A Broker’s Duty of Care – Assessing a Client’s Understanding

This article has been provided by Robin Wood, chartered insurance practitioner and expert on insurance broking market practice and standards, and Roger Franklin, Head of Insurance Litigation at Edwin Coe Solicitors.

Last week, we posed the following case study:

Client A was a fast-growing trendy bakers in London. The broker had acted for them for three years. A fire occurred and their business was destroyed towards the end of their policy year. They were insured for £500,000 gross profit on a turnover of about £5 million, under a combined policy with an indemnity period of 12 months. The client used the gross profit figure in their accounts.

They were able to find alternative premises while their own was rebuilt, but the 12-month indemnity period was substantially inadequate. The client had chosen the 12-month indemnity period as the broker had advised them that the indemnity period would be the maximum time needed to get back into business. The client believed this was the case and indeed they were back in business within that period (just), but their loss assessor advised that they had been badly advised by the broker as to what the indemnity period actually covered.

The adjusters claimed that the correct sum insured for gross profit should have been £3 million and average was applied on a £1 million gross profit claim which was exaggerated by their rapid expansion.

The broker was sued for the losses incurred by virtue of the inadequate insurance.

We asked you to consider what the broker might have done to avoid the claim that they had failed to discharge their duty of care?

Ouch! Business interruption is one of the most common areas where brokers fail to discharge their duty to explain things to a client.

In this case, the first line of defence from the broker was that the client had dealt with their insurance and insured gross profit for years, and so they were quite experienced in insurance matters. This claim is quite likely to be complete nonsense. If this were the case, why would anyone in business appoint lawyers or accountants? Unless a broker has good evidence that the client knew and understood what they were doing, the defence that “they had handled the insurance renewal in the past therefore understood what they were doing”, is not usually a good one.

 To win the argument that the client was experienced, the broker would have to conduct some form of assessment of knowledge and record it. This can be with straight questions:

“Do you understand that you need to insure for full replacement value and costs for your property and if you are not adequately insured, your claim might be reduced proportionately to the level of under insurance?”

“Do you understand that in calculating your Gross profit sum insured, you should assume that a loss might occur on the last day of the policy term. So, it is next year’s turnover and costs and possibly even the year after that or the year after that you should be looking at?”

“Do you understand that the gross profit sum insured is not the same gross profit that appears in your accounts. Do you want me to show you how to calculate a reasonably accurate sum?”

“Do you know that the size of public liability claims has risen dramatically and that a personal injury or third-party property liability claim could readily exceed the £2 million level of indemnity you have under the policy”?

A competent insurance broker will, beyond a proposal form or statement of fact, have a good series of pre-prepared questions for a client which check, in particular, that a client knows and understands significant and onerous aspects of the insurance.

Another good test is the quality of the questions and correspondence with a client. A common but inadequate defence is that “the client didn’t ask any questions, so I assumed they knew what they were doing”. A client who asks questions is often a client with experience because they know what to ask and when to ask questions. No questions can often be a signal of incorrect understanding.

Above all, don’t get caught in the trap of sending documents to a client and asking them to read them and revert back to you if there is something which they do not understand. Of course, ask the client to check the facts (Sum insured, details of what is insured etc) but be careful about asking them to check the policy. That is really the broker’s job when dealing with an insurance inexperienced client.

It is up to the broker to gather information and recommend a suitable policy, so it is up to the broker to advise if the arrangements are suitable and correct. If that were not the case, we would be dealing with a non-advised sale.

So, let us do the sensible thing as a PI Risk Management step and treat clients as insurance layman. Make a note of any evidence which suggests the client has a better understanding. If a client does not want a full explanation at each renewal meeting, then make a note of it. Try to identify where the significant and onerous wordings are in documents or highlight them in glossaries of reports.

The judge in the Café de Lecq case proudly waved the page asking for the premium suggesting that if you signposted key matters on that page, the client could hardly claim ignorance if they had paid the premium!

So how did you get on?

Point 1

The client did not know how to calculate a gross profit sum insured. We need to be clear that unless they volunteer to calculate the sum insured, a broker has absolutely no duty to do this.

The duty is to explain to the client the method they should use to make the calculation. Often, this will include a recommendation about who to refer to if they cannot perform the calculation themselves. The two most common recommendations are a property specialist for the buildings sum insured and an accountant regarding the Business Interruption sum insured, but there are many other specialist valuers who can help them.

Many insurance brokers do offer to calculate the GP sum insured for the client, but it is not your duty to do so.

Point 2

The broker should also advise the client on issues to consider when choosing a sum insured.

One of those will be the condition of average and its effect. Another might be to ask the client to consider what turnover might be on the last day of the policy and how that turnover might change during the indemnity period. These are simple examples. See if you can make a list.

Point 3

It also seems that the broker might not have explained an indemnity period satisfactorily (if at all). It is the explanation that the client can understand which discharges the duty of care.

It is also important to explain that the indemnity period is the time needed to get the business back to the position it would have been if a loss had not occurred. In a fast-growing business, this can mean and indemnity period of at least three years.

Rarely is the indemnity period that which it will take to get back into business. A very common mistake.

Of course, a longer indemnity period means higher premiums and it is a fact that many clients want to limit cost and will choose a 12-month period regardless. As long as the broker has recommended that they consider a longer period and explained the pitfalls of an inadequate sum insured or indemnity period, it is likely that their duty has been discharged.

We will go into greater detail on how to explain things to the client later in the series, but one of the key learning points of this case is that a reasonably competent broker should have a key list of points relating to significant and onerous conditions. This list can be used as appropriate questions with any client (ideally confirmed in writing), to check and establish their knowledge of the insurance arrangements you are recommending.

Many professional insurance brokers I have met over the years have had a bank of these which can also be discussed with colleagues at regular inhouse team meetings.

Many brokers have a firm-specific fact find which allows client facing staff who gather information, to go beyond the questions insurers ask and in particular, test the client’s insurance knowledge and understanding.

Does your client ‘Know and Understand’ what to do to avoid a shortfall in cover and do they apply that knowledge and understanding to present insurers with accurate detail and figures so that they cannot trigger the right for an insurer to avoid or reduce a claim?

If all three (Knowledge – Understanding - Application) are in place, then the risk of a PI claim against you is greatly reduced.

Case Study

This week’s case study is a simple one but needs some thought. You may need to refer to the GFSC Codec on client knowledge to consider the answer you want to give.

ABC Brokers work in the Glens of Scotland and insures local pubs. They place their business with XYZ wholesale brokers in London who specialise in policies for small, licensed premises.

Over a period of a few years, ABC present a number of modest claims where locals have held a Friday night drink and dance session and customers have fallen and claimed for injury.

Underwriters at Lloyds have become concerned about the trend and feel that the best way to deal with the issue is to exclude slip and trip claims on nights when the venue is being used for dancing.

This is added to the policy at renewal and XYZ send the new policy wording to ABC.

Of course, a slip and trip claim arises in the new policy year and XYZ advises the retail broker that the claim will not be paid as the loss has been excluded at renewal.

Clearly, the client (the pub) has not been advised of the change and someone will have to pay the claim. Who do you think should pay? The retail broker or the wholesale broker?

Now that is real CPD! Try to make notes and perhaps create a discussion group so that more than one of you can take part in the CPD exercise.

Do the rules on Client understanding extend to the relationship between separate brokers in the distribution chain from underwriter to client?

About the author

The opinions expressed in this article are the author’s own and do not necessarily reflect the view of RWA Compliance Services Ltd.

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