of the underlying documentation in these transactions over the course of deals that might be in place for a year or two. However, for the insurers, it's all about being able to just understand and manage the risk. So clients should realistically expect to see what we call a material amendments clause in that policy requires that insurers are told about and potentially have to give prior written consent to any material amendments for the insurance cover to remain in place. The nuance then I think comes in what exactly is a material amendment and that's where we sort of focus our efforts. You pay close attention to that. For example, some scenarios, those amendments might be able to be made on the deal side, they can be made without the insured's agreement, let alone insurer consent. So if your insurers put in a requirement that they need to consent to this first, it's completely implausible and doesn't fit with how the deal documentation operates. So just making sure that what's in the deal documentation and what's in the insurance policy align is really important.
Kelly: Ok. That makes sense. So looking ahead if for example, there was a situation where a policyholder client thought that they might be entitled to cover under their non-payment policy. What should they be keeping in mind? Like for example, what are the key timing points that they ought to be aware of? And, and obligations would there be on, on the client once they, once they suspected that a non payment event has occurred?
Ellie: Right, this is, yeah, we get the good stuff once they, once we're actually starting to look at making a claim. So firstly, you want to check the policy wording again and identify first and foremost the notification provisions and the exact detail they contain this is because the obligation to notify often comes way before the obligation to make a claim. So that's at the stage where you, you mentioned the word “suspected” and it's at that stage, generally at which insurers have to have that flagged up to them. As a general rule, it's then advisable to liaise with brokers or insurers directly if that's how the policy has been set up and to do that promptly as well, just to make sure that everybody knows they've been told. And when they've been told. More generally, the policyholder client wants to be alive to any regular reporting obligations. Suspicions aside, the policy is likely to provide for obligations to ensure insurers are up to date about the deal's progress, scheduled payment dates that have been met thus far. And a part of this also involves maintaining good records of those communications and payments provides a clear trail for insurers to follow if we get to a claim scenario. The insured is often under an obligation to take reasonable steps to avert or minimize loss and wants to avoid any unreasonable steps that might increase the loss. On the other side of the coin sometimes costs like this. What we call mitigation costs will be covered under the policy. You just want to check the wording in each case. And then finally, a policy can specifically require an insured to cooperate with an insurer in the pursuit of what a subrogate claim. So this comes further down the line if a claim was paid out and the insurer takes on that role and the obligations on the policy holder can include protecting any rights which may or may not have been segregated and potentially specific requirements further down the line to assist in an actual recovery action depending on how far that goes in terms of providing access to individuals, documentation, records and so on.
Kelly: Oh, interesting. So you, you, you mentioned sort of subrogation which sort of brings me on to my next question for you. So if our client has, has made a claim and has received a payout under the insurance policy. If subsequently, the client manages to recover some of that claim from its from its customer, for example, or some other party, how should the client be treating those recoveries?
Ellie: It's worth going back here to that notion we were discussing earlier, this idea of an insured percentage and an uninsured percentage. I would expect overall a policy to explicitly deal with how recoveries are going to be applied. But generally, it's likely to be the case that first and foremost costs and expenses will be covered. And then after that recoveries would most likely be applied pro rata between the insured and the uninsured percentage. So, insurer and insured are recovering pro rata at about the same rate. Following payment of a claim, this is when an insurer has a right of subrogation that entices them to step into the shoes of the policy holder and they can exercise any of those policyholder rights or remedies against third parties. Again, this should generally be expressly set out in the policy and it can only take effect once the policyholder has been fully indemnified. As we flagged earlier one of the reasons that insurers might actually reject the idea of co-insuring a seller and a purchaser in a deal like this is because of that inability to pursue subrogated recovery against the seller if you're dealing with the purchase or the other way round for an insured loss, that's been suffered. Again it's purely logically what is the point in having a segregated claim where you're also the insurer on the other side having to meet that claim. So I think that's probably about all we've got time for today. It's a bit of a whistle stop tour through the key elements of non-payment trade credit insurance which can be complicated. Um But hopefully that gives a little bit more context to our finance clients or anyone looking to incorporate one of these policies into receivables financing. Kelly, is there anything else you wanted to add?
Kelly: Nothing for me- just to say, thank you very much.
Ellie: Brilliant. Thank you so much everyone for listening.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcast, PodBean and reedsmith.com. To learn more about Reed Smith's insurance recovery group please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
Transcript is auto-generated.
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Business interruption (BI) ranked among the top concerns for companies globally in 2023. Extreme weather events, cyberattacks, fires and explosions, political violence, and COVID-19 will continue to drive BI claims in the coming year. In this episode, insurance recovery partners Mark Pring (London) and Anthony Crawford (New York) discuss BI insurance claims, examine recent case law on both sides of the Atlantic, and offer practical suggestions and insights for those considering whether to notify their insurer and/or to pursue a claim. They also outline tips on negotiating business interruption insurance policies.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Mark: Thank you everyone for joining us and welcome to Insured Success. My name is Mark Pring and I am a partner in Reed Smith's London office. I'm delighted to be joined by my partner Anthony Crawford from our New York office. We are both proud members of Reed Smith's top tier global insurance recovery practice. In today's podcast, we are focusing on the realm of business interruption or BI insurance claims. In the time allowed we cannot delve deeply into specific policy language, but instead, we will look at some recent case law on both sides of the Atlantic and offer some practical tips and insights for those considering whether to notify or pursue a claim as well as those in the throes of negotiating their BI insurance policy. Before we get fully started um, Anthony, what would you say is the accepted definition in broad terms of BI insurance cover?
Anthony: Hi Mark. So here in the US, we would generally say that business interruption or sometimes it is known as business income insurance, it's basically a form of property insurance covering losses of income suffered by a policyholder or business uh due to some type of loss or damage to his premises covered, that's caused by a covered cause of loss, which either causes some type of slowdown or suspension of its business operations.
Mark: That's great. And certainly that's exactly the kind of definition we would we would adopt over here. One thing we will explore is, is the idea of stand alone BI cover where you don't necessarily have to have prior physical loss or damage or any form of loss or damage to the premises. But we'll come on to that. So this topic is obviously very relevant given recent global events such as the war in Ukraine and again, uh the COVID-19 pandemic, I wanted to look first at some of the English case law that has emerged since the pandemic starting in 2020. And I think that the effect of COVID-19 on commercial operations has really transformed the way in which we look at BI insurance. Again, I'm sure on both sides of the Atlantic. Of course, some time has passed since the last lockdown here in the UK. But the rulings made by the English courts during the intervening period have undoubtedly continued to impact on the insurance markets approach to BI insurance generally. As everyone will be aware, COVID-19 led to a surge in BI claims as a result of forced business closures due broadly to lock down and other restrictive measures. At the start back in 2020 existing BI insurance cover to the extent it was bought separately from any physical damage or damage cover had not been negotiated with any clear understanding that something like a pandemic could even operate uh as a, as a real risk. As a consequence in the absence of existing court guidance, there was a lot of uncertainty about how these policies should be construed in the context of those lockdowns and other restrictions. Again, we've talked before about the expedited proceedings in what we call FCA and Arch and others up to the level of the Supreme Court. That was the first case in which the interpretation of BI policies in the context of the COVID-19 pandemic was properly explored. The case was brought as a test case by the FCA, the Financial Conduct Authority, as key regulator for the insurance industry. The FCA was concerned that so many of the BI claims notified as a result of losses stemming from the COVID-19 lockdowns were either being denied by insurers or subject to undue delays. Just to pause here for a moment Anthony, am I right that in the US, you've got no single regulator over the insurance sector and therefore no guarantee there'll be uh as here, pro consumer or pro small business?
Anthony: Yes Mark. That is absolutely correct. So in the United States insurance law tends to be a state law matter with a couple of exceptions for uh sort of maritime cases. Uh but uh therefore each individual state has its own regulator of insurance. Uh And so you will oftentimes can see varying degrees of the bodies of laws that are being developed depending upon the jurisdiction that you are in. Uh And there is absolutely no, unfortunately, no guarantee in either state uh that there would necessarily be pro consumer or a small business pro policy holder.
Mark: Yeah, that's a really helpful comparison. And I know that certain of our colleagues were very surprised when I told them what the FCA was doing in terms of intervening in the test case we're talking about.
Anthony: That would be an excellent policyholder benefit if there was some centralized government entity that was regulating insurance here. But unfortunately, or fortunately, depending on uh how you view it a long time ago, the call was made here in our laws to, to keep it something that is reserved for the States to rule on.
Mark: Got you. Well, back in the UK, the scope of the dispute in arch is, is hard to summarize given that the FCA had selected a significant number of test as it were policy wordings for consideration by the courts. But in broad terms, the key question was whether BI cover for certain perils such as notifiable diseases and prevention of access was actually applicable in the context of COVID-19. The outcome was largely positive for policyholders with the Supreme Court finding that subject to those policyholders establishing an appropriate loss, they could validly claim under the terms of at least most of their covers. The Supreme Court's judgment which was handed down uh back in January 2021 answered many but certainly not all of the core issues in dispute relating to the interpretation of common BI language unsurprisingly. However, lawyers on both sides of the insurance divide have continued to be creative since then. And I should at this stage mention a few key decisions over the last couple of years.
First in February 2022 the court in Corbin and King looked at a denial of access, non damage or fare's NDDA clause. Broadly, the clause provides cover where access to business premises has been restricted or hindered due to actions taken by a statutory body in response to using the language uh examining in Corbin and King, a danger or disturbance within a one mile radius. While in the FCA test case proceedings, it had generally been decided that so-called prevention of access clauses like the NDDA did not provide cover in the COVID-19 context. So that was one of the limited areas where policyholders were disappointed by the Supreme Court. In this instance, the divisional court, the High Court in Corbin and King found that insurers were liable to provide cover in circumstances where businesses were forced to close as a result of lockdown and other measures put in place to stem the spread of disease. So in this instance, COVID-19 was found for the purposes of that policy language from which I quoted, it was found to be a danger uh within that language. And while the relevant clause only provided localized cover, remembering the one mile radius language, it could extend to a disease such as COVID-19 if there were actually cases within the agreed radius. In addition, adopting the Supreme Court's approach to what we refer to as causation in the FCA test case, Uh the judge in Corbin, Mrs. Justice Cockerill found prevention of access clauses and this particular one, the NDDA clause did provide cover for BI losses suffered as a result of the pandemic. Inevitably however, given the amounts involved, many insurers have sought to distinguish the Corbin policy language from their own and have effectively forced various policyholders. Many of them to pursue a further test case this time brought by Gatwick Investment Limited and others against Liberty Mutual and others which was heard last October, its outcome will hopefully resolve or at least reduce ongoing uncertainty for numerous policyholders.
Second in June 2023 Mr. Justice Jacobs handed down judgment on certain what we call preliminary issues in the so-called at the premises or ATP test case proceedings for which six separate claims had been accelerated. In this instance, the policyholders argued that the Supreme Court's finding on concurrent causation, which effectively was to the effect that each and every occurrence of COVID-19 in the country the UK was an equal effective and therefore proximate cause of the government action that led potentially to loss. The policyholder argued that that finding applied in the same way to so called at the premises clauses as it already did supported by the Supreme Court to the so called radius clauses. And we saw reference earlier to radius clauses. So if a single occurrence of COVID-19 within one mile of the insured premises was a proximate cause of government action and therefore business interruption, the same must be true. So the policyholder said for a single occurrence at the premises themselves, not just within the one mile radius, the court supported this while some insurers with the FCA's forceful encouragement drew the analogy between those Radius claims and the ATP claims, other insurers refused to meet those ATP claims. The June decision should in principle unlock a significant amount of cash. Although as I say, a number of insurers with permission are pursuing appeals. So those are the first two key areas uh in terms of further cases that are going through the courts. Finally, for today's purposes, there are the high profile Stone Gate and two related cases heard by Mr. Justice Butcher in mid 2022 and dealing with among other matters, what we refer to as the aggregation of losses. ie. how in practice should the courts identify losses that in this case and I quote, arise from, are attributable to or are in connection with a single occurrence. First of all, there has to be an agreement on what we mean by the single occurrence in each particular instance. So two of the three insured including Stonegate sought to argue that there were multiple occurrences in order that they could claim that the applicable sublimits under their policy for business interruption losses applied on a per premises basis. Their primary argument was that each infection was a separate occurrence and therefore there were separate occurrences for the purpose of the policy in the vicinity of each premises which allowed them then to claim multiple sublimit. If we want to look at the practicalities, Stonegate alone would if correct in their arguments have separate claims of up to £2.5 million in respect of each of its roughly 760 venues. That's £2.5 million times 760 or leave others to do the math. In fact, Stonegate settled its claims just before the court of appeal hearing. But the relevant insurers involved in all three of these cases primarily sought to argue that there was only one or if necessary, a small number of occurrences such that only a single 2.5 million limit in the Stonegate case or a small number of limits of liability would be payable.
The third insured Greggs, the well known bakers, which has now also settled its claims, primarily argued that each of the various government announcements or measures was a separate occurrence. The court rejected the policyholders arguments at first instance and by policyholders there, I mean, the main arguments pursued by Stonegate, in particular to some degree, the court supported Gregg's position. Many insurers relied upon the court's rejection of the argument that losses should only be aggregated if at all on a per premises basis. Uh The court was particularly mindful of the argument that any new government response to the pandemic would likely impact businesses in a unitary way across the country and from the insurer's perspective. Therefore, they took advantage of the idea that you should aggregate all losses that flowed from any particular government response. Perhaps more importantly than the position of the insurers. Their reinsurers have reinforced decisions that already taken to aggregate many covered claims. The appeals from Mr. Justice Butcher's findings in October 2022 even though reduced to various eateries by then uh were heard last November and much attention is focused on the outcome of that remaining appeal on aggregation issues given the very significant amounts at stake amongst policyholders generally. So these three decisions and their relevant appeals will offer some important guidance to all of us and our clients. The message more generally is that while some decisions that followed the Supreme Court judgment did bring a significant amount of clarity, there are still a number of key issues that are not fully resolved. The challenges and the appeals continue. So pausing there, Anthony uh and, and moving away from the UK, there may have been some similar issues but I think you, you, you've faced a somewhat different position in the states. What have you found to be to have been the impact of COVID-19 on the approach of the US courts to BI cover?
Anthony: Well, Mark, unfortunately, on this side of the pond, uh policyholders have not fared as well uh with their COVID related BI claims. So it's important to note a couple of uh nuances with the US court system as I mentioned before. Uh Generally insurance law is a state law matter. Now, federal courts in the United States will also hear insurance cases provided that certain jurisdictional criteria are met. Uh However, when they are hearing these cases, federal courts generally have to apply the law of the state where they're located with and within uh with the certain certain exceptions. And what they will do is that they will look to, you know, any ruling from the, either the state's highest court or then moving down to state appellate courts, if the high court hasn't ruled on a particular issue. The problem here is that with the COVID cases, there was often little or no guidance in state law as to how to rule, uh given the unique nature of the COVID insurance claims that were coming in. And this led to a number of the federal courts having to sort of guess, uh as to how state courts would rule. And unfortunately, the vast majority of federal courts early on started to find that there was no coverage related to property damage. The COVID BI claims and property claims that were coming in. Now, arguably, you know, policyholders would say that the federal courts were ignoring certain procedural rules uh by outright dismissing cases rather than accepting as they should. The allegations in the complaint is true, uh which is a general interpretation and procedural way that you go about, uh looking at motions to dismiss, you know, it's become so much so that even in the recent cases that in litigations that policyholders were initiating, they would go far beyond what would be the normal requirements in their pleadings to include um scientific data to include, you know, evidence from experts, but to no avail the courts were uh and continue to dismiss these cases outright. In a parallel you started to see uh the cases work their way up through the state court systems as well with similar uh disappointing results. Uh in general, what you have found is that the cases have raised a couple of issues. So if number one can the presence of COVID cause uh physical loss or damage to property or was it the case that the various state government shutdown orders that were issued to address the pandemic, that they cause some type of physical loss, uh triggering coverage. Now, we have now had some time over the few last few years to see these state court decisions start to come in as well. And again, unfortunately, uh they have not gone, you know, the way that the policyholders would like them to go. There are still a few notable jurisdictions such as California and here in New York where I am that have cases pending before them and we should see decisions there soon. Now there are some successes that have been had by policyholders. Those are generally policyholders that have specialized policies where the coverage is either not contingent on some type of physical loss or damage or there are other policies that have certain coverage extensions, for example, uh communicable disease extensions. Policyholders have started to see some success with those and those have been moving forward. But the general lay of the land is that again, as I said before, it has not necessarily been that more favorable for the policy all this year.
Mark: Thanks Anthony. It's a depressing picture potentially for policyholders, but obviously very important to know. Now, if we're talking about someone who suffered losses back in 2020 2021 we wouldn't be worrying about or shouldn't be worrying about notification of claims, but obviously businesses can get interrupted, disrupted and so on for all sorts of reasons and continue to do so. So just maybe broadening the picture a little bit and to a degree with the, with the benefit of hindsight based on our experience of the pandemic, what advice would you be giving to a policyholder looking now to notify a claim under a BI policy? What practical considerations do you think they should make sure they get clear before you know before even getting embroiled in a dispute, how do they sort of do their housekeeping first?
Anthony: Ok. Very, very good question Mark. So in general, I would give policyholders the same advice pre-COVID as I would give them post-COVID because at the end of the day, they are presenting insurance claim. So things that I tell policyholder is give notice as soon as possible. So you don't run a file of notice procedures that any notice requirements that you will find in your policies. Uh You also wanna make sure that you're given broad notice to the carriers in your insurance program because what you don't want to do is you find yourself thinking that coverage may only exist in one type of policy. When in reality, you may have coverage that's available to you in under a variety of policies within your program. Other things that you should do is policyholders should always make sure that they're taking steps to mitigate any further losses. As a practical matter, policyholders need to organize a team both internally and working with whatever broker or insurance professional that they're going to be using in order to present and put together a comprehensive approach that will help with their claim presentation to help hopefully ensure success with the claim that they're bringing. You wanna make sure that you got all your relevant documentation. BI claims are notoriously document heavy and it is important that you need a team getting all that information together, organizing it, putting it together in a way that you can present, you know, the best claim that you have for it in order to make sure that it is paid. And I always, always, always recommend that policyholders should work with insurance professionals to make sure that they are presenting their claims in the best light to recover the damages that they suffer as well as understanding all of the coverages that are available. And uh you know, in general, because insurance claims, particularly large uh business interruption claims can be complicated and you wanna make sure that you have as much help as possible to ensure the success of your claim,
Mark: Anthony, many thanks for that incredibly helpful and it won't come as any surprise to know that, you know, that's exactly the sort of advice, I wouldn't have articulated it quite as well, but exactly the sort of advice we would be giving our clients over here. It crosses borders and certainly, you know, in terms of overall lessons learned and lessons that, you know, equally apply to where you may be negotiating new cover, not just making a claim under existing cover policy, language is key to the extent your insurers are open to negotiation in what are tough times. You're gonna want to look very carefully with the help of your insurance broker at the scope of any exclusions, whether the limits and the sublimit of cover available to you are sufficient for your purposes. That of course requires you to understand your business. Any prudent business should continue regularly to identify its risk profile and implement appropriate mitigating steps and insurance is just one of the ways in which you can do that. I will say in, in, in the UK, by way of sort of conclusion to some of the cases, we've talked about the sort of stand alone BI policies that were considered by the Supreme Court are no longer available and the insurance markets if they didn't before certainly take the view now that a pandemic represents if you like a fundamental societal risk that someone else, a government should underwrite rather than the markets themselves and they appear to have little or no appetite for non damage cover. Certainly uh in the pandemic or, or broader disease based contexts. So we're in a very, very different world now. Um Anthony, I mean, just finally, what are you seeing uh from the US perspective in terms of the scope of BI cover following the pandemic?
Anthony: Yeah so even though the insurance industry here in the States has been successful, uh largely in defeating a number of the large COVID claims they have moved as an industry to take steps to explicitly exclude coverage for sort of pandemic claims. There were always virus exclusions that could, that could have been used in policies and a lot of the policies we we found those there. Uh but they, you know, are taking steps to make that a little bit more explicit. But at the same time, uh they're also offering as the industry tends to do coverage extensions that policyholders can purchase. Uh that would actually provide some limited coverage in the future, going ahead for pandemic losses. But the thing I'll note that, you know, COVID was unique. Various steel broad business interruption coverage that remains available to policyholders and always will, just policyholders will have to be cognizant of what their policies say and what their policies are covering. But these recent losses with coverage over COVID claims should not in any way dissuade policyholders uh on the merits of maintaining this type of insurance coverage.
Mark: Yeah, completely agree. Those are, those are very wise words. So wrapping up, there's a lot more to explore here clearly and, and will no doubt be exploring BI insurance in future podcasts. So I look forward to returning. But in the meantime, listeners should be having conversations with their brokers and insurers well, before their renewal date, uh in order again to ensure that their policies actually meet their needs. So thank you to everyone for listening. Uh It's been a pleasure and do look us up on reedsmith.com and enjoy what will no doubt be a very exciting series in terms of Insured Success podcasts. Thank you very much again.
Outro: Insured success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group. Please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome, any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
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Insurance recovery partners Carolyn Rosenberg and Anthony Crawford delve into artificial intelligence, the risks associated with companies using AI in their business practices, and the different insurance products that may help mitigate those risks.
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Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at Insured Success at reedsmith.com. We'll be happy to assist.
Carolyn: Welcome to our inaugural 2024 Insured Success podcast. My name is Carolyn Rosenberg. I'm a partner in the insurance recovery group in our Chicago office and I'll be in conversation today with Anthony Crawford who is also a partner in our insurance recovery group out of New York. Our topic today is AI, artificial intelligence and insurance and you can't help but see word of that, Uh no pun intended, in social media, in a newspaper, Uh certainly the World Economic Forum, recent report indicated that AI powered misinformation is the world's biggest short term threat. There has been a recent 2023 expert study on progress in AI um out of Oxford University that uh created some concern that artificial intelligence could take jobs fifty years earlier than experts predicted. There's been the challenge of AI and the worldwide concerns as well as the promise of AI. The National Security Administration, the NSA, has enlisted AI to fight global hacks. The um there's been stories that AI is helping catch breast cancer earlier because of technology and that AI is being used by nonprofits to help find missing Children. So you've got both the, you know, the horror stories, the concerns the potential exposures. And then of course, on the upside, the promises of AI. Anthony, perhaps you can start us off by indicating, have there actually been any reported lawsuits regarding AI that give us a better handle on how these exposures are being translated into potential causes of action?
Anthony: Yes, Carolyn, thank you. Uh There are, we are starting to see a number of different suits or administrative actions that are coming forth out of uh any of these use of artificial intelligence. One that comes to mind is a recent first with the Equal Employment Opportunity Commission uh having settled a lawsuit uh against an organization called iTutor Group Incorporated. And the basic gist of that was that they were, uh iTutor was using software, AI generated software, that automatically rejected older applicants in violation of the Age Discrimination and Employment Act. And so you can see that this is one of those uses of AI that ultimately cause an organization some liability. And one of the interesting things is that this is this organization had they used pencil and paper or just regular bodies and made the same mistake, they would also face that liability. But the twist here now is that they were using this software that caused that exposure.
Carolyn: Interesting. And have there been any defamation or IP related exposures as well in terms of any potential litigation that you've seen?
Anthony: So on the IP front, yes, there, there have been a number of concerns and you can see this generally in the media about the the use or of AI in this, particularly in the copyright realm and some of the implications there. You're seeing where organizations have to be cautious into making sure that their use of AI isn't violating those rights. And then the uh the other side, you're also seeing where there are complications where artists are actively using AI to help generate works and sort of the implicate the IP implications there as well as you know, other contractual implications where you know, if a particular artist is contracted to do something yet they use AI. Is it the artist doing that? Is the AI doing that? What are the implications there?
Carolyn: Yeah. And I know lawyers themselves are not immune. There have been some well publicized reports about one would call it hallucinations of AI that, that are reporting, you know, uh particular precedents of cases um in court briefs and then upon further examination, um, they don't turn out to be either accurate or in some cases even in existence. And that of course, is, is causing some consternation and concerns about the use of AI in legal research and in briefing. And you could certainly imagine that with respect to any misrepresentative or misinformation, particularly on financial reports that companies and reporting earnings or in reporting on developments could face some potential liability, breach of fiduciary duty. You know, in addition to the kinds of employment, defamation, consumer related IP related exposures that um, Anthony and I have talked about so, you know, but Anthony correct me if I'm wrong, I don't think we've yet seen any coverage, insurance coverage disputes with regard to AI. Is that your view as well?
Anthony: Yeah, Carolyn, I think that that is right. I think that we're seeing a lot of underlying claims that definitely have the potential to be something that would covered by insurance policies. But as of yet, we're not seeing any flood of coverage related litigation with regards to insurance for AI related incidents,
Carolyn: Right, and when we say, ok, there could be these exposures. Now, what do we do about it? And insurance is one potential tool for protection. You know, it, it, it doesn't appear that we need to sort of run out and buy an AI insurance policy. I think some of the ones we've seen on the market have been really more specific for AI companies. But if you're a, an organization or a corporation or a business or a fund that is not AI specific itself but is potentially using AI, what kinds of policies would you traditionally look at to see if there might be coverage for potential AI-related exposure?
Anthony: Carolyn, that's an excellent question. And, you know, I will note, of course, the insurance industry would love for policyholders to run out and buy completely new products. But the reality is uh a as with a lot of the things that we've discussed right now, absent some exclusion, these things should fall in to the traditional policies that already exist right now, such as your areas and emissions policy, your products, liability policies, your employment practices, liability policy. So for example, the EEOC claim that I gave you that at a basic and, and you break it down, it's still a basic age discrimination case, something that is traditionally covered by the employee practices, liability insurance policy. The only difference here is that this company used AI generated technology uh to violate the rights as opposed to using an actual person. You know, some of the other things you may see. For example, if a manufacturer is using an AI Suite to put out a product and there's something wrong with the algorithm and there's ultimately a defect with that product, it doesn't matter that AI was used or not, it's that there's a defect with the products and that will fall traditionally under the products liability type of policy. So the biggest takeaway from this is that entities and policy holders should, you know, not so much if faced with liability, not get so caught up in the AI aspect of it. But you know, the actual facts of the took the alleged violations and then look to their policies that they have in place for any available coverage.
Carolyn: That's very helpful because the, you know, traditional due diligence that one would do, and of course, we do a lot with our clients representing policyholders of reviewing the policies, making sure there's no exclusion, broadening definitions. And of course, being on the lookout if there are any quote AI enhancements that might come on the market, obviously you always want to keep vigilant in a rapidly developing uh field here, but there's no need for sort of immediate running out and, and looking at a policy if you have the traditional coverage that should um hopefully protect depending on the kinds of exposures um and causes of that may that may arise. But all that being said, we do know that AI is being utilized more in the underwriting in the insurance underwriting phase. And there have been some concerns about that from a state regulatory uh perspective. Anthony, what's your sense of what's going on there?
Anthony: Ok. So in essence, a number of states have recognized the potential pitfalls of using this technology in the underwriting process. And what they have done is to start to impose regulations that will safeguard consumers from sort of automatic pricing schemes used by AI that will take into factors that, you know, some not traditionally used in pricing out insurance policies such as social media feeds or uh you know, this uh a potential policyholders, social presence online. And so what these regulators are looking to do is to make sure that the insurance companies maintain, again, maintain and remain vigilant in their underwriting process. And you know, are accountable for any discriminatory practices that ultimately may come from the use of AI. Uh For example, some of the traditional things that we've seen in the past is using occupations or zip codes or education in pricing out insurance policies uh where states have regulators have pushed back on those practices. You're also seeing a rise in the use of AI in actual claims handling and concerns. There are that when you have this automated process looking at claims, uh there is the potential for the entities to get it wrong and unnecessarily deny claims. So you're seeing there's a couple of uh class actions that are out there against uh a couple of largest health insurers in the country regarding the use of AI in their claims handling in the, in the medical insurance field. And that's something that we'll keep monitoring here as you know, as part of our insurance recovery practice to keep a look out for things like that.
Carolyn: It would be interesting too in the same way that if you were to get into a coverage dispute with an insurer to ask the question whether the insurer and its claim handlers are using AI in reviewing claims and it might be a source of interesting discussion or discovery with respect to where that may lead um as among the tools that advocates may have for their clients in this situation.
Anthony: I agree, Carolyn. I think that you are going to see that question becoming a standard interrogatory or, and uh document requests in civil discovery. Uh That's, that's just, it's going to have to be asked and insurers are going to have to answer that question.
Carolyn: Yeah, it's, it's, it's clearly a a brave new world between the potential exposures that uh insurance coverages, but sort of one potential protection and certainly one to consider and be vigilant about uh because there are always enhancements to consider, there are reviews to be done to just make sure. And in the event that there is a coverage dispute to just be this vigilant on the use of AI in both what's been done on the underwriting end and on the claims end, Anthony, any other dos and don'ts or ways in which to be vigilant as we wrap up this podcast from your perspective.
Anthony: So for policyholders, you know, it as with everything, we always advise, look, insurance comes way way later down the line. All right, what is your, your, you know, the starting point for entities should be sound policies and procedures. So if your organization is going to employ AI, the organization should have a firm understanding of how it's going to be employed, what are the risks that are involved with that employment, and how they are going to mitigate those risks on a practical aspect, before some potential claim comes up. Now, obviously, life happens and should an entity be faced with a claim related to AI, I would give them the advice that I would give them for most any other claim. Ok. Give notice early, get help from some type of insurance professional. Make sure you are organized, make sure you have documentation. Uh make sure you have good lines of communication both within your organization with your broker or whatever advocate that you're using as well as with the insurance company.
Carolyn: Yep and coordination is key. Um Knowing also about attorney-client privilege which you do have with your coverage lawyer you do not necessarily have with, you know, other other professionals. Just be vigilant and monitor. Keep up with us. Uh We will be doing more on AI and insurance in our Insured Success podcast along with other topics. We work collaboratively with our colleagues who are deeply involved in AI guidance monitoring guidelines and all other kinds of good stuff. But we thank you for listening today. Anthony, thank you for being in conversation and we look forward to our next chat with you. No pun intended. Take best care. Thank you.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
Transcript is auto-generated.
