Insurance Brokers Obligations to Clients

Possibly to maintain a competitive edge, brokers have moved from their traditional role of insurance intermediary to that of a value-added business partner for both insurers and the insured. In this feature on insurance broking, Lyndon Parnell examines the changing nature of the broker’s role and obligations to clients.

The three major aims for business in managing risk are to:

• contain and reduce costs
• protect future earnings
• ensure governance and compliance.

Today’s competitive pressures and corporate governance obligations force business to scrutinise the price paid for goods and services and ensure value is obtained. The provision of insurance services is constantly focused under the cost microscope – sometimes with catastrophic results.

Many clients put their faith in an insurance broker without understanding the intricacies of the complex insurance industry. All insurance brokers are not the same. Insurance broking firms vary in size, type and professional capacity. Not all brokers have expertise in all areas of specialisation.

In recent years, due to various technological and competitive pressures, the offerings of brokers have expanded into various other services such as risk management, claims management, loss control, contract review, valuations and due diligence audits. And always there is the contradiction of efficiency of delivery vs. client service.

Insurance brokers are not employed to give specialist legal advice, but they do have a responsibility to offer advice to their clients. However, if brokers do give advice on legal matters in response to a client request, they may be in breach of duty if that advice is wrong. For example:

A broker in advising what policies are required by a business is an advisor on legal matters, namely, the types of risk for which the operation of the business may attract liability and the appropriate policies, and if he takes upon himself to so advise and does not do so competently as a broker, he would be liable for loss occasioned by his failure and he could not avoid it by pointing to the fact that his advice involved legal issues.¹

Possibly to maintain their competitive edge, brokers have moved from their traditional role of insurance intermediary to that of value-added business partner for both insurers and the insured, and therefore brokers must have integrity with all stakeholders. There is considerable authority to the effect that insurance brokers must use reasonable skill and care to ascertain their clients’ needs by instructions or otherwise.

Insurance products are becoming more and more technical, and insurers’ offerings are numerous and diverse. Brokers therefore, must have a detailed knowledge of the products offered by the various insurers in the market, the differences in policy wordings, the appetite which insurers have for which specific industry groups, and importantly, insurers’ attitudes to claims.

An intermediary as an agent owes the principal a duty of care which is dependent upon what the agent is employed to do and upon the agent’s status. An insurance broker has a duty to exercise all reasonable care and skill to a standard appropriate to the broker’s professional status and be liable both in contract and tort for any breach of that duty ².

The standard of care expected of brokers is higher than the standard expected of people who do not present themselves as possessing a special skill. Those who, like insurance brokers, present themselves as possessing a special skill and who invite custom to their business on that account cannot complain if, in the absence of a disclaimer, they are held liable for the consequences of failing to exercise that skill in carrying out a customer’s commission.³⁴

Risk management is defined as the systematic application of management policies, procedures and practices to the task of identifying, analysing, assessing, treating and monitoring risk.⁵ There are many insurance brokers who present themselves as risk managers when they have no formal qualifications or methodologies to carry out this function. These insurance brokers are exposed to potential liability.

Insurance brokers are under a duty to exercise reasonable care and skill in the performance of obligations, and a term to that effect is implied  in the contract between the broker and the client.⁶

The primary duties of insurance brokers, and the nature and extent of those duties, flow from insurance brokers’ contracts with their clients. The contract will be the first point of review, along with the factual circumstances of the case, to determine whether the professional duty and skills necessary have met the benchmark required by the client. The contract, usually called a letter of appointment, may expressly specify what the broker is engaged to do and the standard of care to be observed or, on the other hand, imply a standard of care different from that otherwise imposed by law. In practice, contracts are usually prepared by the brokers, who will generally attempt to expressly limit their liability for breach of duty.

Brokers’ duty is to follow the client’s instructions. It is therefore essential to clearly determine and agree what those instructions are. Brokers, when instructed to arrange insurance, are obligated to make reasonable enquiries as to the client’s needs. Where brokers are instructed to arrange or renew insurance, brokers will be liable for any loss resulting from unconscionable delay in carrying out those instructions.

Conversely, it may well be argued that clients do not have the capability to provide knowledgeable instructions to their brokers. The conundrum is that clients often do not have the skills required to give brokers correct instructions.

When it comes to advice, the issue is not what brokers think they know; the issue is what brokers think they know is right, but in fact, is wrong. In addition, insurance brokers don’t know what they don’t know.⁷ This principle is supported by Dr. Daniel J. Boorstin:⁸

The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge.

When an insurer rejects an insurance claim, regularly there is legal action by the insured against the insurance broker. The blame game commences.

Where the broker is in breach of the duty of care, the broker is liable in damages for any loss flowing from the breach. If the breach of duty leaves the client without valid insurance cover which would have responded had it been arranged, the measure of damages will normally be the amount recoverable had the cover been arranged less the amount of any premium which would have been payable.

In the 1987 movie Wall Street, Gordon Gecko says:

I don’t throw darts at a board. I bet on sure things. Read SunTzu, The Art of War. Every battle is won before it is ever fought.

To win the battle before it is fought, it is in both the broker and the client’s best interests to have a written contract by formalising and agreeing the duties and responsibilities of the insurance broker.

It is also the duty of insurance brokers to act with the utmost good faith towards insurers. Failure to comply with the duty of utmost good faith is a breach of the Insurance Contracts Act [1984].⁹

The duty of good faith is defined in the Insurance Contracts Act,¹⁰ which imposes an obligation upon insureds and therefore an obligation on brokers as agents of the insureds to disclose all facts relating to the proposed risks.¹¹ However, in a majority decision, the Court has confirmed an insured’s duty of disclosure under section 21(1) of the Insurance Contracts Act is limited to disclosing matters that affect the insurer’s assessment of the risk of the proposed insurance and does not extend to disclosing every matter relevant to the insurer’s decision to enter into the contract of insurance.¹² Nevertheless, it may well be argued that some insurers might bias the distinction between matters relevant to accepting the risk, and matters relevant to making a decision on whether or not to accept the contract.

In Clyde R Ogden¹³ Macfarlen J considered that the relationship between brokers and clients was that of “lay client and expert and professional broker” and it was therefore “not necessary for the lay client to suggest to the expert professional broker what ought or ought not to be done; what enquiries ought or ought not to be made; or how negotiations should be conducted with the underwriter”.

In Provincial Insurance Australia Pty Ltd v Consolidated Wood Products Pty Ltd¹⁴ Kirby P summarised the principles of law based on negligence by the broker as follows:

1. The duty in law of a broker who is engaged to secure insurance on behalf of a client is “having undertaken to obtain insurance, to exercise proper care and skill in carrying out the insured’s instructions”¹⁵ The duty is owed
   in contract and in tort.¹⁶
2. The foregoing duty does not extend to expounding the law to the assured, but it does extend to pointing out legal pitfalls which might arise in the course of effecting a valid insurance cover and in securing cover for the risk necessary to the assureds’ disclosed or ascertained needs.¹⁷
3. It is normally necessary for expert evidence to be given on what a reasonably careful insurance broker would have done in particular circumstances to enable the court to reach its conclusion. However, where the default of the broker is so rudimentary and obvious, expert evidence of the practice of brokers will not be necessary, for the failure to take a step which was obviously necessary and prudent will entice the court to reach its own conclusion of negligence.
4. It is especially important that an insurance broker should go through with the assured the list of exceptions in the policy obtained, so as to allow the assured the opportunity to request deletion of a particular exception upon payment of a higher premium or to obtain cover with another insurer.¹⁸
5. The assured must prove that it was a breach by the broker of the duty of care to the assured which caused the loss complained of. Usually this involves the proof that the insurance policy obtained by the broker did not cover the risks that had occurred and that proper care and skill would have ensured that a policy was obtained which did cover those risks.

In Bank of New Zealand v Sedgwick James Ltd¹⁹  it was determined that for a cause of action in negligence to exist, four distinct elements must be shown to be present.

1. A duty of care in the sense of a duty recognised by law requiring conformity to a certain standard of conduct for the protection of others against unreasonable risks
2. A failure to display the standard of care called for by the duty
3. Resultant injury to the plaintiff in the sense that the defendant’s act or omission causes loss to the plaintiff where the relevant interest is one which the law seeks to protect
4. Proximity of the injury, that is, absence of remoteness of damage in the sense that the defendant’s conduct was a proximate cause of the plaintiff’s injury.

The broker’s duty nevertheless must be qualified by the practical availability of insurance cover. Courts will look to the commercial reality of insurance cover available in the market as the definitive test. Brokers must assess the risk that can be insured and then obtain the best cover at the best terms possible. If brokers cannot obtain appropriate insurance, they must advise their clients and seek further instructions.²⁰

Brokers must follow the client’s instructions clearly and depart from those instructions at their peril.²¹ In Mitor,²² Burt CJ stated that the standard of care to be exercised by an insurance broker is “… the standard when viewed objectively by the court, expected of a competent, experienced, well informed broker”.

Brokers should explain the cover provided by the contract of insurance, the limitations of the cover and the policy exclusions and provide the client with the insurer’s original policy document. It is implicit that brokers must have detailed product knowledge of the policy wording and why they have recommended this particular insurer and policy over others.

Elilade Pty Ltd v Nonparell Pty Ltd & CIC Insurance Limited²³ illustrates the duty of insurance brokers to highlight important exclusions in the policy of insurance so that clients are able to make fully informed decisions whether or not to seek coverage for the excluded perils. It is not enough just to provide a schedule of information summarising the cover provided. The decision also puts an obligation on the insured to prove the cover could be obtained.

Insurance brokers’ obligations in respect to renewal of a policy of insurance have been described by Woodward J²⁴ when he said brokers had a duty:

1. To secure the best rates available on the market and the best conditions of insurance contracts.
2. To organise a programme of insurance suitable to the industry in which the plaintiff was engaged and to its peculiar needs.
3. To enquire amongst insurers and obtain the best contract for the client.
4. To arrange appropriate cover and maintain it in force.
5. To attend to the renewal of policies effected by the broker.

Letters of Appointment, Letters of Engagement, Terms of Engagement.

As I have previously mentioned, the best way for clients to avoid litigation with their insurance brokers is to formally agree the responsibilities and duties of the broker by way of express contractual agreement. As it is the broker’s duty to follow the client’s instructions, (subject to a duty to exercise reasonable care and skill in the performance of obligations), it is essential to clearly determine and agree what those instructions are.

The conundrum is that clients often do not have the skills required to give the correct instructions. Insurance brokers use different options to contract with their clients which may be biased in favour of the broker. The contract is often oral, some brokers use a Letter of Engagement; other brokers use the NIBA Letter of Appointment and some brokers have developed various hybrid agreements. The courts will always consider written agreements first. In practice, when entering into a written contract with their clients, insurance brokers generally provide a template document for the clients to sign. The services offered in this template are often at odds with promises advertised on the brokers’ website.

Clients should never assume that insurance brokers will carry out all the functions they expect them to perform; therefore there is a need for express contractual agreement for clients to give instructions to their brokers. Failure to do so will result in clients losing control of the insurance program and exposure to uninsured risk.

In my opinion, the issues to be addressed by a client should focus on the broker’s agreement to perform the following duties:

• broker to always act as agent of the client
• all premiums to be net of commissions and agreed fee for service
• brokers recognition of understanding of the client’s business and risk
• client needs analysis
• risk identification by likelihood and consequence
• risk profiling of insurable and uninsurable risk
• risk management and mitigation strategies
• provide risk retention options
• loss control
• insurance broking (obtain the best available insurance protection of all insurable risks in terms of cover, price and security, on a sustainable basis)
• ensure client is perceived by quality insurers as a desirable risk
• claims management
• claims reporting and statistics
• business continuity
• crisis management
• agreed service plan
• provision of original documentation
• monitor insurer security
• details of broker’s professional indemnity insurance policy
• conflict of interest policy
• dispute resolution process
• disclosure of any affiliation with any insurer.

Financial Services Reform Act²⁵ (FSRA)

The FSRA repealed the Insurance (Agents and Brokers) Act 1984 (Cth) and amended the Insurance Act 1973(Cth), the Life Insurance Act 1995 (Cth) and the Insurance Contracts Act 1994 (Cth). The FSRA introduced a regime consisting of three key fundamentals:

• product disclosure
• licensing of financial markets and clearing and settlement facilities,
• licensing and conduct of financial service providers.

It is licensing and conduct that is of particular interest to the insurance industry and insurance brokers specifically. This single licensing regime was intended to provide investors with consistent consumer protection, irrespective of the source of the financial service, and to maintain the standards of conduct and disclosure requirements of financial service providers.

The Act applies to all persons, especially financial intermediaries, who provide a “financial service”, whether as principals or as authorised representatives. Financial intermediaries include securities dealers, investment advisers, futures advisers and brokers, general and life insurance brokers and futures exchange dealers.

“Financial service” is definedwithin the FSRA to encompass sales, advice, dealing in or making a market in “financial products”, operating a managed investment scheme or providing a custodial or depository service.

Critical to the FSRA is the definition of “financial product”, which incorporates insurance products. An Australian Financial Services Licence (“AFSL”) is required by those providing financial services to either wholesale or retail clients. Retail clients include those who seek or are offered one of the following types of insurance policies: motor vehicle; home/building; home contents; sickness and/or accident; consumer credit; travel insurance or personal and domestic property insurance.

Wholesale clients include those who seek or are offered any other type of general insurance policy not already included in the above list. It is through the AFSL that ASIC regulates licensees to ensure they are appropriately skilled, have adequate financial resources (including professional indemnity insurance) and compliance systems which incorporate dispute resolution facilities and procedures.

As AFS licensees, insurance brokers are now governed by Chapter 7 of the Corporations Act 2001.

Summary

Insurance brokers have a duty to exercise reasonable care and skill in obtaining the cover requested by their clients. That duty extends to making reasonable enquiries so that brokers can fully understand the risks and arrange effective and appropriate cover. There is an obligation not to delay in arranging insurance cover.

There is a duty to arrange insurance suitable to the client’s needs and if such insurance cannot be obtained, brokers must promptly advise the client and seek further instructions. There is a duty for brokers to advise their clients of exclusions and limitations in the insurance policy.

To “win the battle before it is fought”. and mitigate risk of litigation with the broker, always ensure that insurance brokers’ duties and responsibilities are formally agreed contractually. When choosing a broker, a client should be satisfied that the broker is credible and reliable, and has the technical ability, market knowledge and resources to deliver on promises.

The client should be confident that the broker has a complete understanding of the business. The most effective risk financing strategy can only be achieved by a process of profiling risk and identifying risk by likelihood and consequence.

All insurance brokers are not the same. Clients should avoid using expense reduction consultants who may simply focus on the cheapest premium rather than the right insurance protection.

Notes

1. Fanhaven Pty Ltd v Bain Dawes Northern Pty Ltd [1982] 2 NSWLR 57 (CA)
2. Caparo Industries Plc v Dickman [1990] 2 AC 605 at 619.
3. Hedley Byrne & Co Ltd. V Heller and Partners Ltd [1963 HKHL 4; (1964) AC 465 at 502 – 503.
4. Cherry Ltd v Allied Insurance (1978) 1 Lloyds Rep at 280
5. The Australian / New Zealand Standard on risk management (AS / NZS 4360)
6. Claude R Ogden & Co Pty Ltd v Reliance Fire Sprinkler Co Pty Ltd & Ors (1973) 2 NSWLR 7 at p 30.
7. With apologies to former U.S.A. Secretary of Defence Donald Rumsfeld.
8. The image: A guide to PseudoEvents in America (1961)
9. The Insurance Contracts Amendment Bill 2010.
10. Insurance Contracts Act 1984 s 21, s 21A.
11. Unity Insurance Brokers Pty Ltd v Rocco Pezzano Pty Ltd [1998] HCA 38; 192 CLR 603; 154 ALR 361; 72 ALJR 937 (20 May 1998).
12. Permanent Trustee Australia Limited v FAI General Insurance Company Limited (in liquidation) [2003] HCA 25, (8 May 2003).
13. Claude R Ogden & Co Pty Ltd v Reliance Fire Sprinkler Co Pty Ltd & Ors (1973) 2 NSWLR 7
14. (1991) 6 ANZ CAS 61 – 066 (CA NSW).
15. Fanhaven Pty Ltd v Bain Dawes Northern Pty Ltd [1982] 2 NSWLR 57 (CA).
16. Brickhill v Cooke [1984] 3 NSWLR 396 (CA).
17. Geoffrey W Hill & Associates (Insurance Brokers) Pty Ltd v Squash Centre (Allawah North) Pty Ltd (1990) 6 ANZ Ins Cas 61 – 012 (CA NSW).
18. McNealy v Pennine Insurance Co. Ltd [1978] 2 Lloyds Rep 18 at 20 (CA)
19. (1995) 8 ANZ Ins Cas 61 – 280 (HCNZ) at 76,097.
20. Eagle Star Insurance Co. Ltd v National Westminster Finance Australia Ltd (1985) 58 ALR 165 (PC).
21. Mitor Investments Pty Ltd v General Accident Fire & Life Insurance Corp Ltd [1984] WAR 365.
22. Ibid.
23. [2002] FCA 909.
24. Pennant Hills Restaurants Pty Ltd v Barrell Insurances Pty Ltd (unreported NSWC (1977)
25. Financial Services Reform Act 2001