Wordings do matter
Contract drafting has been brass tacks for lawyers since the dawn of time. In its broadest terms, it involves putting the scope of a bargain reached between parties into clear and effective language.
As a practice, the preparation of insurance contracts — or policy wordings as they are typically referred to — is under the heat of the industry's spotlight.
This article explores why these contracts are set apart because of the regulatory landscape in which they operate, who gets to decide what "good" looks like, and why lawyers working on them need to have their eyes up and commercial antenna switched to receive for the new zeitgeist — particularly following the implementation of the consumer duty by the Financial Conduct Authority on July 31.
Why are insurance policies different?
First and foremost, insurance policies are a product.
For insurers, the words on the page are the very thing they sell and so what they look like is important and highly responsive to powerful market forces. The contracts need to be distinctive and speak the insurer's individual voice, yet not so left-of-field that no one will want to buy them or broker their sale.
The underwriting of insurance business in the U.K. is heavily regulated and in the last decade we have seen a step change in the pace of new initiatives, emanating most notably from the FCA, all of which impact upon wordings.
Building on a general trend in business to promote the use of plain English, at its heart, the regulatory objective has been and remains, to engender behaviors that mitigate the imbalance of knowledge and understanding between financial institutions and their end users, and to ensure that the entirety of the purchasing journey is transparent and transacted in a manner that is "clear, fair and not misleading,"1 so that buyers of insurance can make informed decisions about what it is they are purchasing.
For instance, in 2018, the EU Insurance Distribution Directive was a key shift in the protection of customers — consumers and some commercial customers — taking out insurance.
New regulation strengthens consumer protection
A central tenet of the consumer duty, implemented in the summer of this year, is ensuring that information provided to customers about products is clear and understandable, and that it meets their needs, taking into account, for example, their characteristics, the complexity of the policy and the communication channel used.
Complementing the rulemaking and enforcement work of the FCA, the Financial Services Compensation Scheme, or FSCS, in existence since 2001, aims to secure an "appropriate degree of protection" for policyholders where insurers cannot meet their obligations to pay claims.
While the scheme forecasts that it will pay out in excess of £230 million ($180 million) this financial year in compensation relating to general insurance matters, it is not an absolute safety net.
Indeed, as demonstrated by the Court of Appeal of England and Wales in Manchikalapati v. Financial Services Compensation Scheme Ltd. on Sept. 5,2 the statutory framework empowers the FSCS as scheme provider to restrict the types and scope of claims it will compensate.
Global developments affect insurance policies
Beyond regulation, other factors are at play.
In recent years, we have experienced an intense proliferation of geopolitical risk and technical innovation. The development of new risk markets and products is a powerful strategic asset for the government as capital can flow and innovation will thrive by hedging risk.
Furthermore, new risks demand new products and insurance structures, such as embedded insurance products or evergreen and parametric models, that are becoming commonplace.
Digital contracts and platforms facilitate new ways to communicate and particularize the scope of the cover being provided, with real advances taking place in the personal lines space.
Significant investment is needed to pivot large institutions that have built their operating models on the concept of a contract being a physical one.
It is also worth acknowledging that insurance policies are perhaps the most heavily disputed and litigated contracts.
There will always be coverage disputes around the interpretation of contractual language in insurance policies. This is perhaps not surprising, given these contracts routinely bake in a complex mechanism to govern the adjustment of an indemnity that is by its nature unquantified following a particular risk event having taken place to trigger the policy response.
However, in the eyes of the regulator, high dispute and complaint trends are an indicator that something has gone wrong. That assessment has, in significant part, become possible because of the power of data.
The Coronavirus pandemic and the resulting 2021 U.K. Supreme Court business interruption test case in Financial Conduct Authority v. Arch Insurance UK Ltd.3 was a significant "sit-up" moment for the industry that laid bare the impact of the push-pull factors articulated above.
The case surfaced the fundamental challenges posed by systemic risk and a significant divergence in expectation between insurers, their customers, the regulator and, to some extent, the courts, as to what the policies were expected to respond to and how they would perform.
The test case was also somewhat of a landmark moment for the FCA — seen as the champion of the consumer market — in taking up the cause for small businesses.
Over recent years, the FCA has made it increasingly clear in its commentary and in the regulation released, which applies equally to small businesses, as it does consumers, that these insureds are to be afforded the same levels of protection.
From a policy wordings perspective, this means no let up for the small business market where we can expect to see significant scrutiny in the months and years to come.
Where do we go from here?
As night follows day, after such a moment, a period of correction is a natural consequence.
In the context of litigation concerning the proper interpretation of wordings, we have seen no abatement in the judicial appetite to push back on arguments perceived as commendable to none but pedantic or — with milder vernacular — commercial lawyers, in favor of a common-sense approach that references the likely level of comprehension of the reasonable policyholder buying the product.4
Indeed, the conceptual agility demanded of policyholders to navigate complicated contractual structures, like carve backs within exclusions, comes into sharper focus the simpler the wordings get.
Two cases highlight the interpretation of policy wordings
Similarly, literary devices, such as whether inference can be properly drawn from the absence of certain language that is consistently applied elsewhere, are increasingly relevant.
Judge Nigel Bird, sitting in the Technology and Construction Court, held that inferring an intention to not apply the rule in Arch requires more than the absence of particular language in the war exclusion that was applied in different exclusions within the policy.
The court held the reasonable policyholder would not read the wording in this way and would expect this to be dealt with expressly.
Widening the lens further, the courts continue to contextualize insurance language in a way that actively promotes the regulatory objectives described above.
Manchikalapati is a case in point. While not directly concerned with the interpretation of a policy wording, it involved a close examination of connective language ubiquitous within policy exclusions: the meaning of "in respect of" and "in connection with."
Taking a step back, the Court of Appeal was not persuaded that the nexus between two concepts connected in this way was as wide as was argued when specifically set against the statutory framework that empowers the FSCS to restrict the types and scope of claims to be compensated.
This reminds us there is no place for complacency and particularly with exclusionary language, which by its nature seeks to take back something that has first been given in an insuring clause.
Regulation on insurance policies expands
The complaints jurisdiction of the Financial Ombudsman Service, or FOS, was significantly expanded to include more small businesses in 20196 and its maximum compensatory award again increased to £415,000 in April. Its decisions speak to the fact that a sound coverage argument is not always enough to justify declining cover.
The FOS seems willing and able to rewrite insurance policies on what it deems to be fair in the context of their assessment of the reasonable expectation of the policyholder.
There are examples where the FOS has determined that cover should be available notwithstanding an exclusion in a wording on grounds that, as an unusual or onerous term, it was not sufficiently drawn to the customer's attention. For example, FOS has done so by not including it within the insurance product information document or policy summary.
The consumer duty, which is a bit of a misnomer as it applies to all U.K. consumer and commercial insurance other than large risks, and in summary includes consumers and small business commercial customers,7 represents a major shift for insurers and those drafting the insurance products they are selling.
An upgrade on the existing rules, including the "Treating Customers' Fairly" regime, the duty demands an entirely new point of reference, which puts the reduction of foreseeable harm and the delivery of good outcomes8 for the insurance buyer front and center.
Harnessing the full potential of data, insurers are required to conduct quantitative and qualitative assessments of how those outcomes are being delivered.
For example, high customer query rates or midterm variations might indicate the policyholder does not understand what it is they are buying or that the product does not meet their needs.
What have we learned?
A technically clever wording, while important, is no longer a differentiator in terms of what good looks like, or as we have seen, enough to ensure they perform as expected. Wordings need to be drafted in a way that actively improves understanding, rather than shifts the onus onto the end user.
The example that the writer often reaches for as food for thought and to highlight the shift in focus required can still be found in many commercial combined products offered to small and medium-sized enterprises business.
Within the introductory paragraphs may be language in a helpful tone, such as, "the insured must read the policy carefully and tell their broker if it does not meet their needs."
These products are designed, with laudable intention, as a one-stop insurance solution, to make the customer's life easier.
In consequence however, these policies are large documents and routinely equivalent in word count to a small novel, like C.S. Lewis' "The Lion, the Witch and the Wardrobe," or F. Scott Fitzgerald's "The Great Gatsby" — although, even to the most enthusiastic wordings lawyer, less riveting.
Such expressions of expectation on the roles of the contracting parties when viewed in this context are patently unrealistic and unreasonable.
Yes, it is important to draft wordings with one eye on the likely arguments that will arise, but in the age of the consumer duty, this approach can be damaging.
President Abraham Lincoln quoted poet John Lydgate when he said, "You can please some of the people all of the time, you can please all of the people some of the time, but you can't please all of the people all of the time."
The FCA have nailed the colors to the mast for us. The delivery of good outcomes for the policyholder is something upon which we should not compromise and in respect of which policy wordings plays a vital role.
This article was originally published in Law360.
4For example, see Lady Justice Andrews' dissenting judgment in Al Mana Lifestyle Trading LLC v United Fidelity Insurance Co PSC  EWCA 2049 (Comm); or Allianz v University of Exeter  EWHC 630 (TCC)
5Allianz Insurance plc v University of Exeter  EWHC 630 (TCC) (paras 57-68); This concerned the language, "…regardless of any other cause or event contributing concurrently or in any other sequence to…" which renders express the ruling in Arch that in the case of multiple proximate causes of loss, where one may be covered and another excluded, the exclusion will prevail to exclude the loss.
6Consumers, micro-enterprises and small businesses (whose annual turnover is less than £6.5m and either has a balance sheet of £5m or employs fewer than 50 employees) are within scope
7Large risks are contracts of insurance covering risks in certain categories for commercial insureds such as aircraft, ships credit and goods in transit and other categories of risk where the commercial insured exceeds two of the following three criteria: (i) balance sheet total: €6.2 million; (ii) net turnover: €12.8 million; (iii) average number of employees during the financial year: 250. See also the FCA Handbook, Article 13(27) of the Solvency II Directive and article 2(1)(16) of the Insurance Distribution Directive.
8The four Consumer Outcomes are: (i) 'products and services, (ii) price and value, (iii) consumer understanding and (iv) consumer support).