Andy Brookes: Simon you were questioning if insurers accurately price the change in coverage that comes from changing the wording, a world where changes in coverage were clearly priced. Is that a world we are in? Who thinks their firm is actually pricing the marginal change in coverage to the client? Is it possible?
Simon Kilgour: I think some of our insurer clients are now more interested in trying to price legal risk in contracts. In other words, they would be willing to agree more generous clauses on the basis that they were receiving more money because there is inherently more risk. An example might be that you come up with a great wording, but if it is governed by a different law from which you are used to negotiating those contracts under – for instance New York Law or English Law – then although you might know the answers here or in New York, you will not necessarily know the answers in a foreign jurisdiction. That automatically creates an uncertain legal risk, so you can price for that. However, in terms of coverage it is ultimately down to underwriters to put in place systems which can identify where there is increased coverage – either by deviation from standard exclusions or by giving more coverage or bigger limits – and pricing for it. We would focus on the contract quality aspect, and if it is a bad contract we are not saying not to write it, just that it is a bad contract and that you do have legal risk that is probably not priced for at the moment.
Andy Brookes: You mentioned some interesting data earlier in work that you have been doing in terms of looking at the impact of slightly different clauses?
Simon Kilgour: Yes, we spend a lot of time looking at the variables. Certainly at the treaty reinsurance level, a lot of these contracts are very similar, but they are different. The trick is not necessarily identifying what is an institute clause, but identifying the institute clause where it changes slightly. The problem is not the 90% that is mode, but the 10% that is not. At the moment, because there are not model wordings, it is difficult to identify that 10% variable so the question is: how dangerous is that 10%? Does it produce fantastically broad coverage for the cedant that the insurer did not realise it was giving and did not price for and is there unnecessary legal risk? Although there are institute clauses, they are not all the same. You can go and find 20 different ultimate net loss clauses, but they are not all the same and this is the difficulty. It is how you start putting all those pieces of the jigsaw together.
Andy Brookes: You were telling me earlier about the number of clauses in other particular areas.
Simon Kilgour: Yes, there are over 60 different war and terrorism exclusions so which one is your model clause? There are differences. I think the Market Reform Slip specifies that you must have a period clause and a sum insured limit section, but we are aware – for reinsurance treaties – that there are 21 different variables for the limits provisions. Some of these variables are important. It is down to the underwriters who are on the front line to be satisfied which clauses they regard as their model form. They are ultimately the ones who do these transactions.
Andy Brookes: Martin, do you recommend any particular one of those 60 to your membership?
more use of more model products that people are familiar with and do not have to be analysed – or necessitate the involvement of lawyers – at that time, because you have not got the time and a line has to be put down.
Andy Brookes: Steve do you want to comment on contract certainty as a driver for the use of model wordings?
Steve Hulm: I think Martin is right. I think contract certainty has driven a need for having more model wordings in place up front, for giving it consideration and also, as Simon said earlier, giving consideration to the wording before renewal. As he said, you can start it six months earlier and that may help.
Andy Brookes: How much has contract certainty changed processes in your firms in terms of doing things earlier, having things ready well before renewal as Martin described?
Simon Robinson: On the direct side contract certainty has moved the discussion about elements of the wording into pre-inception and pre-renewal, whereas previously it was largely post-renewal. Some of that has been driven by the clients themselves who have said that what they would like is the broadest coverage for the smallest price. Although we all know that will not really happen, what is worse for them is when they think that a policy covers an incident but it turns out that it does not and ultimately all three of us lose. In that sense, some clients are coming to us and stating their intentions prior to renewal; to explain their need, agree that up front and then use that as a basis for renewal. The danger to us is that same basis will be used to market the risk out in the market, but you can never guard against that.
Martin Roberts: Although all the work needs to be done prior to putting the line down, when the client receives his evidence of cover within 30 days, if it is not quite what he wanted, contract certainty does give him the opportunity to go back and renegotiate that. It might be a price sensitive change to the terms or not, but we are in a much better position there than having the policy nine months into the contract or even when it has expired! It does enable you to get that legal analysis from the client if you cannot do that before inception by way of copy slip, then certainly when you receive the evidence of cover. That is a greater improvement in terms of timing.
Simon Robinson: That is an important point. I am sure that it is the same with many companies, but one thing that we try to get with our underwriters is that if a contract needs to be endorsed and renegotiated and something needs to be changes it can be done. Nothing is cast in stone, but you cannot just sit with a draft policy for the next nine months and wait until somebody decides to move it from their desk and say it is the final one. It needs to be prompt to fulfil our obligations as an insurer and to ensure that we have an efficiently working insurance market here.
Andy Brookes: Kristin, do you want to comment on how contract certainty has changed behaviour within your firms?
Kristin van Niekerk: I agree with Simon. I think that the impetus is coming from all sides. It is coming from the cedants, the reinsurers and also the brokers. I think that is quite positive. Everyone is making an effort to reach this because the rewards are obviously not just for us, but across the board: for the cedant, the reinsurer and the broker.
Andy Brookes: Steve, is there anything from the contract certainty perspective that you want to add?
Steve Hulm: It strikes me that contract certainty is not the end of the road. It does not necessarily deliver contract quality in the sense of a contract that is of the highest legal standard and would stand up in court and that the clauses will not clash. You can go through the whole contract certainty process and tick all the boxes and still have clashes between clauses. Therefore, it is only part of the job and there is still part of the job to do.
Andy Brookes: Barbara, you were nodding at that?
Barbara Chandler: Yes, we have been doing a lot of work with binding authority business in the Lloyd's market. Binding authorities could reasonably be described as the forerunner in terms of the model wording in the market. At Xchanging, we are very much at the tail end of the policy wording validation process. We are touching it after the broker has drafted the wording, and the coverholder and the underwriter has reviewed it. Even today, with policy wordings in binding authority business, we still have some form of quality issue with about 40% of what we see. We need to separate out the two distinct elements of contract certainty achievement and production of a good quality document that our clients are happy with and gives us absolute clarity. One of the issues we have not touched upon yet is the role of the wordings expert in producing these wordings in all organisations. That is critical and we are at risk of losing some very good experience in this market by going down the model wording route. This creates an expectation that you can take something off the shelf, cut and paste your clauses, and have a wording, because you have used a model wording. That does not necessarily give you a good quality product at the end.
Andy Brookes: What do you see happening to those experts?
Barbara Chandler: It is interesting. Please shout if you disagree, but your traditional wordings expert in the London market is 40-plus years old. There is not a lot of young blood coming through and we are not very good at training these people up and recognising their value in the business process. I think it has changed with contract certainty. A lot of wording teams are at the front of the process rather than being the afterthought in the back office, but we need to do more to recognise that and make sure that we have fresh blood coming in so we can build that knowledge and experience base going forward.
Andy Brookes: It sounds like a recipe for driving the price up. Are wording experts more expensive than they were and harder to come by?
Andy Brookes: That seems like a reasonable mechanism for recruiting new blood?
Simon Robinson: Ultimately there is a career path for a broker and for an underwriter and there should be one for a wordings expert in that sense. I personally believe that in having your building blocks – each of which would need a tag on them to explain when to, when to not and why to use it, and do not just cut and paste because you end up with a false level of security on the product – actually building experts would rather spend their time – and are more useful doing so if they are expensive – on the true bespoking element which is required. That is where we need the expertise in the market.
Simon Kilgour: Can I just challenge Simon a bit there? You spoke about the wordings expert as if he was distinct from the broker or the underwriter. I would say that underwriters and brokers need to pay more attention to wordings. Historically they have not done so in the London market. That has been part of the problem because you would have a force of underwriters and perhaps a very small force of wordings people serving them. The underwriters would believe that it was not their job to check the wordings because other people did that, but actually they were the ones who had to be alive to these differences. I agree that if there was a model to work off then the question is making sure they are properly supported to understand, value and price those deviations, but that has certainly not been the approach of the majority of underwriters in my experience.
Andy Brookes: Martin, do you want to comment on that point? Do underwriters feel more responsible for the wordings they use than they used to?
Martin Roberts: Yes, the LMA – wanting to implement this – established a group called the Wordings Forum four years ago. If I wanted to see any of the members of that forum, I would have to phone them up in their offices. Now I can see half of them if I walk through the room because they sit alongside the underwriters. That has been a significant cultural change. The wording specialists are now part of the underwriting team and are not a distinct species. Contract certainty has been a great driver in making them very important. Hopefully that will drive up the quality. I agree with Steve that the great challenge is the way that this is driving up quality. I have seen some young people coming into the market in the last year, so it is not all grey hair!
Andy Brookes: Simon raised the point about whether underwriters take their responsibilities sufficiently seriously. I understand your point that wording people are closer to the box but what about the underwriters' sense of their own responsibility for the fullness and coherence of the coverage?
Martin Roberts: Again, that is the operational risk side of the underwriter. It is up to individual businesses to manage. I have seen increasing signs of managing agents taking an overall look at their underwriting and the quality of it and that is emerging now. Everything that Steve said about having a set of clauses is fine, but unless it actually fits together, it does not get you where you want to be.
Andy Brookes: Steve have you seen those behavioural changes as you visit market firms?
Steve Hulm: I think so, but people are usually on their best behaviour. It is very difficult to tell what is going on as a company.
Andy Brookes: Victoria and Kristin, do you want to say something about what initiatives are underway in your firms? We have agreed that there is a prize for the industry and a greater use of model wordings will bring an improvement to everybody's wellbeing – the client, broker and insurer and all points in between – so what are we doing to achieve that? We have heard that contract certainty is a stimulus in that direction and has led to some changes in behaviour, but I am interested in what is happening in individual firms. I am also interested what is happening on the client side Paul.
Victoria Price: Understandably, I think everyone is quite worried about being compliant from 1 January, rather than taking on board what the concept of contract certainty is all about.
Andy Brookes: Compliant with contract certainty?
Barbara Chandler: I would agree with that. We have certainly seen a mood change in the London market in terms of achieving contract certainty. In the early part of the second quarter of 2006 we were seeing a lot of pressure on us as a service provider to produce our checks and speed up the process. The pendulum certainly seems to be swinging to the market now and we are getting a lot of feedback. Particularly on the Lloyd's side, but less on the company side, looking at making sure the checks are still full and relevant. We are doing all of the quality checks that go beyond ticking the box in terms of contract certainty. Actually, I think there is now a realisation that this has got to go beyond just saying that you have gone past the bar and the bar is down there, it is about keeping the bar at that level, making sure we are jumping over it and getting a good quality document out. That is certainly the feedback that we have had, I do not know if you agree with that Steve.
Steve Hulm: Yes, I agree with that.
Andy Brookes: Simon, you were telling me about the location of your unit within your firm.
Simon Robinson: What we have been trying to do for the last few years is to move the underwriters to a position where they can have a debate with brokers and clients about operational risks and capital costs and on that basis, rather than talk about the specific products – which is only the second line – the unit Underwriting Quality was formed as a resource for underwriters and the underwriting director to say that they were going to produce this volume. It is not so much about ticking the boxes or just producing the premium, but about the quality of what we put in that box as well; the interface with all the regulatory pressures that we have got and compliance and freeing up the underwriters in that sense to be underwriters, but to also understand some of the links they have got in that process and who does what further down or further up that chain. In terms of what contract certainty was, the key for us was that it started out being a project within our business actually run by underwriters, but has now been moved back into the operational risk side. Providing a product for our clients is what we are about and I think the London market will be – and will remain – a very attractive place for international clients going forward if it does that properly. Martin's example of the marine market was a very good one in that regard because it shows that you do not necessarily have to view relatively model institute clauses as a negative thing. They can be your tools in producing an internationally viable product.
Andy Brookes: That is very interesting for what insurers are doing, thank you. What are brokers doing differently?
Steve Hulm: I would think brokers are driven by contract services, for example, to consider the use of model wordings, but I think they are still in a dilemma. They still face off to clients and clients want the best deal and to feel that they have got an individual deal. Therefore, I think brokers are in a tight spot to be honest. They are more likely to go along the line of, "my client wants this particular cover so I am going to make something bespoke". Putting my market hat on, I think that the challenge for us is to let them do that, but in a framework that is still based on model wording. There is a model wording, they have made the specific change, and it is more visible to the client, the market, and the insurer that is going to write it. That is challenging.