Devil in the Details (March 01, 2006)

In July 2001, a number of insurers and reinsurers signed an agreement with leaseholder Larry Silverstein to insure the World Trade Center.

Two months later, a hijacked commercial airliner slammed into the north tower of the twin skyscraper structure. Eighteen minutes later, a second hijacked plane slammed into the south tower. Both towers ultimately collapsed into heaps of rubble.

In the lengthy lawsuit that ensued, it was made clear that – even after the agreement was supposedly signed, sealed and delivered – key terms of the contract remained vague. For example, the insurers and the insured had not hammered out details as to what constituted an “occurrence.”

Big money rides on such clarity. Silverstein, for example, defined the coordinated plane crashes as two separate events or “occurrences.” Thus, he argued that insurers owed him two separate payments of US$3.5 billion – the maximum amount allowed for a single occurrence – for a grand total of US$7 billion. Insurers, however, defined the disaster as a single occurrence and as such they quoted the property loss limit at the maximum US$3.5 billion.

The courts sided with the insurers. But the whole legal squabble gave risk managers something to talk about, namely “contract certainty.”

What is contract certainty? United Kingdom regulators, who have perhaps taken the greatest interest in the issue, say this: “Contract certainty is achieved by the complete and final agreement of all terms (including signed down lines) between the insured and insurers before inception. Furthermore, full wording must be agreed before any underwriter formally commits to the contract.”

In other words, no more “deal now, details later.”

The UK Financial Services Authority (FSA) says although it wants a market solution to the problem, it is prepared to step in if the market cant realize the regulators targets. The FSA wanted 30% of business volume to meet the regulators definition of contract certainty by the end of 2005. This target will increase to 85% by the end of 2006. In the UK, inurers and insureds have 30 days to get all of their legal mumbo-jumbo in order.

Is contract certainty an issue in Canada? Well, yes and no.

It’s hard to tell, because Canadian regulators dont appear to have published many public reports relating to the issue. At the same time, the scuttlebutt is that Canadian regulators did some behind-the- scenes probing after contract certainty collapsed right alongside the ‘Twin Towers.’

Risk managers say there is definitely more for Canada to do with regards to the issue. Select sources suggest that some pre-2004 contracts have dragged on for as long as three or four years before the legal terms seem set for finalization.

Others say brokers need to be aware of the financial wherewithal of the companies that have not achieved any version of contract certainty. If, for example, a contract isn’t certain and the insurer loses a $1-billion lawsuit because of this uncertainty, does the insurer have adequate capital to absorb the hit? If not, then contract certainty would become everyone’s problem as the entire industry suffers the effects of the insurer’s insolvency.

Of course, insurers and reinsurers definitely dont want to raise too much of a fuss over contract certainty, lest Canadian regulators take too much active interest in the issue. And frankly, they have a point: There should be a market solution to this problem. A collective resolve and dialogue is essential if the industry wants to quickly nail down the legal details of insurance contracts.

It is important to recognize that individual solutions are in the works. Some Canadian reinsurers, for example, have stopped using phrases such as “wording to be discussed” when negotiating treaties. For many reinsurers, the treaties of Jan. 1, 2006 included language that all insureds and insurers agreed to in writing prior to the date of inception. If an insured had a problem with the treaty on, for example, Jan. 7, 2006, they would put their concerns on a list of terms and conditions to be negotiated prior to the inception of a Jan. 1, 2007 treaty.

In this way, it is hoped that market standards will be developed in Canada without the need for any further regulatory intervention.