Contract certainty - "Deal now, detail sooner?"
Speech by David Strachan, Insurance Sector Leader, FSA
The Insurance Institute of London
10 January 2006
Introduction
I am very pleased at having been given the opportunity to address you at the first of this year's Insurance Institute Lunchtime Lectures. It is apparent from the popularity of these lectures that they are seen as providing an excellent opportunity to hear first hand about developments and initiatives in the London market. I hope that I am able to continue this trend. Indeed, judging by the number of people present today, the subject of today's lecture is one of those crowd-drawing initiatives. Or perhaps it is simply that New Year resolutions have left many of you with the stark choice of being here, or spending your lunchtime in the gym, working off the excesses of the festive season!
I would certainly like to believe that the London market is so determined to find a solution to the age old problem of contract certainty – or lack of it – that this and other opportunities to hear about developments cannot be missed. You know that the FSA is absolutely committed to finding an end to the practice that has come to be known as "deal now, detail later" in the insurance market. We know from our recent discussions with senior market participants that you are too. But we also know that achieving this end is not as simple as changing the odd process here and there or making lots of noise in speeches and articles. There are some big obstacles and issues to tackle in the 11-and-a-half months left of our two-year challenge to get the market to deal now with detail now. The big question today has to be "is it still deal now, detail later or is the market on its way to making deal now, detail now a reality?".
So, today, I want to share with you our view of market progress since John Tiner announced our challenge in New York in December 2004. I will share the results of our mid-way 'stocktake' and give you some indication of the areas we think you, as individuals, as firms and as a market, need to address in the next few months. It is important to state at the outset that our 'stocktake' is exactly what it says on the tin – it is not a formal decision about whether we will need to intervene in the market through new rules and guidance. We will not be able to make that decision until we have seen how the market has fared against its own targets for the end of the first year of the challenge. That decision will be taken and announced towards the end of this first quarter of 2006. That said I do want to outline our own plans for the months ahead, which will continue to run in parallel with the market's efforts and activities.
Background
I don't need to remind you why we need to resolve contract uncertainty in the insurance market. You know that contract certainty reduces the risks to all parties in the insurance chain. If all goes to plan, in January 2007, policyholders will know exactly what protection they have bought; brokers will reduce the legal, fiduciary and operational risks which they are running; and underwriters will have a clearer view of their underwriting exposure, for both full and 'subscribed to' risks. There will be greater certainty at inception of the contract with full policy documentation provided promptly thereafter: the deal now with detail now. Reaching this golden moment can only bring benefits to all in the insurance chain. And it is for this reason that our focus has been on buyers, brokers and insurers, operating in both the subscription market and the non subscription market.
Since John's announcement, under the admirable leadership of Nick Prettejohn's Steering Group, the working groups for the subscription and non—subscription markets have brought considerable energy and effort to bear on finding solutions. A definition of contract certainty, agreed by all parties last summer, is now being implemented through market codes, supplemented with guidance, FAQs and industry presentations. In addition, the CII has made great efforts to increase the skills and competency of individuals operating in the market, launching in October last year the Contract Certainty Certificate and Commercial Insurance contract wording exam. Such a brief summary of progress does little justice to the huge amount of work undertaken by the relevant trade associations and market groups over the course of the last year. The tools to deliver change to processes and behaviours are now in place. In the coming months, much more is planned to help resolve some of the crunchy issues which have been identified by you, as practitioners, as you start to use these tools in your day to day dealings with each other.
On our part, as you would expect, we have followed the market's progress closely. We have also met on four occasions senior representatives from brokers, underwriters and insureds to hear first hand how developments are taking shape and bedding down. The last of these meetings was in early December – a public record is on our website together with the presentations provided by Nick Prettejohn, Nick Starling for Duncan Boyle, and Andrew Cornish. That meeting was a key staging post in the challenge and provided a very important input to our own 'stocktake' of progress.
The second key input to our 'stocktake' was the visits we undertook in November to firms operating in the London Market. These visits were a vital part of assessing progress by individual firms at the coalface. To do this, we met with underwriters and brokers to see how they were adapting their own processes and behaviours when transacting business leading up to the 1 January renewal period. We are most grateful to all those firms that gave us their time – 12 in total including Lloyd's managing agents, brokers, insurers and reinsurers. We recognise that this is always the busiest time of the year for many firms operating in the London Market and the hurricane season last year added to the pressures on those involved.
So what did we find? A number of key themes emerged from our visits:
· leadership and engagement;
· signed lines;
· some issues about the costs and benefits for the London Market;
· contract certainty and the current renewal season;
· implementing market codes and guidance;
· management information and tracking; and
· ICAS.
Given that these themes emerged in each of our visits, we think it is fairly safe to conclude that these issues are exercising others in the London Market. I would, therefore, like to take each in turn and give you our thoughts on each of them.
Leadership and engagement
First, an initiative as significant and all-encompassing as contract certainty, and the associated cultural change necessary to achieve it, requires strong leadership. We have seen some very clear examples of this: the cross-market group of larger managing agents; individual firm initiatives designed to change behaviour as well as process; and the work of the market Steering Group to name but a few. Our visits confirmed that ongoing leadership in the months ahead is going to be vital to retaining the momentum that has been built up. And with leadership must come engagement. We will expect to see evidence of leadership and engagement within all firms so that each and every person for whom contract certainty is relevant knows what it means for them and what they need to do to contribute to their firm’s and ultimately the market's solution.
Signed lines
Second, it is clear that the subject of signed lines has sorely vexed the market as this was the first issue raised with us by most firms we met. Many are concerned that this aspect of the Code of Practice will be difficult to achieve, especially during the peak 1 January renewal period. On the other hand, we sensed true commitment to greater clarity over signed lines and to improving current practices. We welcome the efforts to develop further guidance on this, and encourage the market to resolve this issue in a practical way as a matter of urgency.
Cost and benefit implications
Third, some concerns were expressed to us about the risks of London “going it alone” on contract certainty. In our view there is significant commercial advantage if the UK insurance market achieves contract certainty, for a number of reasons. First, at a time when managing the underwriting cycle demands tighter control over costs, reducing the time spent on rewording and reworking contracts will contribute positively to this. Second, as I have already mentioned, achieving contract certainty will give all concerned greater control over their risk profiles. Third, if the London Market solution to contract certainty works, your market will be more competitive as a result. Overseas buyers and brokers will see their own risks reduce by placing business in a market where details of the deal are agreed at inception, not months afterwards. High standards of corporate governance may well also make it very difficult to place business in centres which do not deliver contract certainty when that same business can be done in a marketplace that does. That has to be to your advantage.
At our meeting with the CEOs, there was general agreement that contract certainty should result in increased efficiency and competitiveness for the UK insurance market and the initial costs associated with achieving contract certainty (which will clearly exist) would be outweighed by the long term benefits.
Indeed, there should be no doubt that our desire to maintain the competitive position of the UK markets was one of the key drivers to our contract certainty challenge. And having seen the progress made in the UK markets in the past year, we now plan to raise awareness of our initiative with our counterparts in other key insurance jurisdictions. Similarly, we have encouraged AIRMIC to engage with their US and European counterparts (FERMA and RIMS) to encourage a change in mindset of your overseas clients.
Contract certainty and the current renewal season
Fourth, uncertainty over reinsurance rates post-Katrina has been cited by the market as an obstacle for timely 2005 renewals and was a key focus of attention during our discussions. We understand that market conditions have been very difficult, and we recognise that market convention is to secure reinsurance programmes before committing capital for primary business. However, we would not expect these issues to prevent progress this year or to prevent discussions about renewals earlier in the process. Whilst none of us would welcome such events given the human and economic losses experienced last year, we cannot overlook the possibility of similar catastrophes in the second half of 2006 just as the challenge is nearing its end. We expect firms to prepare on that basis and make sure that they revise their approaches to take account of lessons learned this time.
We have seen good examples of progress on wording agreed ahead of decisions on price, and of firms starting to negotiate renewals much earlier in the process. Some firms have brought wording specialists to work at the front line alongside underwriters and brokers. And these firms are seeing real results – in some cases, wording on large corporate programmes is being agreed by inception; in other cases a base wording is being used as a default in the event that full wording is not agreed by inception. We would encourage other firms to challenge and change their existing practices as and where appropriate.
We have also heard a number of firms say that contract certainty was not a primary driver for changing practice ahead of this renewal period because the target set by the market – of 30% at the end of 2005 – was easily attainable. Many firms have therefore decided to focus on the market's end-game target of 85% of transactions meeting contract certainty. Whilst we are pleased to see that firms are taking a strategic approach to addressing this issue by focusing on the longer term, we believe it is dangerous to be complacent about the year end that has just passed. We will be receiving data next month which will demonstrate how well the market has fared against the year-end target and, as I have already mentioned, that will be a key determinant in our decision about regulatory
Market codes and guidance
Fifth, we were encouraged to hear positive feedback from firms about the value of the Market Codes and guidance. There are some very practical issues which need resolution - in addition to signed lines which I've touched on already – and the market groups are working hard to provide you with further help. On our part, we are expecting some very clear examples by the Working Group of the type of transactions which fail to meet the targets set at each critical stage – in other words, what will be in the 15% at the end of this year?
All firms in our sample had project plans in place, which was to be expected given the importance of this issue. However, these varied from a single page of actions to more detailed and strategic plans. We have no prescription about the level of detail required to deliver contract certainty in individual firms. But we would expect you and your Boards to know what you need to do, by when, by whom and how if you are to achieve contract certainty by the end of this year.
Management information and tracking
Sixth, we were pleased to see changes in the way some firms – both brokers and underwriters - measure progress through the use of management information and other tracking systems. However, we were surprised that some underwriters had not made plans to develop tracking mechanisms to monitor their own firm's progress against the market target of 30% by the end of 2005. Over the coming months good management information will be vital for the market to measure performance against its targets. And vital for individual firms that will need to demonstrate both to their boards, and to us, that they are well on their way to achieving contract certainty.