Product Governance Implications following the FCA Covid-19 Business Interruption Test Case
The interpretation of insurance contracts has often been a source of dispute for decades, if not centuries. Now the Financial Conduct Authority’s (FCA) Business Interruption (BI) test case has once again demonstrated how vitally important it is to ensure that effective controls are placed around the drafting and application of policy wordings. The FCA’s ‘Dear CEO’ letter of 22 January 2021 places clear obligations on insurance firms – and, therefore, the Senior Managers who run them – to review the way they interpret BI policies and interact with claimants. As a result of this, a number of insurers will now be paying claims where they might not have expected to, with the consequent unexpected impact on their loss ratios.
This raises an important question – Aside from the specifics of the BI issue, how should Senior Managers in insurance firms be structuring the control processes around policy wordings?
These controls, or “product governance” protocols, should be an intrinsic aspect of good practice as observed by Underwriting, Claims, Risk Management and Operations personnel. To satisfy SM&CR expectations, particularly around individual accountability and the fulfilment of ‘reasonable steps’, Senior Managers in firms should be actively promoting a pro-active approach that supports an effective product governance regime, with outcomes being reported to their Boards and senior management teams in a timely and transparent manner.
Commonly Disputed Language
BI policies commonly include words such as “event”, “incident” and “occurrence”, which are left open to interpretation in the case of a loss. The FCA’s test case has carefully analysed a representative sample of BI wordings and concluded that whilst they use different language with the intention of achieving the same coverage, they often lead to disagreements over their actual meaning.
One of the key areas now open for discussion is “non-damage” business losses, which requires a more complicated policy structure to create the level of coverage the insured is looking for and that the insurer is willing to provide and charge a premium for.
Addressing Policy Wording Governance
Insurance companies should now be looking very carefully at their BI policy wordings; indeed the FCA’s ‘Dear CEO’ letter makes it a requirement for them to do so. The test case raises questions with regard to the way insurers, across all classes of business, control and govern their policy contracts.
To minimise the risk of wordings being interpreted to an insurer’s detriment, some mitigating actions are required, including;
- Know your subject. Ensure your underwriters have expert knowledge of the industries and / or activities they are covering, including circumstances that may trigger claims and the profile of accumulation risk. Underwriters should monitor the changing risk environment and respond promptly with appropriate policy wording changes.
- Analysis of declined claims. You should assess why policyholders (and indeed their brokers) may believe a declined claim should actually be covered – is there confusion over the policy wording?
- Legal review of policy wordings. Your policy wordings should be assessed by an experienced legal professional against the outcome of recent cases, in order to determine how certain language has been interpreted and whether there is any consequent risk exposure in relation to your own policy wordings that arises from this.
- Risk management review. You, via your risk function, should assess the steps underwriters take to identify the key areas of potential dispute.
- Board oversight. Policy wording governance and its ongoing effectiveness should be a standing item on your Board’s agenda.
- Wording authorisation. You should have a clear, robust sign-off process in place to facilitate adoption of new and changes to existing policy wordings. This process should be ‘owned’ by a Senior Manager and actively involve all relevant areas of the business.
- Limit net exposures. Inner limits may be appropriate to contain accumulation of claims. Also, you need to be sure your reinsurance protection matches the exposures carried.
Implications for the insurance sector
The effective governance of policy wordings is a key issue for the Boards of insurance firms. Chief Executives will, of course, be overseeing compliance with the FCA’s recent letter, but more is also expected of other Senior Managers as they are accountable and take responsibility for the implications of their firm’s policy wordings.
It is imperative that the obligations imposed by the SM&CR regime and also the Product Governance requirements set down in the Insurance Distribution Directive (IDD) are integral to your review of your firm’s governance arrangements and that any remedial actions are taken in a timely and properly co-ordinated way.
Building a firm-wide appreciation of policy wording governance
Insurers and insurance intermediaries should also be determining whether their controls and governance around policy wordings are sufficiently embedded within the firm’s staff training and CPD arrangements. A coherent programme of training courses and briefings to raise awareness will help to nurture a culture in which Underwriting, Claims, Risk and Operations teams give full and careful consideration to the implications of policy language and terminology on the firm’s financial position and reputation.
These training initiatives should be sponsored by a member of the Board. This, combined with the general principles of Board oversight and associated individual accountabilities means that it is vitally important for Senior Managers, as well as those to whom they delegate, to understand and appreciate the regulatory requirements that they and their business areas need to adhere to. Even if you believe that you have the requisite knowledge and experience, recent developments mean that it’s probably highly advisable for you to refresh your memory at least.
Can you really afford not to?